STAFF NOTE FOR THE G20
THE ROLE OF THE SDR—INITIAL CONSIDERATIONSJuly 15, 2016

EXECUTIVE SUMMARY
Following the recent diagnostic of the international monetary system (IMS), theIMF will explore whether a broader role for the SDR could contribute to its
smooth functioning. The economic rationale for or against broader use of the SDR will
be examined, focusing in particular on identifying any gaps and market failures the SDR
could help address in light of the increasingly multi-polar nature of the global economy
and growing financial interconnectedness.
This note sets out some initial considerations on this matter. The note sketchessome key issues bearing on the role of the SDR in each of three concepts: (i) the official
SDR, or “O-SDR”, the composite reserve asset issued and administered by the IMF;
(ii) SDR-denominated financial market instruments, or “M-SDRs,” which could be bothissued and held by any parties; and (iii) the SDR as a unit of account.
M-SDRs reduce foreign exchange and interest rate risk relative to single-currency
instruments, but there are some drawbacks and challenges. The basket nature of
M-SDRs would allow the volatility of returns to be lower than for a similar singlecurrency instrument. However, the SDR only represents one of many possible sets ofportfolio weights, and issuers or investors could use existing instruments to replicate
their preferred weights at a relatively low cost. There are also challenges to market
development, including settling and clearing of M-SDR transactions, dealing withpotential basket redefinition, and fostering secondary market trading in order togenerate liquidity and market depth.
There are potential benefits to using the SDR as a unit of account, which have tobe weighed against other considerations. Publishing economic statistics and financial
statements in SDR terms could help users identify valuation changes. Statisticalauthorities would need to invest in communicating the rationale for any change inpractices.
While the official SDR under its current framework is not playing a significant rolein the IMS, a re-examination of its role is expected to inform whether any specificreform options should be pursued. The evolution of the IMS has given rise to an
active debate on how much concern is posed by high rates of reserve accumulation,
global imbalances, and rising claims on reserve issuers, and on whether the O-SDR
could contribute to addressing these issues.

THE ROLE OF THE SDR—INITIAL CONSIDERATIONSCONTENTSINTRODUCTION _________________________________________________________________________________ 3
SDR-DENOMINATED FINANCIAL INSTRUMENTS (THE “M-SDR”) ____________________________ 4
A. Diversification Properties of the SDR Basket ___________________________________________________ 4
B. Other Potential Advantages ____________________________________________________________________ 8
C. Potential Disadvantages _______________________________________________________________________ 9
D. Market Development Issues ___________________________________________________________________ 9
SDR AS A UNIT OF ACCOUNT _________________________________________________________________ 12
ROLE OF THE OFFICIAL SDR (THE “O-SDR”) __________________________________________________ 14
BOXES
1. Historical Experience with SDR- and ECU-denominated Instruments___________________________ 5
2. Technical Aspects of the Official SDR _________________________________________________________ 15
FIGURES1. Development of M-SDR and US Dollar/SDR Exchange Rate ____________________________________ 6
2. Indices of Primary Commodity Prices _________________________________________________________ 12
3. Indices SDR Basket Changes and U.S. Dollar-SDR Exchange Rate _____________________________ 13
TABLES
1. SDR Currency Basket and Interest Rate Instruments ___________________________________________ 6
2. Correlation Coefficients, 2005–15 ______________________________________________________________ 7
References _______________________________________________________________________________________ 17
ANNEX
I. Diversification Properties of the SDR Basket ___________________________________________________ 19

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THE ROLE OF THE SDR—INITIAL CONSIDERATIONSINTRODUCTION1
1.
Following the recent diagnostic of the international monetary system (IMS), the IMF
will explore whether a broader role for the SDR could contribute to its smooth functioning(IMF, 2016a). In particular, it aims to identify any gaps and market failures the SDR could help
address in light of the increasingly multi-polar nature of the global economy and growing financial
interconnectedness. Unlike the most recent discussion on the role of the SDR in 2011 which focusedon reform options (IMF, 2011a, 2011b), the economic rationale for or against broader use of the SDR
will be examined.22.

This note distinguishes between the role of the SDR in its three concepts. These are:

The official SDR, hereafter referred to as the “O-SDR.” This is the reserve asset defined by the
IMF’s Articles of Agreement and administered by the IMF; most of the SDR 204.1 billion stock
outstanding was allocated in 2009 in the aftermath of the global financial crisis.



SDR-denominated financial instruments, which could be both issued and held by any parties,
hereafter referred to as “M-SDRs,” for market-based SDRs.3 M-SDRs emerged in the 1970s andearly 1980s before the market faded, but there has been renewed interest recently.



The SDR as a unit of account, for such uses as reporting economic statistics and financial
statements, and pricing transactions—examples of the latter include Suez Canal fees and theMontreal Convention on damages, such as lost baggage, incurred by air carriers.

This note sets out some initial considerations on market incentives for M-SDRs, aspects ofdeveloping such markets, and reporting statistics in SDR terms. The note also sketches some key
issues that would factor into an examination of the economic rationale for or against a broader roleof the O-SDR.

1

The note was prepared by an IMF staff team from the Strategy, Policy, and Review; Finance; and Monetary andCapital Markets Departments, in consultation with the Legal and Statistics Departments. The team was led by Kristina
Kostial and comprised Wojciech Maliszewski, Neil Meads, Hui Miao, Andrew Swiston, Camilo Tovar, and Frank
Wallace, under the overall guidance of Alfred Kammer.
2

In their discussion of The Case for a General Allocation of SDRs During the Eleventh Basic Period (IMF, 2016b),
Executive Directors generally concurred that it would be premature to bring a proposal for an SDR allocation orcancellation to the Board of Governors, pending further work on, among other things, the role of the SDR (see IMF,
2016c).
3

Previous analysis has used the phrase “private SDR” instead of “market SDR.” The M-SDR terminology is used sinceboth private and official sector entities could issue or hold such instruments.

