7.2
INNOVATIVE CLIMATE FINANCE
An SDR bond for ØáÞâÖéÚěãÖãØÚ
Special drawing rights offer another way that multilateral development banks could mobi- lise finance to support countries with adapting to climate change – but there are some misconcep- tions about how this could work.
S pecial drawing rights are the International Monetary Fund’s unique reserve asset. They are created when the IMF agrees to make a per- petual loan of SDRs to its members. They can be converted into any of the constituent currencies upon which the value of the SDR is based (US dol- lar, euro, Chinese renminbi, Japanese yen and British pound sterling). This is done through a special window at the IMF, through which members can sell SDRs to other members for the currency needed to settle private transactions. However, the bulk of any newly cre- ated SDRs flows to the IMF’s biggest shareholders, as they are allocated based on members’ past contributions, not to countries with the most need. That creates an opportunity, as very few of the reserves created in the 2009 and 2022 allocations have been mobilised. How could this work? Mechanisms exist to channel SDRs through the IMF – such as the Resil- ience and Sustainability Trust and the Poverty Reduction and Growth Trust – but they have their limits. The IMF is not set up to fund projects – in fact, it cannot do that. The RST, for instance, provides long-term funding to meet a long-term balance of payments needs, so it rewards countries with additional borrowed reserves for implementing good policies. But there is no good reason why SDRs should only be channelled through the IMF. The multilateral development banks are all authorised SDR holders, and thus can borrow them from IMF members and exchange those SDRs for hard currency, just as shareholder countries can. Moreover, through development banking, the MDBs are structured to allow SDRs to be used to finance long-term clean energy lend-
ing and real projects while retaining reserve assets. The key to all development banking is that the holder of a bond backed by the balance sheet assets of a credible financial institution has a liquid trad- able asset: it can be sold for cash, even as the funds raised by the bond are invested in a diverse portfolio of long- term projects. An SDR bond (which would set- tle in SDRs) or an SDR-denominated bond (which would settle a constitu- ent currency but pay a coupon linked to the SDR rate) thus could function as a reserve asset in the same way that dollar and euro bonds now issued by the World Bank and other develop- ment banks function as reserve assets. Around 40% of the World Bank’s exist- ing bonds are held by reserve managers seeking a liquid AAA credit. Most countries are constrained because they hold SDRs as part of their foreign exchange reserves and must maintain their SDRs as a reserve asset. Some – although not gener- ally the large countries with the most SDRs – have legal flexibility and can hold equities as part of their reserve portfolio. Switzerland and China, for instance, operate under tighter con- straints and generally can only invest in bonds or deposits. The flexible definition of a reserve asset led the African Development Bank and the Inter-American Devel- opment Bank to explore whether countries would be willing to use their SDRs to buy subordinated (or junior) debt that would qualify as equity. How- ever, this proposal proved to be a step too far for most of the big SDR holders. Clarity on bonds Currently idle SDRs could provide the MDBs with standard bond financing. Such bonds could settle in SDRs or any of the constituent currencies. A bond
Brad W Setser, Whitney Shepardson senior fellow, Council on Foreign Relations
THERE IS NO GOOD REASON WHY SDR S SHOULD ONLY BE CHANNELLED THROUGH THE IMF. THE MULTILATERAL DEVELOPMENT BANKS ARE ALL AUTHORISED οÍÃÊÇ¿ÀÍμɿ THUS CAN BORROW THEM FROM IMF MEMBERS AND EXCHANGE THOSE SDR S FOR HARD ¾ÐÍÍÀɾÔÅÐÎÏ AS SHAREHOLDER COUNTRIES CAN.
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Financing a Just Transition
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