Tag Archive for: ECB

EU Budget – the effects of fiscal policy

| 20-02-2018 | treasuryXL |

Every year the EU raises money by applying a levy on member states that represents a percentage of their Gross National Income (GNI). The EU Budget operates on a 7 year plan and then an annual budget is proposed and agreed. The EU strives to use 94% of expenditure on policies and 6% on administrative costs. As with all budgets, there are 2 sides – income and expenditure. There are 4 main sources of income – traditional own resources, VAT (BTW) based resources, GNI based resources, and other resources. There are 6 main sources of expenditure – growth, natural resources, security and citizenship, foreign policy, administration, and compensations.

Furthermore, there are a number of correction mechanisms designed to rebalance excessive contributions by certain member states, including – the UK rebate, lump sum payments, and reduced VAT (BTW) call rates. On the expenditure side, Growth and natural resources – which include the common agricultural and fisheries policies – account for more than 90% of expenditure. Every country within the EU makes contributions and receives expenditure within their state from the EU. The difference represents the net contribution per country per year.

When a country pays a net contribution, the excess funds are redistributed within the EU to other member states. This payment to other member states is a fiscal transfer. Information relating to the sum of fiscal transfers used in this blog were sourced at – www.money-go-round.eu

This website shows gross payments, gross receipts and net balance per country per year from 1976. The top 5 net payers since 1976 have been Germany, France, the united Kingdom, Italy and the Netherlands. These 5 countries have contributed a net balance of EUR 925 billion. Conversely, the top 5 net receivers since 1976 have been Greece, Spain, Poland, Portugal and Ireland. These 5 countries have received a net balance of EUR 410 billion. This is a redistribution of both income and wealth.

Classically, the objectives of redistribution of incomes are to increase economic stability and opportunity for the less wealthy members of society. This should lead to a society where financial wealth is more evenly divided, increasing the standard of living among the poorer members. Without this mechanism, there is more risk of economic crises and less harmony between citizens of different social classes. One of the main questions has always been how long and beneficial this transfer should be. There is a danger that some people become permanently dependent on the transfer and do not actually improve their own living standards – they are seen to consume more, but not to improve their standard of living.

So how does it look within the EU?

The country that has received the most from fiscal transfers has been Greece. They ascended to the EU (in its previous incarnation) in 1981. They have been a net receiver of the EU budget for every year since 1981. In total, they have received EUR 118 billion in transfers. What Greece ever did with all this money is the subject of many articles – but it does not appear that the money was used to raise the living standards of the poor or invest in the infrastructure of Greece.

And therein lies the major problem for the EU – the mechanism used for redistribution has had no long term beneficial effect on the economy. There is no system of checks and balances to control what is done with the money. The ECB published a report at the start of 2017 about household finance and consumption in the EU. Its findings were that disparity was growing within the EU. Other reports have highlighted that whilst eastern Europe has seen large rises in GDP per capita growth, this added wealth has not been distributed evenly among all residents.

The ideals of the EU are worthy and noble – their implementation and management however, are not creating the society that they dreamt and spoke about.

Next – can fiscal union work?

 

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Are public debts sustainable?

| 19-02-2018 | treasuryXL |

A few weeks ago the EU Commission released a report on debt sustainability within the EU. It provides an overview of the challenges faced by member countries over the short, medium and long term to meet the original convergence criteria – specifically, that existing Government debt is less than 60% of GDP. As with most Government related documents it is long – over 250 pages. A lot of attention is drawn to the Debt Sustainability Monitor (DSM) and the challenges faced to achieve the abovementioned criteria by 2032.

Any forecast is open to different interpretations, especially one that looks 15 years into the future. At the end of 2017, 15 of the 28 countries within the EU (in other words more than 50%) have Government debt that exceeded 60% of GDP. The average ratio for all 28 countries – on the basis of the sum of all Government debt and all GDP – is 83%. Let us focus on those 15 countries who, currently, do not meet the criteria. The figures for this article have been taken from the following website – debtclocks.eu

 

 

 

 

 

 

 

 

 

 

This shows the countries – ranked by the current Debt to GDP ratios – from high to low. 3 countries have been highlighted in yellow as their figures have been originally shown in their own currencies. For the sake of comparison these figures have been converted into EUR.

Assumptions

  • The current debt will remain constant for the next 15 years. Debt that falls due for redemption is rolled over – no new additional debt is assumed.
  • The criteria in 2032 is that the debt is 60% of the GDP at the end of 2032
  • The current debt is assumed to be 60% of the GDP at the end of 2032
  • Projected GDP at the end of 2032 is adjusted so that it is a factor of 1.67 larger than the debt
  • A constant annual growth rate is determined whereby the existing GDP at the end of 2017 will constantly grow to equal the expected GDP at the end of 2032.

Results

The top 7 countries have debt ratios around 100% or higher of GDP at the end of 2017. The constant annual growth rates that they would have to achieve under the scenario shown above are all greater than 3% per annum.

Annual growth rate since 1996 for the EU have averaged 1.7% – before the financial crisis there was an annual growth of 2.5%. For the last 10 years since the crisis, the average annual growth rate within the whole EU is just 0.8%. Even in 2017, the growth was just 2.5% – back at the same level as before the crisis. The data for this part came from tradingeconomics.com

It would be appear to be presumptuous to expect future annual GDP growth to consistently exceed the current long term trend. Of course this is a scenario relying on only 1 factor – namely growth in GDP to meet the 60% criteria – whilst ignoring any other possible factors.

Conclusion

As constant growth, as shown above is, not realistic, then other factors will have to come into play if the long term scenario relating to debt criteria is to be achieved. If not through growth, then either through increases in Government receipts (more taxes or selling of national assets) or decreases in Government expenditure (less subsidies, pensions, smaller investments).