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THE ROLE OF THE SDR—INITIAL CONSIDERATIONSSDR-DENOMINATED FINANCIAL INSTRUMENTS (THE“M-SDR”)
3.
This section examines the incentives for market participants to deal in M-SDRs anddiscusses some considerations for development of M-SDR markets. The current legal framework
for SDRs under the IMF’s Articles of Agreement does not preclude any market participant fromissuing or holding M-SDRs.4 Some M-SDRs were issued in the 1970s and 1980s, but activity has
since been dormant, unlike markets for the European Currency Unit (ECU), which developed
throughout the 1980s (see Box 1). While the ECU benefitted from the movement toward European
monetary integration, other factors are explored in more detail in this section, with a view toassessing constraints on activity in M-SDRs. A further avenue for research could include assessmentof the potential systemic contribution of the M-SDR should deep, liquid markets develop.

A. Diversification Properties of the SDR Basket
4.
M-SDRs should reduce foreign exchange and interest rate risk relative to singlecurrency instruments by inheriting some of the diversification properties of the O-SDR. The
SDR valuation method aims at ensuring a stable value of the SDR in terms of the major currencies of
the world—a key consideration in switching its valuation to a basket of currencies in 1974 (IMF,
2015a and Polak, 1979). With the basket weights reflecting the importance of the currencies in theworld’s trading and financial system, this also helps limit the influence of a particular currency orgroup of currencies on the value of the SDR (Table 1).5


The weighted returns on the instruments in the SDR basket have been less volatile than
the returns of the individual components. The value of the SDR has been more stable thanthe value of the individual currencies, as their fluctuations have displayed low or negative
correlations, buffering the impact of exchange rate movements on the value of the SDR(Table 2).6 Similarly, the SDR interest rate has been less volatile than its individual components,
as the component rates have been positively correlated, but to a low enough degree that thebasket provides some diversification relative to the individual components (Table 2).7

4

With market forces determining the interest rates on M-SDRs (which could vary by instrument), the M-SDR market
could develop independent from the O-SDR.
5

The currencies included in the basket are also widely traded in foreign exchange markets, so are less likely toexperience large fluctuations due to market illiquidity. Furthermore, the currencies in the basket are those of thelargest exporters. Owing to their economic size, their exchange rates are less likely to encounter variability due toidiosyncratic shocks.
6

The highest correlation is for the Chinese renminbi-U.S. dollar currency pair, reflecting in part that the renminbi wasmanaged against the dollar during some of the sample period.
7

The SDR interest rate is determined by market rates on representative three-month instruments in the currencies
that comprise the SDR currency basket, using the same weights (Table 1). These instruments have a credit profile ofthe highest quality, fully comparable to that of government paper available in the market or, in the absence ofappropriate official paper, comparable to the credit risk of prime financial instruments (IMF, 2015b). The SDR interest
rate has been set at a weekly frequency since 1983.

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THE ROLE OF THE SDR—INITIAL CONSIDERATIONS

Box 1. Historical Experience with SDR- and ECU-denominated Instruments
While SDR-denominated assets have been issued previously, a deep, liquid market did not develop. This box
contrasts experience with SDR-denominated assets with the development of private markets for theEuropean Currency Unit (ECU).
SDR-denominated assets were first issued in 1975 and reached a peak in the early 1980s. By end-1981 it wasestimated that up to 50 banks were prepared to accept and manage SDR deposits, such deposits amounted
to SDR 5–7 billion, while SDR 563 million in SDR-denominated bonds had been issued, and five syndicatedbank loans worth SDR 908 million had been extended (IMF, 1987). However, the SDR market quickly dried
up—no SDR bonds or credits have been issued since 1981 and bank deposits declined. By contrast, themarket for ECU-denominated assets became well-developed: The basket currency was created in 1979 aspart of the European Monetary System (EMS), and by 1990, the ECU ranked as the sixth most-used currency
in terms of outstanding international bonds.
Development of SDR and ECU markets reflected, in part, ready-made diversification benefits of basket
currencies, especially for retail investors. In the lead-up to the end of the Bretton-Woods system, the U.S.
dollar devalued by around 17 percent, and the U.S. dollar depreciated further in the late 1970s (Figure 1). In
this environment, SDR-denominated assets offered investors and bond issuers stability, in the absence ofalternative hedging instruments. However, the U.S. dollar strengthened substantially in the early 1980s,
reducing the appetite of many investors for such diversification. By the mid-1980s, a further round of U.S.
dollar depreciation did not result in a revival of the SDR market—possibly in part because of financial
liberalization (easing restrictions on investing in component currencies—see below) and innovation, withcurrency swaps allowing the transformation of liabilities from one currency into another. 1 The ECU alsooffered diversification, but benefitted from relative stability of currencies within the basket, and from beingreflective of a growing range of commercial and financial dealings (at least within Europe) for a number ofincreasingly integrated economies.
The ECU’s initial market development may have benefitted from opportunities for regulatory arbitrage. The
use of basket currencies allowed markets to by-pass restrictions on the use of the Deutsche mark to
denominate bonds for non-residents (Dammers and McCauley, 2006). As such, when investor demand in theDeutsche mark rose and demand for the U.S. dollar fell, demand for the ECU increased since it acted as a
Deutsche mark proxy given the mark’s high weight in the ECU basket. Restrictions on the under-writing ofDeutsche mark bonds were eventually lifted, however, and internationalization of the Deutsche markincreased as financial liberalization required under the single market proceeded. Demand was also
supported by yield differentials amidst relative stability of currencies within the basket (IMF, 2011). Given thepresumption of continued stability, issuers from countries with relatively higher interest rates and investors
from countries with relatively lower interest rates could both gain by issuing/investing in ECU rather thantheir respective national currencies.
The private ECU market was bolstered by official sector interest and support. For example, several European
institutions issued bonds in ECUs and the EC—through publicly favoring expansion of private use of theECU—was seen as committed to the ECU during the transition to the Euro. As the private ECU market
expanded, European central banks also started holding private ECU as part of reserves to use for market
intervention (Allen, 1993). Although the private ECU market declined following the ERM crisis, the market
recovered as the introduction of the Euro approached and reflected the EC’s commitment to convert one
ECU for one euro (Dammers and McCauley, 2006). Private sector market development was also facilitated by
the BIS helping to develop an ECU clearing system.
______________
1

