Questions and answers on foreign exchange swaps
What is a foreign exchange swap?
In a foreign exchange swap, the purchase (sale) of foreign currency at the current spot rate and the sale (purchase) of the foreign currency at a later date are simultaneously agreed, with the SNB exchanging Swiss francs for a foreign currency. The exchange rates for the spot and forward transactions are determined at the time the transaction is concluded.
Why does the SNB enter into foreign exchange swaps?
SNB foreign exchange swaps against Swiss francs can be split into three groups - first, swaps as monetary policy instruments for managing liquidity on the Swiss franc money market; second, liquidity swap agreements to provide SNB counterparties with foreign currencies; and third, swaps for supplying foreign money markets with Swiss francs via other central banks.
How can the SNB increase liquidity on the Swiss franc money market using foreign exchange swaps?
It does so through liquidity-providing foreign exchange swaps. The SNB sells Swiss francs to its counterparty for the term of the transaction, receiving foreign currency as collateral. The Swiss franc amount is credited to the counterparty's SNB sight deposit account for the term of the foreign exchange swap; liquidity on the Swiss franc money market increases accordingly. If these foreign exchange swaps are not renewed at the end of the term, this means that liquidity is again withdrawn from the Swiss franc money market. The SNB's contracting parties are commercial banks which fulfil certain requirements. Foreign exchange swaps are concluded via auction (volume tender) or on a bilateral basis with a wide range of counterparties. Foreign exchange swaps were the SNB's most important instrument for supplying the Swiss franc money market with liquidity until 2000, when they were replaced by repo transactions.
How are SNB counterparties supplied with foreign currencies through foreign exchange swaps?
What is involved here is a foreign exchange swap between central banks which serves to provide banks and other financial market participants in Switzerland with the foreign currency they require - in particular, US dollars. For this purpose, the SNB obtains foreign currency from the relevant central bank through liquidity swaps. The central bank in question receives Swiss francs from the SNB as collateral. The SNB provides the foreign currencies to financial market participants in Switzerland, as required, by means of repo auctions. In these transactions, the SNB takes on the function of a foreign currency intermediary. The foreign exchange swaps do not have any impact on the supply of money in Swiss francs and are therefore neutral in terms of monetary policy. However, they help to counter tension on the financial markets.
How can the SNB supply foreign money markets with Swiss francs through foreign exchange swaps with other central banks?
In this case, too, a foreign exchange swap between central banks is involved. The aim is to eliminate a Swiss franc shortage on the part of foreign banks which do not have direct access to the SNB's money market transactions. For this purpose, the SNB provides foreign central banks with Swiss francs through foreign exchange swap arrangements. They can then pass these on to commercial banks in their area of influence, as required. As collateral for providing Swiss francs, the SNB generally accepts foreign currencies from the central bank in question or, when necessary, other securities. These foreign exchange swaps increase Swiss franc liquidity and therefore have a monetary policy impact; at the same time they help to counter tension on the financial markets.
When did the SNB last use foreign exchange swaps as a monetary policy instrument?
From 10 August 2011, the SNB concluded monetary policy liquidity-providing foreign exchange swaps against US dollars, euros, pounds sterling and Canadian dollars, in order to accelerate the increase in Swiss franc liquidity which it had already announced. As at the end of September 2011, some CHF 80 billion of liquidity-providing foreign exchange swaps were outstanding. This high level was reduced in the months that followed. Some of the swaps were replaced by liquidity-providing repo transactions and a certain reduction in liquidity was permitted, but the overall level remained exceptionally high. At the beginning of summer 2012, finally, foreign currency sales aimed at securing the minimum exchange rate of CHF 1.20 per euro led to another expansion of liquidity on the Swiss franc money market, so that the foreign exchange swaps became unnecessary. Since the end of June 2012, no more liquidity-providing foreign exchange swaps have been outstanding at the SNB.
What swap agreements are currently in use at the SNB?
The only swap agreement currently in use with another central bank is the one with the US Federal Reserve. So far, the offer of US dollar liquidity has only been taken up in individual cases - the last occasion was in January 2012, with repayment being made at the end of March 2012. The weekly results may be found at US dollar auctions conducted by the SNB.
The central banks participating in swap agreements designed to provide the markets with US dollar liquidity are the Bank of Canada, the Bank of England, the Bank of Japan, the European Central Bank (ECB), the US Federal Reserve and the SNB. In October 2013, these central banks announced that their existing, temporary swap arrangements would be made permanent, and remain in place until further notice. These inter-central bank swap arrangements enable the reintroduction of operations to make foreign currencies available should market conditions so dictate.
Has the SNB concluded any other swap agreements?