Or……………..through fiscal union leading to transfers from the “richer” countries.
Next we will look at the history of fiscal transfer within the EU.

If you want more information please feel free to contact us via email  [email protected]

 

Forward Rate Agreement (FRA)

| 05-01-2018| Arnoud Doornbos |

Money Market outlook

At the press conference on 14 December 2017, the ECB announced that expectations for economic growth and inflation have been adjusted upwards. But despite optimistic growth, the ECB is not yet fully convinced of a continued upward trend in domestic price pressures. And thus Draghi: “An ample degree of monetary stimulus … is necessary for underlying inflation pressures to continue to build up.”

For this reason, the ECB will maintain the buying program at least until September 2018. And only then will an increase in policy rates come into the picture. Since the beginning of 2017, investors have seen the chance that the ECB will implement an increase in policy interest rates. This has not yet had an effect on the three-month Euribor rate. This has been stable at around -0.3% for the whole of 2017, and we expect that this will be the case in the vast majority of 2018 as well.

But markets will go up again for sure during time and borrowers need to prepare themselves for that moment. A good interest rate risk management can help to extent the pleasure of using favorable low interest rates for your company. Hedging your short term interest rate exposure with FRA’s could be a good idea. Good timing is essential.

 

 

Definition

A Forward Rate Agreement’s (FRA’s) effective description is a cash for difference derivative contract, between two parties, benchmarked against an interest rate index. That index is commonly an interbank offered rate (-IBOR) of specific tenor in different currencies, for example LIBOR in USD, GBP, EURIBOR in EUR or STIBOR in SEK. A FRA between two counterparties requires a fixed rate, notional amount, chosen interest rate index tenor and date to be completely specified.

FRAs are not loans, and do not constitute agreements to loan any amount of money on an unsecured basis to another party at any pre-agreed rate. Their nature as a IRD product creates only the effect of leverage and the ability to speculate, or hedge, interest rate risk exposure.

 

 

 

How it works

Many banks and large corporations will use FRAs to hedge future interest or exchange rate exposure. The buyer hedges against the risk of rising interest rates, while the seller hedges against the risk of falling interest rates. Other parties that use Forward Rate Agreements are speculators purely looking to make bets on future directional changes in interest rates.

In other words, a forward rate agreement (FRA) is a tailor-made, over-the-counter financial futures contract on short-term deposits. A FRA transaction is a contract between two parties to exchange payments on a deposit, called the Notional amount, to be determined on the basis of a short-term interest rate, referred to as the Reference rate, over a predetermined time period at a future date.

At maturity, no funds exchange hands; rather, the difference between the contracted interest rate and the market rate is exchanged. The buyer of the contract is paid if the published reference rate is above the fixed, contracted rate, and the buyer pays to the seller if the published reference rate is below the fixed, contracted rate. A company that seeks to hedge against a possible increase in interest rates would purchase FRAs, whereas a company that seeks an interest hedge against a possible decline of the rates would sell FRAs.

 

Valuation and Pricing

 The cash for difference value on a FRA, exchanged between the two parties, calculated from the perspective of having sold a FRA (which imitates receiving the fixed rate) is calculated as:

where N is the notional of the contract, R is the fixed rate, r is the published -IBOR fixing rate and d is the decimalized day count fraction over which the value start and end dates of the -IBOR rate extend.

For USD and EUR this follows an ACT/360 convention and GBP follows an ACT/365 convention. The cash amount is paid on the value start date applicable to the interest rate index (depending in which currency the FRA is traded, this is either immediately after or within two business days of the published -IBOR fixing rate).

For mark-to-market (MTM) purposes the net present value (PV) of an FRA can be determined by discounting the expected cash difference, for a forecast value r:

where vn is the discount factor of the payment date upon which the cash for difference is physically settled, which, in modern pricing theory, will be dependent upon which discount curve to apply based on the credit support annex (CSA) of the derivative contract.

Quotation and Market-Making

 FRA Descriptive Notation and Interpretation

 

How to interpret a quote for FRA?

[EUR 3×6  -0.321 / -0.301%p.a ] – means deposit interest starting 3 months from now for 3 month is -0.321% and borrowing interest rate starting 3 months from now for 3 month is -0.301%. Entering a “payer FRA” means paying the fixed rate (-0.321% p.a.) and receiving a floating 3-month rate, while entering a “receiver FRA” means paying the same floating rate and receiving a fixed rate (-0.321% p.a.).

Due to the current negative Money Market rates means receiving actually paying and the other way around.

 

 

 

 

 

 

Arnoud Doornbos 

Interim Treasury & Finance

 

 

E-learning Banken en Financiële Markten in Vogelvlucht @ Financial Training Hub [ontvang korting via treasuryXL]

Ontvang via treasuryXL korting op deze e-learning en/of de e-learning MiFID II/ MiFIR.
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Uitgelicht: ECB strenger voor fintechbanken

| 31-10-2017 | Peter Schuitmaker |

 

Recentelijk lazen we een artikel over de verhoogde toezicht dat de ECB wil toepassen op Fintech-partijen die bancaire diensten aanbieden. (bron: FD ) De ECB schrijft in zijn eerder uitgebrachte gids Guide to assessments of fintech credit institution licence applications dat fintechs zorgen voor unieke risico’s in het financiële systeem. De ECB zegt “Fintechbanken moeten aan dezelfde standaarden voldoen als andere banken.” treasuryXL vroeg een van onze experts, Peter Schuitmaker, om zijn mening:

Is er een fintechzeepbel?