The first currency swap occurred in 1981 between the World Bank and IBM. The estimated principal amount ofoutstanding currency swap contracts is estimated to have increased from just $2-3 billion in 1982 to around$80–100 billion by end-1986. See Hammond (1987) for more details on swap market developments.

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THE ROLE OF THE SDR—INITIAL CONSIDERATIONS

Figure 1. Development of M-SDR and U.S. Dollar/SDR Exchange Rate

Table 1. SDR Currency Basket and Interest Rate Instruments
Basket weights
Current

Interest rate 1/

As of October(3-month instrument)

1, 2016

Dollar

41.9

41.73

U.S. Treasury Bill.

Euro

37.4

30.93

Central government bonds with AA rating and above. 2/

Pound

11.3

8.09

U.K. Treasury Bill.

Yen

9.4

8.33

Japanese Treasury Discount Bills.

10.92

Benchmark yield for China Treasury bonds. 3/

Renminbi

1/ On October 24, 2014, the Executive Board of the International Monetary Fund amended the rule for setting the SDR
interest rate by introducing a floor of 0.050 percent (5 basis points) and changing the rounding convention for calculating
the SDR interest rate from two to three decimal places.
2/ Published by the European Central Bank.
3/ Published by China Central Depository and Clearing Co., Ltd.

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THE ROLE OF THE SDR—INITIAL CONSIDERATIONS

Table 2. Correlation Coefficients, 2005–15(Monthly Changes)
Currencies
Dollar

Euro

Pound

Interest Rates
Yen

Dollar

1.00

Euro

-0.87

1.00

Pound

-0.24

0.14

1.00

Yen

0.22

-0.52

-0.38

1.00

Renminbi

0.91

-0.80

-0.20

0.16

Renminbi

Dollar

Euro

Pound

Yen

Renminbi

1.00

1.00

0.19

1.00

0.40

0.79

1.00

0.05

0.34

0.42

1.00

0.01

0.50

0.48

0.38

1.00

Source: IMF staff calculations.
Notes: For exchange rates, correlations are against the SDR. See Table 1 for a description of the interest rate instruments.
The renminbi is shown since it will be included in the SDR basket effective October 1, 2016.



Risk-adjusted returns also would have typically outperformed the risk-adjusted returns ofinvestments in single-foreign currency securities. Annex I compares the risk-return propertiesof a synthetic SDR bond with those of three-month Treasury bills in each of the component
currencies, plus the Chinese renminbi (RMB) since it will be included in the SDR basket effective
October 1, 2016.8 For investments outside the investor’s own currency, the synthetic SDR bondearned higher returns per unit of risk, as measured by Sharpe ratios (average return, divided by
the standard deviation of returns) than for most single-currency instruments, with the exceptionof returns on RMB-denominated instruments.9 The high risk-adjusted returns of the synthetic
SDR bond were driven by its low exchange rate volatility.10

Returns on M-SDRs would be expected to reflect uncovered interest parity of thecurrencies in the SDR basket plus premiums associated with the credit characteristics of
the issuer. Holding constant the latter, an M-SDR should have a return with a lower variancethan that of a comparable instrument denominated in one of the component currencies (vanden Boogaerde, 1984; Hoguet and Tadessee, 2011; Dammers and McCauley, 2006).

5.
M-SDRs could therefore be attractive to investors and issuers by offering a prepackaged diversification option. The above discussion applies to the weighted returns on the
instruments in the SDR basket vis-à-vis the individual components, which are short-term Treasury
securities in the component currencies. Ultimately the underlying risk of the M-SDR will not movesolely with these rates, but will depend on other factors such as the term premium and the8

The synthetic SDR bond consists of the instruments in the SDR basket, but the return differs from that on the OSDR in that the floor of five basis points on the O-SDR interest rate (in effect since 2014) is not applied.
9

Investments in the investor’s own currency typically display the highest risk-adjusted returns by construction, since
returns are measured in the investor’s own currency. This eliminates foreign exchange risk on the home currency
instrument, which is the largest source of risk.
10

The high risk-adjusted returns in RMB were driven by its appreciation over the sample period, which outweighed
its volatility.

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THE ROLE OF THE SDR—INITIAL CONSIDERATIONS

creditworthiness of the issuer, which will be reflected in the demand and pricing of the instrument.11
This could blunt the diversification properties for M-SDRs, though divergences should be boundedby arbitrage. The costs would also need to be weighed against those of alternative instruments thatprovide similar diversification benefits, as discussed later in this section. The diversification aspect
may be particularly attractive to retail investors (Dammers and McCauley, 2006), or official investors(e.g., central bank reserve managers, treasury operations of international organizations) withportfolios benchmarked to the SDR or with SDR-denominated liabilities.