As part of the extension of the swap agreement with the US Federal Reserve in November 2011, the SNB decided to participate in the development of a network of temporary reciprocal swap agreements with the central banks listed above. This allows the SNB to provide the other central banks with Swiss francs for their counterparties, if required. Conversely, it would also be in a position to provide liquidity not just in US dollars, but also in Canadian dollars, pounds sterling, yen and euros. At present there is no need to provide banks in Switzerland with liquidity in any foreign currencies other than US dollars. The agreements were concluded as a precautionary measure to ensure that liquidity-providing operations could be initiated rapidly if required. In October 2013, these arrangements, like those for the provision of US dollars, were converted into standing arrangements. The SNB also has a swap arrangement with the National Bank of Belgium, which was put into place many years ago primarily with a view to possible requirements in connection with payment transactions. In June 2012, the SNB and the National Bank of Poland also concluded a CHF/PLN (zloty) swap agreement as a precautionary measure, in order to cover the need for Swiss franc liquidity in Poland, if required. In July 2014, the SNB signed a swap agreement with the central bank of China. Aside from the possibility of allowing liquidity in renminbi and Swiss francs to be made available to the relevant markets as required, this swap agreement constitutes a key prerequisite for the development of a renminbi market in Switzerland.
When was the last time that foreign exchange swaps were used to supply foreign money markets with Swiss francs via other central banks?
From October 2008 to January 2010, the SNB provided mainly banks abroad with additional Swiss franc liquidity through EUR/CHF foreign exchange swaps. These swaps were carried out under swap agreements with the ECB, the National Bank of Poland and the Hungarian central bank.
Why is the SNB one of the leading central banks in the world in terms of its network of liquidity swap agreements?
In the global financial system, the Swiss financial centre and the Swiss franc hold a key position. That is why the most important central banks around the world are interested in including the SNB in the swap agreement network. Conversely, participation makes sense for the SNB, to ensure that it has access to liquidity in foreign currencies if required.
What is the usual duration of a foreign exchange swap agreement?
The contracting parties have the freedom to set the terms of monetary policy foreign exchange swaps as they wish. However, the duration does not usually exceed three months.
The terms of foreign exchange swaps between central banks under liquidity swap agreements depend on the transaction used to provide the temporary liquidity to financial market participants. When US dollar operations were introduced in 2007, 28-day terms were standard in the initial period; they were followed by swaps with various terms, some of them only one day long.
What does a foreign exchange swap cost?
The price of a foreign exchange swap depends on market conditions, in other words, the interest rate spread between the currencies in question. This means that, from an economic standpoint, during the term of the foreign exchange swap, the customer pays the rate of interest on the currency borrowed and receives the rate of interest on the currency lent.
In the case of monetary policy foreign exchange swaps, banks needing liquidity are required to pay a premium in addition to market interest rates. By contrast, if the SNB wishes to provide the market with liquidity, it may under certain circumstances - for instance, if the level of liquidity in the market is already very high - have to pay a premium to banks. In the SNB income statement, these premiums are not stated separately, but rather as part of the net result from foreign currency positions.
Which item in the balance sheet does the SNB employ for reporting the foreign exchange swaps it uses as monetary policy instruments?
Foreign exchange purchased temporarily under monetary policy foreign exchange swaps is reported in the balance sheet as part of foreign currency investments; the Swiss francs which have been temporarily sold are credited to the commercial banks' sight deposits at the SNB. Exchange rate gains or losses on the foreign exchange are reported for the term of the foreign exchange transaction under 'other assets' (profits), or under 'other liabilities' (losses). Once the term has expired, the items cancel one another out.
On its data portal under Foreign currency investments of the SNB, the National Bank publishes tables of quarterly data showing its foreign currency investments broken down by currency including and excluding foreign exchange derivatives and with and without investments and liabilities in connection with foreign exchange swaps.
Which item in the balance sheet is employed for reporting the foreign exchange swaps the SNB uses to supply its counterparties with foreign currencies?
The US dollars passed on under the liquidity swap agreement with the US Federal Reserve are stated on the assets side under 'claims from US dollar repo transactions' and on the liabilities side under 'other term liabilities'.
Which item in the balance sheet does the SNB employ for reporting foreign exchange swaps used to provide foreign money markets with Swiss francs?
The collateral received under the liquidity swap agreements in operation during 2008 and 2009 for providing foreign money markets with Swiss francs was reported on the assets side under 'balances from swap transactions against Swiss francs', and on the liabilities side under 'banks' sight deposits'.
What happens to foreign exchange swaps when they expire?
Depending on monetary policy requirements - liquidity provision or absorption - the SNB allows foreign exchange swaps to expire or it renews them, either partially or completely.
The same applies for foreign exchange swaps between central banks. In this case, what is important is whether the commercial banks still require the liquidity which they can obtain via repo auctions.
Does the SNB incur currency risk or any other risk by entering into foreign exchange swaps?
The forward transaction is concluded at the same exchange rate as the spot transaction, and includes a discount or premium to adjust for the currency-related interest rate spread. Consequently, foreign currency investments resulting from foreign exchange swaps do not include any direct exchange rate risk. However, the parties in a foreign exchange swap are exposed to a fulfilment risk. The cash provider is exposed to such a risk because its counterparty may default, and this can result in a replacement cost risk since the currency from the swap is already planned for use in further investments and will now have to be obtained on the market. In the meantime, however, the exchange rate may have moved to the disadvantage of the SNB.