Peter Schuitmaker – Registered Advisor for Business Transfer and Succession

Door de opkomst van ICT, met name de mobiele platforms (telefoons en tablets) en de gebruikte software (apps) is de bancaire dienstverlening ook in een innovatieve stroomversnelling gegaan. Waar traditionele banken de nieuwe ICT gebruiken om hun diensten te vereenvoudigen en te verbeteren, deels ook om operationele kosten te drukken, zijn een groot aantal fintech bedrijven die juist -denkend vanuit de ICT technologie- producten en diensten aanbieden. Het zijn vaak niche producten of een producten met een beperkte functionaliteit die juist wel aansluit bij een zekere doelgroep.

De ECB heeft dat geconstateerd en wil op die fintech dienstverlening enige grip krijgen. Dat lijkt vrijwel onbegonnen werk, omdat het aanbod, zowel de functionaliteit als de onderliggende ICT, zeer divers is. Hoe dan ook, geen richtlijnen waarbinnen fintech bedrijven zich op de markt mogen begeven en ontwikkelen, lijkt ook geen optie. Vandaar deze eerste voorzichtige poging “Guide to assessement of fintech credit institutions”. De motivatie is nobel: men wel gelijke monniken, gelijke kappen. Maar hoe zaken zich zullen ontwikkelen en binnen welke termijn aanvullende of nieuwe richtlijnen nodig is laat zich lastig voorspellen. Maar erg optimistisch daarover ben ik niet!

 

Peter Schuitmaker

Registered Advisor for Business Transfer and Succession

 

 

Will the ECB taper off its Quantitative Easing programme?

| 23-10-2017 | Lionel Pavey |

On the 26th October the ECB will have their next meeting. One of the main topics will be regarding the current QE programme and a possible announcement over its extension into 2018. Currently the ECB has, after 2 ½ years of QE, purchased more than EUR 2 trillion of mainly Government bonds. At present their monthly purchases amount to roughly EUR 60 billion per month.

A poll organized by Reuters would seem to indicate that the monthly programme would be tapered down to EUR 30-50 billion per month and possibly last for another 6 to 12 months from the start of 2018. Inflation is expected to be around 1.5 per cent till at least the start of 2019 – below the ECB target of just below 2 per cent.

However, under the current rules that govern the QE progamme the upper limit on outstanding purchases is around EUR 2.5 trillion. Taking the existing monthly purchases through to the end of 2017, implies starting 2018 with a balance of at least EUR 2.2 trillion – leaving just EUR 300 billion of headroom for future purchases. If it cut monthly purchases in half, the scheme could be extend to the end of the 3rd quarter in 2018, but no further.

Can the ECB continue QE longer than expected?

The constraints imposed on QE mainly relate to the purchase of Government bonds – maximum 33 per cent of each countries outstanding debt and maximum 25 per cent of any bond issue. The provisions written into the Maastricht Treaty clearly state that the ECB may not finance member states. QE also purchases non-bank bonds (covered bonds, corporate bonds and asset backed securities) which are subject to different criteria – maximum of 70 per cent of any bond issue.
At present, the ECB only holds about 13 per cent of the eligible bonds leaving a large headroom for future possible purchases.

It is conceivable that the ECB could reduce its purchase of Government bonds and simultaneously increase its purchase of corporate bonds, thereby maintaining liquidity to its QE programme. The major drawback is that it would reduce the amount of freely tradable corporate bonds in circulation and have an effect on their price.

What does this mean for interest rates?

As long term debt instruments use Government bond yields as the basis for calculating their yield, when the ECB stops buying Government bonds, the yields on all other debt instruments will increase. At the moment the benchmark (German 10 year Government bonds) yield around 0.4 per cent per annum and the 10 year Interest Rate Swap yields around 0.9 per cent per annum. In 2014 (the year before QE started) German yields averaged 1.25 per cent even though they were in a downward trend the whole year. Assuming the yield spread between Government bonds and Interest Rate Swaps (IRS) remained constant, this implies 10 year IRS moving to at least 1.75 per cent. This would still be below the long term average since the inception of the EURO in 1999 that stands around 3.35 per cent, but a significant increase from the current level of 0.9 per cent.

What happens when the next crisis arrives?

The ECB is not the only central bank to use a form of QE. The Fed, Bank of England and Bank of Japan all have their own versions. When these countries also taper out their QE, naturally there will be a corresponding rise in interest rates. However, if a new financial crisis was suddenly to happen (not unthinkable at the moment) all 3 of these central banks can reapply QE to stimulate their economies. An additional increase to their balance sheets can be accommodated.

Unfortunately for the ECB the very criteria that now applies would make it impossible to restart QE. The ECB could not just increase its balance sheet – current criteria and regulation make that impossible. Any attempt to change the rules would be met by objections from national governments within the EU and legal action. The Bundesbank were very vocal in their objections to the implementation of QE in 2015 – those protests will not have softened by now.

This shows the constraints prevalent upon the EURO – monetary policy is the only tool that the ECB has at its disposal. One policy can not be used to fix all the problems present with the economies of all member states.

 

 

Lionel Pavey

Cash Management and Treasury Specialist

 

Blockchain and Central banks: a Tour de Table (Part II)

| 2-2-2017 | Carlo de Meijer | treasuryXL |

We found this article of our expert Carlo de Meijer and wanted to share it with you. This is the second part of this article, after Part I,  and a slightly shorter version than the original.
A year ago central banks were looking at the blockchain technology, mostly because they wanted to understand what private banks were talking about. The central banks are now embracing the blockchain technology to revamp their own infrastructures. Major central banks worldwide have spent the past year organising their own working groups dedicated to exploring blockchain technology and digital currencies. They thereby try to work out answers to the big questions: how would turning its cash digital affect the economy and financial stability? And determine whether the technology would be robust enough to stand up to hackers.