B. Other Potential Advantages
6.
Both issuers and investors could reap gains from M-SDRs by consolidating the numberof denominations in which they operate. This was a factor supporting private activity in the ECU(Allen, 1990; Tosolini, 2014). While the costs of operating in multiple currencies may have declined
as financial market infrastructure has developed, and the M-SDR is settled in a smaller number ofcurrencies than the private ECU was, there could still be scope for savings. For investors withportfolios benchmarked to the O-SDR, M-SDRs could reduce the need for portfolio rebalancing
compared to investing in single-currency bonds. Further analysis of the typical transactions costs forissuance of and investment in foreign currency securities (including the foreign exchange leg of thetransaction) could help identify the potential magnitude of reduced costs.
7.
Gaining exposure to a currency subject to capital controls could be another advantage,
though the potential pickup in RMB exposure is limited. A driver of the private ECU market was
the combination of restrictions on issuance of instruments denominated in Deutsche mark with theclose relationship of the value of the ECU to the mark (Box 1). Effective October 2016, M-SDRs could
offer similar exposure to the RMB. While there could be unsatisfied demand for RMB exposure
among international investors, M-SDR activity associated with this would be limited by the fact that
the RMB exposure embodied in the O-SDR (just over 10 percent) is small in comparison to theweight of the mark in the ECU (over 30 percent).12 Activity would be further limited by the existenceof an active offshore RMB market (see PBC, 2015 and IMF, 2015a), which already provides a channel
for exposure to the RMB.13
8.
M-SDR activity has also been suggested as a potential channel for domestic investors
subject to controls on capital outflows to gain exposure to reserve currencies.14 For example in

11

However, this would also apply when comparing single-currency instruments with risk-free, short-term instrumentsin that currency.
12

In addition, given the European Monetary Union convergence criteria, the currencies in the ECU basket were
expected to remain within a certain range of the central parity, which limited expected fluctuations against the mark.
13

Reserves managers also already have unrestricted access to onshore RMB markets.

14

In the presence of capital controls, issuance would likely be onshore and settlement carried out in the domestic
currency. This would make such activity similar to some existing and historical examples of instruments indexed to aforeign currency but payable in the domestic currency. These instruments have tended to be more attractive whendomestic investors attach a high risk to depreciation of the domestic currency, underscoring the store… (continued)

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THE ROLE OF THE SDR—INITIAL CONSIDERATIONS

China, there may be untapped demand among domestic investors for exposure to reserve
currencies as capital controls are gradually lifted. From this perspective, M-SDRs issued in theonshore market could potentially reduce demand for foreign currency and reduce capital outflows
by allowing domestic market participants to diversify their foreign exchange risk. From theperspective of issuers of M-SDRs in the onshore China market, they would in essence be assuming
foreign exchange risk by indexing their liabilities to a foreign currency instead of issuing directly in
RMB.15 Those issuers with needs for foreign exchange may instead find it more attractive to tap
international markets, if they have access.

C. Potential Disadvantages
9.
The main disadvantage of M-SDRs is that with fixed currency amounts, the basket
represents only one of many potential sets of portfolio weights. With M-SDRs, investors andissuers would take as given the currency weights of the SDR basket.16 Given the existence of deepand liquid markets in each of the component currencies, as well as alternative instruments such as
foreign exchange and interest rate derivatives, a key question is whether investors or issuers findthat the benefits of the pre-packaged diversification discussed above outweigh those of
constructing a customized portfolio with their preferred currency weights. In practice, entities that
may not find it feasible to invest or issue in a number of currencies may find M-SDRs a more
attractive diversification option than entities with access to a wide array of markets and risk
management products would.
10.
The complexity of M-SDRs may pose a hurdle to some issuers and investors. In theearly stages of market development, and in the absence of a well-defined yield curve, market
participants would need to price the instrument referring to yield curves in each currency in addition
to pricing the credit risk of the issuer. This challenge in pricing M-SDRs may constrain demand andsecondary market trading. The basket nature of M-SDRs also signifies that an issuer or investor
engaging in an M-SDR transaction is taking on an asset or liability exposure in five currencies. This
could require, for regulatory purposes, parallel transactions on the other side of the balance sheet,or hedging the individual currency exposures. Similar such complexities weighed on thedevelopment of the private ECU market (Tosolini, 2014).

D. Market Development Issues
11.
Settlement and clearing of M-SDR transactions is a critical aspect of market
development. Once an M-SDR market developed and accounts denominated in M-SDR werewidespread, such accounts could be used for settling coupon and redemption payments, which…of value properties of the reserve currency exposure. In some jurisdictions, onshore issuance could carry higher
transfer risk than comparable issuance in the international capital markets.
15

For a potential issuer such as the People’s Bank of China, such issuance would reduce its sizable long position inforeign currency.
16

The effective weights in the basket also fluctuate on a daily basis with exchange rates.