Central banks and blockchain experiments

Central banks are now even experimenting with digital currencies. A growing number  have made public their efforts in the digital currency and blockchain spaces. Several – and really the most enthusiastic – central banks, including the Bank of England, the Banque de France, the People’s Bank of China, the Bank of Canada, the Central bank of Russia, the Dutch central bank, and the Federal Reserve in the US, are exploring the concept of issuing their own blockchain-based digital currency. Countries like Barbados,  Senegal and Tunisia even introduced their block-chain-based digital currency. Other central banks have expressed stated their intent to develop interbank payment systems based on a blockchain. The European Central Bank recently announced a new research undertaking in partnership with the Bank of Japan. And last month the US Federal Reserve released its first major research paper on blockchain.

Tour de Table

What are all those various central banks doing. In an alphabetical order we will investigate the various initiatives.

Argentina
The Argentinian government and Central Bank authorities are focusing on finding innovative solutions. They have asked the blockchain community to join efforts to “eradicate financial exclusion, transfer the financial industry, promote financial opportunities and reduce inflation”.

The Central Bank of Argentina in narrow cooperation with the Ministry of Production and the Innovative Ministry organised the “Financial Innovation Hackathon” in November last year. On the first day of the hackathon, central bank vice president, Lucas Llach, talked about how blockchain could be a source of innovation in the financial industry. Though Mr. Llach said that its focus now is to work on improving new payment methods, he however added:

Australia
The blockchain issue is also on the radar of the Reserve Bank of Australia. Its head of payments, Tony Richards, said in February last year the RBA “has not reached a stage where it is actively considering this but in the more distant future it is even possible that we may see a digital version of the Australian dollar”. In a recently published paper the RBA however expressed a reserved view on the role blockchain and distributed ledger technology may play in the equity market in the short and medium term. The RBA paper highlights challenges associated with the transition to a new market blockchain-based structure including risks and technical challenges.

Barbados
In a sense, money issue on a blockchain is already happening on the island of Barbados. Early last year tech startup Bitt launched a blockchain-backed Barbadian Dollar, with the support of the country’s Central Bank. The Barbados central bank approved issuance of digital representations of the Barbadian dollar, each equalling a dollar issued by the Central Bank of Barbados, using blockchain. The approved platform, operated by tech startup Bitt, allows users to transact with each other. The ultimate goal is to digitize all the different fiat currencies of the Caribbean region in the hopes of providing the citizens a service that enables them to instantly send money anywhere.

Canada
The Central Bank of Canada last year teamed up with the country’s five largest banks and the R3CEV banking-backed consortium for the “Project Jasper” to create a blockchain enabled currency. In a simulation run last summer, the central bank issued so-called CAD-Coins on to a Ethereum blockchain platform. The banks used the CAD-Coins to exchange (fictional) money in the same way they normally do at the end of each day to settle their master accounts. A great deal of testing however is still necessary before the Bank of Canada can decide whether distributed ledger technology is “ready for the real world”.

China
China’s central bank is looking to recruit blockchain experts to study the technical architecture of digital currencies. The central bank has been working to create and issue a digital currency for years in order to replace cash, the bank’s governor, Zhou Xiaochuan, has said previously. Blockchain technology is among the systems it has examined, such as a series of other digital ledgers that can be reconciled efficiently. The central bank would still retain control over the country’s money supply. A timetable for the launch of China’s sovereign digital currency has not been announced, as of yet.

Denmark
The central bank of Denmark plans to issue blockchain-based E-krone as its reserve currency. The central bank says “blockchain technology, or a variety of that, for example” would be an obvious model to use for virtual currency. Governor Lars Rohde says pros include lower transaction costs. Using such a virtual currency would also make crime harder and improve financial oversight. But when it comes to the societal implications of switching to such a model, Rohde says the Danish central bank still has “more questions than answers.”

Europe
The European Central Bank and Bank of Japan agreed to launch a joint research project to study potential use cases of blockchain technology for market infrastructure. This initiative comes after the ECB revealed that “it is open to taking a closer look at exploring the potential for blockchain technology as a means to further innovation among central banks around Europe”. The bank is “toying with the idea” of tapping distributed ledger technology, among other options, for its renovation of the Target2 real-time gross settlement system and Target2-Securities platform. If this is to happen, more research into the technology is needed, prompting a collaboration with the Bank of Japan which will see findings released next year.

Finland
Also the Bank of Finland joined the growing list of worldwide central banks interested in blockchain technology. Finland’s central bank, collaborating with the Ministry of Finance, held a seminar in November, aimed to discuss “blockchain technology’s risk and rewards in order to forward innovation in the country’s economy”. They thereby  gathered together with the country’s leading researchers from universities, think-tanks, and various industries, to discuss the possibilities offered by distributed ledgers.

 

France
The Banque de France, the country’s central bank, has revealed details about a blockchain experiment for the identification process within the Single Euro Payments Area (SEPA). As well as security reinforcement, this experiment aims at exploring possible consequences of decentralised ledger management functions of SEPA Credit Identifier. The first testing was carried out in July last year in cooperation with the IT-startup Labo Blockchain, a group of French banks, and Deposits and Consignment Fund (Caisse des Dépôts et Consignations). For the experiment, the bank provided the participants with necessary software elements to be installed in external clouds or in their trial IT systems. The central bank stated that a “comprehensive assessment” will be carried out in the coming months to understand the results of the experiment. During January 2017, more details of the experiment will be revealed at a conference organized by the French Payments Committee in Paris.