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THE ROLE OF THE SDR—INITIAL CONSIDERATIONS

would be greatly facilitated by having an M-SDR clearing facility.17 However, until these conditions
are in place, transactions would need to be settled in one or more of the component currencies.18
The issuance terms of individual instruments could specify who would elect the currency ofsettlement and when. Whether this could inhibit secondary market trading, or if standardization ofsuch terms would help, could be discussed with market participants. For the private ECU, the BIS
provided clearing services for commercial banks, and further examining this experience could
provide valuable lessons. Another point for dialogue with market participants and financial
intermediaries is whether there would be a need to adjust their infrastructure or information
technology systems to facilitate M-SDR activity.
12.
If M-SDRs were primarily accumulated by buy-and-hold retail investors, they could beless liquid than comparable single currency claims. As noted above, with the pre-packaged
diversification of M-SDRs more likely to appeal to small-scale investors, their liquidity may be lower
than comparable single-currency instruments subject to frequent trading by institutional investors,
which could lead to an interest rate premium on issuance that may be sizable until a deep and liquidmarket develops. IMF (2011a) examined various studies of other financial markets and suggested
the liquidity premium could lie within a wide range, from 25 to 150 basis points, postulating acentral tendency of 80 to 100 basis points. The premium would be expected to decline as issuanceincreased, but the market would face a first-mover problem—issuers could be dissuaded fromentering the market until it developed enough to reduce the premium. The degree to which the low
initial supply and buy-and-hold behavior would affect market liquidity is subject to a wide range of
uncertainty and could be refined through further research.19
13.
While M-SDRs may initially attract more activity in short-maturity instruments, a fullyliquid M-SDR yield curve would facilitate market development. A curve specific to M-SDR
instruments would facilitate pricing and secondary market trading. Initially, M-SDRs could be priced
off the swap curves in the component currencies, though a substitute for the RMB such as theTreasury yield curve may need to be used since a liquid swap curve has not yet developed. Shortdated claims would help reduce the uncertainties related to the SDR basket review cycle, and could
be easier to market to buy-and-hold investors. As with a number of examples in developing local
currency bond markets, the maturity of instruments could be lengthened once the market gained
experience at the short end of the curve.
14.
Market participants would need to resolve how to deal with potential revisions to the
SDR basket at the time of quinquennial SDR reviews. An “open basket” approach would specify
that the instrument would be indexed to the official basket definition at the time, which exposes
17

Tosolini (2014) describes the evolution of this process for the private ECU. M-SDR clearing and settlement may
require amendment to legal and regulatory frameworks governing clearing and settlement.
18

The national regulations governing clearing and settlement in each component currency would apply.

19

For some countries, M-SDR activity could also adversely affect the turnover and liquidity of their local currency
market by segmenting the market. For emerging and developing markets, official sector issuers may thus face a
tradeoff with the objective of developing local currency bond markets.

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THE ROLE OF THE SDR—INITIAL CONSIDERATIONS

participants to redefinition risk. Alternatively, the “closed basket” approach maintains the basket
definition in effect upon entering into the contract, which limits risks but can lead to nonstandardized instruments.20 M-SDRs would also grapple with this issue, given that the SDR currency
basket is reviewed by the IMF every five years.21 Uncertainty surrounding basket redefinition could
adversely affect demand, the maturity of new issuance, and trading in the secondary market, but
given the broad stability in the composition of the SDR basket, the magnitude of this risk should not
be overstated.22 Experience with the private ECU suggests that the “open basket” approach ispreferable.23 This would preserve a unified definition of the M-SDR, facilitating development ofmarket conventions, dealer arrangements, regular issuance, and support for repos and forwards,
which would help boost liquidity and thus support secondary market trading.
15.

Other market development issues include:Official involvement. Since a number of supranational issuers denominate their balance
sheet in SDRs they may be attracted to issue M-SDRs to minimize currency mismatch andinvest in M-SDRs to reduce portfolio adjustments and lower trading costs, subject to theexistence of a liquid market. Experience with the Asian bond fund initiative may provide
some guidance on where official sector involvement could support market development. In
order to promote local bond markets, in 2005 Asian central banks pooled reserves toestablish the Asian bond fund to invest in local currency bond markets. The Asian bond fundis managed independently, enlarged the professional investor base, and helped develop
yield curves in the local bond markets.

Foreign exchange markets. Liquid foreign exchange markets with trading in forward
contracts typically facilitate activity in fixed-income instruments, as occurred with the ECU.
However, foreign exchange trading in basket instruments is currently rare, and with this lessof an immediate precursor than a subsequent milestone for market development, this issue
will be left for future work.

Investor indices. Inclusion in major bond indices or creation of an M-SDR index could help
enlarge the investor base by facilitating the participation of institutional investors. The MSDR would first need to attain a certain minimum issuance scale. Other considerations will
be explored further.

20

Under this approach, contracts for M-SDRs would need to specify the source of exchange rate quotations for eachcurrency in the basket, in order to allow instruments to be valued against the old, closed basket in case a currency
subsequently drops out of the official basket.
21

The SDR valuation review typically evaluates the currency selection criteria, the selection of currencies, theweighting methodology, and the composition of the SDR basket. The last SDR valuation review was conducted in2015 (IMF, 2015a, 2015b).
22

For previous basket redefinitions, the BIS, which offers deposit facilities to its central bank clients, has engaged incompensatory payments to adjust for the changing basket in terms of the principal and interest rate. The amount has
been small as the adjustment of basket weights has not been significant. The market could potentially adopt similararrangements as a convention to deal with basket redefinitions.
23

Tosolini (2014) notes that this contributed to the development of the private ECU market.