Germany
The Bundesbank, jointly with Deutsche Börse, is testing the functional prototype of a blockchain-based system for the trading and settlement of securities. Designed to provide the technical functionality for the settlement of securities in delivery-versus-payment mode for centrally-issued digital coins and the pure transfer of either digital coins or digital securities alone, the two institutions plan to develop the prototype further over the next months so that they can analyze the technical performance and the scalability of this kind of Blockchain-based application.
Some of the features of the prototype presented include its capability to be used for blockchain-based payments and securities transfers and the settlement of securities transactions against both instant and delayed payment; and its ability to maintain confidentiality/access rights in blockchain-based concepts on the basis of a flexible and adaptable rights framework. It can also enable the general observance of existing regulatory requirements; identify potential to simplify reconciliation processes and regulatory reporting; and implement a concept based on a blockchain from the Hyperledger Project. It is also capable of settling basic corporate actions such as coupon payments on securities and the redemption of maturing securities.

Hong Kong
Hong Kong’s de-facto central bank, the Hong Kong Monetary Authority (HKMA) intends to launch an innovation hub that will test blockchain and distributed ledger solutions. The HKMA has begun work on the initiative with the Hong Kong Applied Science and Technology Research Institute (ASTRI), an initiative founded by the government to enhance its competitiveness in technology.

The Hong Kong Monetary Authority (HKMA) recently has published a new white paper on distributed ledger tech. The HKMA produced the paper in partnership with ASTRI. The white paper release is only the first step in a wider process, HKMA chief executive Norman Chan said the government is planning further research. And ASTRI is looking to publish a follow-up paper sometime in the middle of next year, building on its past findings and exploring “whether some of this work can be put into action”.

India
The Institute for Development and Research in Banking Technology (IDRBT) established by the Reserve Bank of India – India’s central bank – recently explored blockchain applicability to the Indian banking and financial industry by conducting a workshop with bankers, academicians, regulators and technology partners. The participants produced a White Paper detailing the areas of adoption in the financial sector in India. The Institute also attempted a proof-of-concept on applying blockchain technology to trade finance with the participation of banks, National Payments Corporation of India and a solution provider.

Japan
The Bank of Japan – the county’s central bank – is showing increased interest in blockchain and distributed ledger technology. Accordingly, the staff in the Payment and Settlement Systems Department of the Bank are deepening their understanding of new technologies by test-driving distributed ledgers. These trails by the bank’s staff simply aim to understand the mechanics of DLT, rather than (already) applying it to the Bank’s own liabilities or its payment and settlement systems. Considering the Japanese government and the central bank’s optimism towards the blockchain technology, it is highly likely that they will lead various projects to help banks integrate blockchain platforms in their existing systems.

Netherlands
The Dutch Central Bank (DNB) is exploring blockchain technology as a way to create a permanent digital replacement of cash. The DNB set up a successful three-months trial to run an experimental virtual currency derived from blockchain software, DNBCoin, but nick-named Dukatons (after a 17th century silver coin used in the Netherlands). This DNBCoin could end up being the digital currency issued by the Dutch central bank. Most of the details regarding this project however remain still unknown for the time being.
The Dutch Central Bank has also revealed plans to prepare an experiment aimed at assessing if an entire financial market infrastructure (FMI) can be built on a blockchain, that is much more difficult to hack. The experiment envisions how an FMI’s internal operations could be distributed among participating nodes. To hack and disturb the market infrastructure an attacker would need to gain more than half the computing power running the nodes.

Nigeria
Concerned about the rapid growth of blockchain experiments all over the world, Nigeria’s Deputy Governor of the Central Bank of Nigeria has “sounded the alarm” for relevant agencies to begin to take the disruptive technology more seriously. Speaking at an event organized by the Nigeria Electronic Fraud Forum (NeFF), Deputy Governor Adebayo Adelabu described the “blockchain revolution as a “swim or sink” situation. He noted the need for regulators and operators in the Nigerian financial system to be well informed and not left out in the blockchain technology.
For that reason the Central Bank of Nigeria (CBN) and the Nigeria Deposit Insurance Corporation (NDIC) have instituted a joint committee to look into the effects of the crypto currency and other blockchain technology and its effect on the Nigerian economy.

Russia
In February last year the Bank of Russia – the Russian central bank – established a ‘working group’ to study blockchain technology, in an effort to understand and look for the viability of its real-world applications in the Russian financial market. By April, a report revealed that the Central Bank was considering allowing banks to record and store data of all their transactions on a blockchain. And in July 2016, the Bank of Russia set up a consortium of banks that counted as Russia’s first blockchain consortium.
The Bank of Russia has developed and tested on an Ethereum-based blockchain prototype called ‘Masterchain’ for financial messaging, to be used by banks in Russia.A number of country’s largest banks and financial institutions took part in developing the Masterchain prototype, including Sberbank, Alfa Bank, Bank Otkritie, Tinkoff Bank, and Qiwi. The ‘Masterchain’, as explained by the central bank, is ‘a networking tool’ for participating members using blockchain technology. The platform enables for “prompt confirmation of data actuality” to a transacting customer. The innovation also makes instant communication possible between counterparties among the platform, while assuring confidence in financial transactions.