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THE ROLE OF THE SDR—INITIAL CONSIDERATIONSSDR AS A UNIT OF ACCOUNT
16.
The SDR is used in a handful of instances as a unit of account for economic statistics,
financial statements, and pricing of transactions. International reserves data is published in SDR
terms by China and in International Financial Statistics, a number of international and regional
institutions use the SDR as a unit of account for their balance sheets, and the lending of somemultilateral development banks is denominated in SDR. The SDR is also used to price sometransactions with a multinational character—Suez Canal fees and damages, such as lost baggage
claims, incurred by air carriers under the Montreal Convention. Overall, though, uptake of the SDR asa unit of account has been low.
17.
There are some potential benefits to such uses. The diversification properties of the SDR
basket noted above imply that presenting data or pricing transactions in SDR terms would smoothout valuation changes from fluctuations among major currencies. For commodity prices, forexample, price fluctuations are often in the opposite direction as fluctuations in the value of the U.S.
dollar. For this reason, observed commodity price volatility is lower in SDR terms than in terms of
U.S. dollars (Figure 2). From the perspective of a commodity exporter, pricing commodities in SDR
terms could thus stabilize receipts in terms of the domestic currency (IMF, 2011a). Whether there
would also potentially be complementarities between SDR commodity pricing and M-SDR
development could be examined further.

Figure 2. Indices of Primary Commodity Prices
2005=100

USD

U.S. dollar peak-to-trough =-55%
SDR peak-to-trough = -52%

SDR

U.S. dollar peak-to-trough =-55%
SDR peak-to-trough = -50%

240
220
200

200

U.S. dollar trough-to-peak =345%
SDR trough-to-peak = 244%

180

160
150

140
120
100

100

U.S. dollar trough-to-peak =114%
SDR trough-to-peak = 103%

80
60

50

40

20
0

0

2000

2001

2002

2003

2004

2005

2006

2007

2008

2009

2010

Combines indicies of non-fuel primary commodity prices and energy prices

Sources: IMF Commodity Price Database; and IMF staff calculations.

12

INTERNATIONAL MONETARY FUND

2011

2012

2013

2014

2015

2016

THE ROLE OF THE SDR—INITIAL CONSIDERATIONS

18.
Basket redefinition presents one potential drawback. Uncertainty on the outcome ofquinquennial SDR reviews―either through inclusion of new currencies or through adjustments inthe weights of currencies in the basket―could in theory affect the attractiveness of the SDR as a unitof account by reducing its ability to act as a common, stable (over time) base for prices. For
example, Figure 3 highlights that the observed U.S. dollar-SDR exchange rate differs from that
implied by some earlier constructs of the SDR basket. Thus, there is some redefinition risk, but thisshould not be overstated as Figure 3 also shows that near-term fluctuations in the value of the SDR
would have been broadly similar even if the weights had not changed. Furthermore, the observedbasket has displayed a lower long-term variance than if the weights had been fixed over time,suggesting that, abstracting from the relatively small redefinition risk, the changes in weights havemade the SDR a more stable anchor of value.
19.
Statistical authorities considering publishing statistics in SDR will need to weigh anumber of other considerations. These include: (i) while end-users could in principle perform theirown conversions, offering the data pre-packaged in SDR terms could increase uptake and familiarity
with it; (ii) authorities would need to be prepared to publish in both SDR and U.S. dollar terms for
those users who continue to demand the latter; (iii) improvements in technology may be lowering
the cost of disseminating statistics online in more than one currency; and (iv) any change inreporting practices should be clearly communicated to data users and markets to avoid confusion
over its rationale. The IMF is exploring the feasibility of publishing online also in SDR terms statistics
on the balance of payments and international investment position, and the COFER survey on official
holdings of foreign exchange reserves.24

Figure 3. Indices SDR Basket Changes and U.S. Dollar-SDR Exchange Rate
Ja nuary 1981=100
150
1981 Weights
1991 Weights
140
1999 Weights
130
2006 Weights
Observed SDR
1201986 Weights
1996 Weights
2001 Weights
2011 Weights

110
100
90

80
70
1981

1986

1991

1996

2001

2006

2011

2016

Sources: Haver Analytics; IMF, International Financial Statistics; and IMF staff calculations.

24

Conversions would be performed by the IMF using the exchange rates it already disseminates, to keep fromexpanding the reporting burden.

INTERNATIONAL MONETARY FUND 13

THE ROLE OF THE SDR—INITIAL CONSIDERATIONSROLE OF THE OFFICIAL SDR (THE “O-SDR”)
20.
The O-SDR is a unique instrument among international reserve assets in two key
respects. First, it is allocated according to IMF quotas rather than accumulated through a balance of
payments surplus. Second, it is not the direct liability of any single economy but represents a
potential claim on the freely usable currencies of other participants in the SDR Department (Box 2).
These characteristics also signify that quota-based O-SDR allocations are not targeted to match theliquidity needs of individual countries, and larger allocations would raise the potential claims ofmembers using O-SDRs on other members’ freely usable currencies.25
21.
While the O-SDR under its current framework is not playing a significant role in the
IMS, a broader re-examination is expected to inform whether any specific reform options
should be pursued. Larger allocations and other options for reform have been discussed
extensively in the past, but those most likely to have a systemic impact have failed to achieve thehigh degree of consensus among the membership necessary for implementation—including, insome cases, amending the IMF’s Articles of Agreement. As such, a first step could be to examine, inlight of the evolution of the IMS and its current features, why the O-SDR has played only a minor
role in the IMS and the economic rationale for or against a broader role, before going into how this
could be accomplished.
22.
The evolution of the IMS has given rise to changing perspectives on the role the OSDR should play. The O-SDR was created as a supplement to reserve assets in the late 1960s underthe Bretton Woods system of fixed but adjustable exchange rates, amid concerns over thesustainability of continued accumulation of claims on the United States—the “Triffin dilemma”(Triffin, 1961). While such concerns persisted after the move to a system of floating exchange rates,
the O-SDR played only a minor role in the IMS, and despite the aims of the Second Amendment of
the Articles of Agreement to make the O-SDR “the principal reserve asset of the IMS” (Article VIII,
Section 7 and Article XXII), consensus was never reached on the more far-reaching reform proposals
discussed at the time (see Boughton, 2001 and McCauley and Schenk, 2015). Significant reserve
accumulation in recent decades and the resulting capital flows from emerging to advanced
economies, along with the rising public debt of reserve currency issuers, have spurred reneweddiscussion on whether the O-SDR has a broader role to play as a reserve asset, with the general linesof the debate as follows:Some argue that the O-SDR could mitigate the effects of the existence of a modern form of
the Triffin dilemma (see Ocampo, 2010 and Zhou, 2009). According to this view, with thelarge magnitude and volatility of capital flows, and no mechanism for symmetric adjustmentof surplus and deficit countries, the incentives are in place for: (i) excessive reserve
accumulation and uphill capital flows as non-reserve-issuing countries attempt to avoid