Senegal
Senegal has recently become the third country in the world (next to Barbados and Tunisia) to introduce a digital currency based on blockchain technology. Named eCFA, the digital currency will be legal tender and is to circulate alongside the current fiat currency, CFA Franc, is. Senegal’s eCFA comes from a partnership by Banque Régionale de Marchés (BRM) and eCurrency Mint Limited, where BRM will issue the digital tender currency, the eCFA, in compliance with e-money regulations of the Banque Centrale des Etats de l’Afrique de l’Ouest (BCEAO), the Central Bank of the West African Economic and Monetary Union (WAEMU). While the eCFA will use the blockchain to keep track of transactions, it will be issued and regulated solely by the central bank, but confer the benefits of transparency and cryptography to prevent counterfeiting and fake transactions. After Senegal, WAEMU will introduce the eCFA in Cote d’Ivoire, Benin, Burkina Faso, Mali, Niger, Togo and Guinea-Bissau.

Singapore
The Monetary Authority of Singapore (MAS), the country’s central bank, and the Singapore stock exchange are to launch a pilot project called Utility Settlement Coin with eight local and foreign banks to test the use of blockchain technology for interbank payments. Singapore’s DBS Group, HSBC, Bank of America, JPMorgan, Credit Suisse, and Bank of Tokyo-Mitsubishi UFJ are all working with MAS on the program with support from the global banking consortium R3CEV. R3 blockchain research lab and BCS Information Systems will support the project.

Under the pilot system participating banks will be able to pay each other directly with this digital currency instead of first sending payment instructions through MAS, and banks will be able to later redeem the digital currency for cash. Banks will thereby deposit cash as collateral with the MAS in exchange for digital currency issued by the central bank.
Eventually, the project could result in a payment system for participants to transact in different global markets round-the-clock that are today limited by time zone differences and office hours. Participating banks The next phase of the project will involve transactions in foreign currency, possibly with the support of another central bank.

South Africa
The central bank of South Africa is also looking into the applicability of the blockchain technology in the industry of finance. The Reserve Bank of South Africa’s governor, Lesteja Kganyago, publicly expressed the organization’s “openness” towards blockchain technologies and their intent to help startups come up with innovative solutions using the technology.
The central bank is particularly concerned with the technological and security-related issues blockchain platforms may present. Both the government and central bank of South Africa agree that the blockchain technology and cryptocurrencies need further guidance and assessment from the government before it can be offered to organizations in the public sector.

South Korea
The Bank of Korea has published a report titled “Present Status and Key Issues of Distributed Ledger Technology” detailing policy issues which could hinder the growth of distributed ledgers and also estimates the cost-cutting effect of the application of the blockchain technology. The report mentions that blockchain implementation could save the bank about KRW 107.7 billion (16% of its total costs).
The Bank of Korea is considering implementing a supernode to help mitigate privacy concerns, should it seek to adopt distributed ledger technology. Furthermore, the report recommends implementing the technology for major settlement services such as the BoK wire+ (Bank of Korea settlement system). Addressing privacy issues, according to the report, would require PKI based Key Exchange, Supernode (Central Manager) – who will have access to transaction information along with the trading partner, and Confidential Transactions which will be applicable to distributed systems and maintain anonymity and make deals with parties to access deal information.

Sweden
Riksbanken, Sweden’s central bank, is also thinking about using the blockchain to issue digital money.
The plans to issue an “eKrona”, a blockchain-based digital version of the Swedish Krona, was recently disclosed by the deputy governor of the Riksbank Mrs. Cecilia Skingsley. It is however still in discussions whether digital currencies should complement notes and coins, or replace them. The Riksbank currently is “in the early stages of exploring the idea and is launching a project to explore various possibilities.” Right now it is too early to hope for a quick introduction of the eKrona. Several issues – like traceability, interest, and delivery – have to be examined. Also, the Riksbank does not know which technology it will use to build the eKrona at present. The blockchain is one of the several technologies the Riksbank will look at.

Switzerland
At the kick off at the SIBOS conference last October in Geneva, the president and chairman of the board of Switzerland’s central bank Mr. Jordan described a financial system “turned on its head” by blockchain and distributed ledgers.
“Such systems could render the reconciliation of transactions and balance data between banks and the third-party system obsolete. The paradigm seems to have been turned on its head. Decentralization, not centralization, now appears to promise the greatest efficiency gains.” Jordan said the Swiss National Bank is now in discussions with market participants, regulators and other central banks about what to do next.

Tunisia
Tunisia is one of the early adopters of a blockchain-based digital currency. Late 2015, Tunisia had over half a million people using its digital currency, eDinar. The country’s post office, La Poste Tunisienne, then announced it would partner with Monetas and DigitUs to integrate the country’s digital currency with blockchain technology. This digital currency is issued solely by the Tunisian central bank.

Ukraine
Ukraine is now also exploring the potentials of an electronic money concept. As part of the nation’s Cashless Economy project, the National Bank of Ukraine (NBU) is to issue a blockchain-based digital version of the Hryvnia by next year. At first the currency will circulate alongside its physical version.

United Kingdom
Within the Bank of England, a team is already considering what a central bank-issued digital currency could mean. They have worked with PwC’s blockchain team in Belfast to help them develop a Proof of Concept and explore blockchain.
The Bank of England has released a significant Blockchain paper “Macroeconomics of central bank issued digital currencies,” which discusses the macro-economic consequences of a central bank making a digital form of cash available to the general public. In the model, digital cash is created only when the central bank purchases bonds from households or investors. This central bank digital currency, implemented via distributed ledgers, would compete with bank deposits as medium of exchange. However, banks would still be able to create money.
The model suggests that the introduction of digital cash would have some key benefits: it could boost GDP by around 3%, due to “reductions in real interest rates, in distortionary tax rates, and in monetary transaction costs”, it could give the central bank (via countercyclical CBDC price or quantitative rules) a second monetary policy tool to stabilise the economy; and, it could improve financial stability.

United States
The Federal Reserve is also taking a much closer interest in blockchain and what it can offer to the financial sector. The Federal Reserve released a report on Distributed Ledger Technology (DLT) or blockchain early December last year. The document reviews the potential and challenges for the new technology to disrupt and benefit financial services.

The Fed believes utilisation of DLT will become clearer as the technology matures. They further state:
“The driving force behind efforts to develop and deploy DLT … is an expectation that the technology could reduce or even eliminate operational and financial inefficiencies, or other frictions, that exist for current methods of storing, recording, and transferring digital assets throughout financial markets.”
Without making any grand predictions the authors believe DLT adoption will require future research to better understand the impact to the financial industry. Challenges to mass adoption include a list of risk, business and technical hurdles.

If you would like to see the full article please click here.

 

 

Carlo de Meijer

Economist and researcher

 

Blockchain: What happened during my stay in South Africa? (Part III)

| 4-1-2017 | Carlo de Meijer |

chains-iiIn december 2016 I travelled throughout South Africa. My main focus was on the country, the people, the safaris, the Big Five and not on blockchain! Being back home I was curious to learn if there were developments in the blockchain area. A number of interesting reports were launched and there had been growing blockchain and distributed ledger activity in the financial industry from start-ups, to banks, central banks, the market infrastructure and consortia. 

In earlier articles on treasuryXL I focussed on new reports and startups (Part I)  and on banks and consortia  (Part II) while in today’s article I want to write about central banks, market infrastructure and card schemes.

CENTRAL BANKS

Central banks in Japan, Sweden and Singapore, among others , have launched blockchain efforts, with the European Central Bank (ECB) announcing a new research undertaking in partnership with the Bank of Japan on 6th December. The US Federal Reserve recently launched its first major research paper on blockchain.

Japan’s Central Bank Staff are Running Blockchain Trials

Japan’s central bank is researching and testing blockchain to study the possible use of distributed ledger technology for market infrastructure. They are “test-driving” blockchain technology to understand the innovation, according to its governor Haruhiko Kuroda. Speaking at a financial forum centered around digital innovation and Fintech, the Bank of Japan’s governor underlined blockchain as having the potential to “significantly affect” the basic pillars of financial activities – money and ledgers.

ECB and Bank of Japan research DLT for market infrastructure

The European Central Bank and Bank of Japan agreed to launch a joint research project to study potential use cases of blockchain technology for market infrastructure. This initiative comes after the ECB revealed that it is open to taking a closer look at exploring the potential for blockchain technology as a means to further innovation among central banks around Europe. The bank is toying with the idea of tapping DLT, among other options, for its revamp of the Target2 real-time gross settlement system and Target2-Securities platform. If this is to happen, more research into the technology is needed, prompting a collaboration with the Bank of Japan which will see findings released next year.

Bundesbank and Deutsche Börse test blockchain for securities settlement

Germany’s central bank has teamed up with Deutsche Börse to develop a functional prototype for blockchain technology-based settlement of securities. The prototype thereby enables the settlement of securities in delivery-versus-payment mode for centrally-issued digital coins, as well as the pure transfer of either digital coins or digital securities alone. In addition, this technology is capable of settling basic corporate actions such as coupon payments on securities and the redemption of maturing securities, using code from the Hyperledger Project as a basis. Both parties now plan to work on it over the next few months to test its technical performance and scalability. According to the Bundesbank, the project is aimed at providing a basis for further exploring the use of the tech in the securities trading space.

French Central Bank Pilots Blockchain

According to a report issued by the Banque de France it was announced that they tested blockchain technology for potential uses in managing SEPA Credit Identifiers, or identification markers used to establish the identity of creditors within the Single Euro Payments Area. This marks its first publicly acknowledged blockchain trial by the central bank. The trial was conducted with blockchain startup Labo Blockchain in collaboration with the Caisse des Depots et Consignations.

MARKET INFRASTRUCTURE

SWIFT unveils blockchain proof-of-concept (PoC) for bond trading

SWIFT recently unveiled its first proof-of-concept (POC) for managing the entire lifecycle of a bond trade based on blockchain technology. The internal POC demo tackles the issue of asset servicing across the full lifecycle of a bond trade, from issuance to payment of coupons and maturity. For the tests, Swift set up five separate nodes on a simulated network, stretching from Swift offices in California as the ID provider to an account servicer in Virginia and three investing banks in Sao Paolo, Frankfurt, and Sydney. SWIFT expects to see a number of other POCs come to fruition in Q1 2017.

SWIFT intends to sketching out a roadmap of key initiatives planned for 2017. These include working with vendors and member banks to deliver a blueprint for a SWIFT-run distributed ledger and the development of a DLT sandbox. For the latter, SWIFT intends to collaborate with member banks on a select number of use cases for the future application of distributed ledger technology as part of their Global Payments Innovation initiative.

ICAP to process foreign exchange trades on blockchain in 2017

ICAP, a UK-based operator and provider of post trade risk mitigation and information services, has announced plans to start processing foreign exchange trades on blockchain. For that, ICAP brings along its subsidiary Traiana and has teamed up with Axoni, a US-based technology company to supply the code to customers in March 2017. Traiana will thereby act as a messaging hub for forex, fixed income and swaps deals. They thereby provide services to monitor pre-trade risk and automate post-trade processing of financial transactions in listed and over-the-counter trading markets. Also, it will reconciles transaction, reference, market and portfolio data before it is transmitted to regulators, clearing houses or back to financial institutions.