25

With O-SDR use not subject to conditions, and currently no safeguards to ensure that holdings are reconstituted
over time, O-SDRs can in principle be used for long-term financing rather than short-term liquidity needs.

14

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THE ROLE OF THE SDR—INITIAL CONSIDERATIONS

balance of payments deficits and build precautionary liquidity buffers;26 and (ii) undermining
policy discipline in reserve currency issuers, manifested in current account and/or fiscal
deficits. In such an environment external balances can become unanchored fromfundamentals, or disinflationary pressures can emerge as all countries cannot simultaneously
improve their balance of payments. The O-SDR could help reduce these incentives by
providing access to international liquidity.

Box 2. Technical Aspects of the Official SDR
The official SDR, hereafter O-SDR, is the reserve asset created in 1969 and defined under the IMF’s Articles
of Agreement. The O-SDR is not a currency, but a potential claim on the holdings of freely usable currenciesof participants in the SDR Department (currently all IMF members). Furthermore, it is allocated by the IMF tothese participants according to their quotas. Allocations are not targeted based on need or any otherconsideration, but aiming to supplement existing reserve assets. These characteristics imply that it is neither
a direct liability of any single economy nor accumulated through a balance of payments surplus.
The O-SDR can be held on the balance sheets of participants or used unconditionally to obtain a freely
usable currency to meet a balance of payments need (or for other reserves management purposes).
Originally, participants who used a large share of their holdings were required to reconstitute them overtime, but this requirement has been suspended since 1981. Transactions and holdings are limited toparticipants in the SDR Department, the General Resources Account within the General Department of the
IMF (as a result of transactions between participants and the IMF), and prescribed holders (someinternational financial institutions and regional central banks; prescribed holders can hold O-SDRs but do
not receive allocations).
O-SDRs are primarily exchanged for freely usable currencies through voluntary exchanges between
members, typically mediated by the IMF through the system of Voluntary Trading Arrangements (VTAs). The
designation mechanism remains as a backstop by ensuring that participants with a balance of payments
need can exchange on demand their O-SDRs with participants with a strong external position (suchparticipants cannot be obligated to increase their holdings of O-SDRs to more than twice their cumulative
allocation), but this mechanism has not been used since 1987.
Since 1974 the O-SDR has been valued based on a basket of currencies, which currently includes the U.S.
dollar, euro, Japanese yen, and pound sterling. The basket will be expanded effective October 1, 2016 toinclude the Chinese renminbi, reflecting its rising international use and trading. The O-SDR carries aninterest rate determined by the yields on three-month treasury bills of the component currencies, making its
return comparable to that of an asset of the highest credit quality.
The O-SDR mechanism is self-financing and levies charges on allocations, which are then used to pay
interest on O-SDR holdings. If the O-SDR holdings of a participant are equal to its allocation, the charges areequal to the interest received. If a participant’s holdings rise above its allocation, it effectively earns intereston the excess. Conversely, if it holds fewer O-SDRs than allocated, it pays interest on the shortfall.

26

Obstfeld (2011a) sketches a mechanism through which this could occur.

INTERNATIONAL MONETARY FUND 15

THE ROLE OF THE SDR—INITIAL CONSIDERATIONSOthers argue that the globalization of finance has weakened the link between themacroeconomic policies of reserve currency issuers and the currency denomination ofreserve assets, allowing the creation of sufficient liquidity in reserve currencies that is
independent of the policies of reserve issuers. According to this view, the importance of
external imbalances and the precautionary motive in the growth of reserves are bothoverstated. Proponents of this view see little impact from broader use of the O-SDR.27

23.

In the current context, some questions to look into as part of this work include:Impact on reserve accumulation, global imbalances, or external adjustment: By raising
effective liquidity buffers, how much would a higher stock or greater usability of the O-SDR
reduce accumulation of reserves through balance of payments surpluses? Would broader
use of the O-SDR affect external adjustment in deficit countries and in reserve currency
issuers?28 Would it have an inflationary impact, or help avert potential risks of global
deflation? Further examination of the effects of the 2009 allocations could provide evidence
on some of these questions.

Is the O-SDR serving as a truly liquid and usable reserve asset? How does its status as a callon other reserves affect its attractiveness relative to other reserve assets?



As a departure from the unconditional use of the O-SDR as conceived under the current
framework, O-SDRs (whether the existing stock, or new issuance) could be used as a means
to finance crisis prevention instruments such as precautionary liquidity facilities, or augment
the resources available via conditional lending. Such uses could provide access to liquidity
without a permanent commitment of freely usable currency.29 A key open question is, would
this reduce self-insurance or improve incentives for policy adjustment (see Obstfeld, 2011b)?
Furthermore, would such objectives be best achieved by the O-SDR as defined in the Articles
of Agreement, or by an alternative asset or funding vehicle? Conditional use of the O-SDR
would also be related to issues such as the IMF’s lending toolkit and the size of IMF
resources, so further analysis would need to be coordinated with ongoing work in thoseareas.