Everex trials blockchain remittance in Thailand

Everex, a financial inclusion blockchain development company seeking to improve access to financial services and markets for un- and under-banked population across the world, has tested blockchain remittance. Over 100 migrant workers transferred money instantly over blockchain to their homes in Myanmar in the last months. Therefore, over 850,000 Thai baht (around USD 24,000) were transferred using the Everex wallet, a mobile and web based app that sends digitized national currencies using Ethereum blockchain.   Overall, average transaction took less than a minute and recorded savings of over 7% in remittance cost and currency exchange rates.

CARD SCHEMES

MasterCard files blockchain patents focused on payments and transacting

MasterCard has filed to the US Patent and Trademark Office (USPTO) four applications related to its work (focused specifically on payments and transacting) with blockchain and distributed ledger technology. The applications focus on methods and systems for authorizing, processing and securing blockchain-based transactions. MasterCard is arguing that a combination of blockchain and its existing payment technology could bring great benefits for those making digital payments. Publication of the applications comes weeks after the credit card company released a set of experimental blockchain APIs.

Lotte Card rolls out biometric authentication based on blockchain in Korea

Lotte Card, a large card issuer company in Korea, has adopted a biometric-based authentication system service in its payment app jointly with Blocko, a blockchain startup. Blocko is the provider of Coinstack, a blockchain-based development platform, and has a large number of references in providing blockchain technology in Korea.   Financial organizations in Korea, including banks, card companies and Korea Exchange, are actively adopting blockchain technology, but this is the first case in Korea of commercialized blockchain technology combined with biometric-based authentication system.

carlodemeijer

 

Carlo de Meijer

Economist and researcher

 

Has the Bond bull market run out of steam?

| 02-11-2016 | Lionel Pavey |

building2

The yield on Dutch 10 year government bonds has increased sharply in the last month (October 2016) –from 0.02% at the start of the month to 0.28% at the end – bond prices of course move in the other direction and have gone down. Why?

Possibility that the Federal Reserve will raise rates in America? Uncertainty over when the ECB will end their QE programme and the knock-on effects in the market?



ECB president Draghi has not said if the programme will end in March 2017 as originally envisaged. As monetary policy has not delivered the boost to the economy that was expected, maybe it is time for Government to look at changes to the fiscal policy via a Keynesian stimulus leading to lower taxes and an increase in direct government spending.

So if the bond market has reached the bottom and prices will start to rise, what will be the consequences?

The ECB is holding over EUR 1 trillion worth of bonds – can they unwind this position? Immediate selling would lead to a collapse in prices and a large increase in interest rates – deflating an already fragile economy and withdrawing liquidity from the financial system. Could the debt be monetized – the scale involved has never been seen before, so difficult to say.

But, what will happen to bond prices when yields start to rise?

If the yield on 20 year government bonds in the EU was to increase by 2% from their current levels, this would lead to a fall in price of 25%. If the yield on 30 year government bonds in the EU was to increase by 3% from their current levels, this would lead to a fall in price of 44%.

As the ECB would have to sell their existing bond holding at lower prices, there would be a huge loss on their portfolio – who ultimately would have to bear this loss?

What would be the effects on the equity markets – there has to be a knock-on effect if bond yields rise leading to a fall in equity prices. Is the current fragile market able to absorb these transactions – is there enough liquidity in the market?

Very worrying times ahead – companies will have to review their funding strategies, but this can lead to opportunities.

Lionel Pavey

 

 

Lionel Pavey

Cash Management and Treasury Specialist – Flex Treasurer

How long can interest rates stay so low?

| 08-09-2016 | Lionel Pavey |

rating

How long can interest rates stay so low? When we talk about interest rates, it is helpful if we know the basic theory of how the level of an interest rate is determined.Classical thinking states that there are 5 components in interest rates (x).

 

5 Components in interest rates:

  • Risk free rate – a constant rate with no inflation
  • Inflation – the future expectation for inflation is added to the risk free rate.
    These, together, are called the nominal interest rate
  • Default risk premium – the individual credit score of the borrow
  • Liquidity premium – compensation for offering a product that can be difficult to sell on
  • Maturity premium – in a normal positive yield curve, longer maturities have a higher interest rate

A review of various data providers show that the “indicative rate” for a bullet loan with a maturity of 5 years for a Dutch local authority would be 0.06% per annum. Let us look as this rate compared to the 5 components already mentioned.

C, D and E are all premia and would, therefore, have a positive value. Even if their collective value was zero, it would imply that “nominal” 5 year interest rate would be 0.06%. This nominal rate, as previously stated, comprises both the risk free rate and the expected inflation.This leads to the presumption that either risk free rates are zero or that future expectations of inflation are negative.

According to the ECB inflation (HICP) index in July 2016 prices rose by 0.2% as an annual percentage change. The target inflation rate for the ECB is below, but close to, 2% over the medium term. Central banks set interest rates whilst keeping a watchful eye on headline and expected future inflation (it is a lagging indicator). Many studies claim that inflation indices overstate the true inflation figure, which would imply that the true inflation change would be zero or slightly negative.

If we were to enter a recession now there would be no room to use monetary policy as done previously as there is no space to lower rates any further. This would then only leave fiscal policy, but there is no unity within the Euro zone on fiscal policy.

It would appear that the present policy of quantitive easing (QE) has lead us to very low interest rates coupled with minimal inflation and no significant growth in GDP. Therefore, it is not improbable to envisage the current period of very low interest rates being maintained for quite some time in the future.

Furthermore, when QE stops, the ECB will eventually have to sell the bonds they are holding. Such an action could, conceivably, lead to a large rise in interest rates causing disruptions in the economic cycle. In the current environment, monetary policy can not revive the economy.

Lionel Pavey

 

Lionel Pavey

Cash Management and Treasury Specialist – Flex Treasurer