27

See, for example, Farhi and others (2011), and Borio (2013, 2016).

28

Note that these potential channels for the SDR to contribute to IMS stability are different from that ofdiversification of international currency use. Given the characteristic of the O-SDR as a claim on existing freely usable
currency, diversification is more of a consideration in the context of reducing volatility through increased use of the
M-SDR.
29

The impact on those who could potentially be called upon to provide freely usable currency under such facilities
would also need to be taken into account.

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THE ROLE OF THE SDR—INITIAL CONSIDERATIONS

References
Allen, Polly Reynolds, 1990, “The Private ECU Markets: What They Are, Why They Exist, and Where
They May Go,” Journal of Banking and Finance 14: 845–76.
________, 1993, “Artificial Currencies: SDRs and ECUs,” Open Economies Review 4: 97–110.
Borio, Claudio, 2013, “Commentary: Global Liquidity: Public and Private,” in Global Dimensions ofUnconventional Monetary Policy, Proceedings of the Jackson Hole Symposium, Federal Reserve
Bank of Kansas City.
________, 2016, More Pluralism, More Stability? Speech at the seventh high-level SNB-IMF conference
on the international monetary system, Zurich (May) http://www.bis.org/speeches/sp160510.htm.
Boughton, James, 2001, Silent Revolution: The International Monetary Fund 1979–1989 (Washington:
International Monetary Fund).
Dammers, Clifford, and Robert McCauley, 2006, “Basket Weaving: The Euromarket Experience withBasket Currency Bonds,” BIS Quarterly Review (March): 79–92.
Farhi, Emmanuel, Pierre-Olivier Gourinchas, and Hélène Rey, 2011, Reforming the International
Monetary System, (London: Centre for Economic Policy Research).
Hammond, G M S, 1987, “Recent developments in the swap market,” Bank of England Quarterly
Bulletin (February): 66–79.
Hoguet, George, and Solomon Tadesse, 2011, “The role of SDR-denominated securities in official
and private portfolios,” BIS Papers 58: 165–86.
International Monetary Fund (IMF), 2016a, Strengthening the International Monetary System—A
Stocktaking (Washington, IMF).
________, 2016b, The Case for a General Allocation of SDRs During the Eleventh Basic Period(Washington, IMF).
________, 2016c, Report of the Managing Director to the Board of Governors and to the Executive Board
Pursuant to Article XVIII, Section 4(c) (Washington, IMF).
________, 2015a, Review of the Method of Valuation of the SDR—Initial Considerations (Washington,
IMF).
________, 2015b, Review of the Method of Valuation of the SDR (Washington, IMF).
________, 2011a, Enhancing International Monetary Stability—A Role for the SDR? (Washington, IMF).

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THE ROLE OF THE SDR—INITIAL CONSIDERATIONS________, 2011b, The Chairman’s Summing Up: Enhancing International Monetary Stability—A Role for
the SDR? (Washington, IMF).
________, 2011c, The Case for a General Allocation of SDRs During the Tenth Basic Period (Washington,
IMF).
________, 1987, The Role of the SDR in the International Monetary System, IMF Occasional Paper 51(Washington, IMF).
Israelsen, Craig, 2009, “Refining the Sharpe Ratio,” Journal of Performance Management 13, 23–27.
McCauley, Robert, and Catherine Schenk, 2015, “Reforming the International Monetary System in
the 1970s and 2000s: Would a Special Drawing Right Substitution Account Have Worked?”International Finance 18, 187–206.
Medeiros, Carlos, and Simon Nocera, 1988, “The Potential Role of the SDR in Diversified Currency
Portfolios of Central Banks,” IMF Working Paper 88/81 (Washington, IMF).
Obstfeld, Maurice, 2011a, “The International Monetary System: Living with Asymmetry,” NBER
Working Paper No. 17641 (Cambridge, MA, NBER).
________, 2011b, “The SDR as an International Reserve Asset: What Future?” Rapid Response 11/0885(London, International Growth Centre).
Ocampo, José Antonio., 2010, “Building an SDR-Based Global Reserve System,” Journal of
Globalization and Development 1, Article 14.
People’s Bank of China (PBC), 2015, RMB Internationalization Report 2015 (Beijing, PBC).
Polak, Jacques, 1979, “The SDR as a Basket of Currencies,” IMF Staff Papers 26, 627–653.
Shimizu, J., and E. Ogawa, 2005, “Risk properties of AMU denominated Asian Bonds,” Journal of
Asian Economics 16, 590–611.
Tosolini, Valentina, 2014, “The development of the private ECU market: technical aspects andfeatures,” in The ECU and the SDR: Learning from the Past, Preparing the Future, Triffin
International Foundation and Centro Studi Sul Federalismo
https://www.uclouvain.be/cps/ucl/doc/euro/documents/FIT-CSF_ECUandSDR_Nov2014.pdf.
Triffin, Robert, 1961, Gold and the Dollar Crisis: The Future of Convertibility (New Haven, Yale
University Press).
van den Boogaerde, Pierre, 1984, “The Private SDR: An Assessment of its Risk and Return,” IMF Staff
Papers 31, 25–61.
Zhou, Xiaochuan, 2009, “Reform the international monetary system,” BIS Review 41/2009.

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THE ROLE OF THE SDR—INITIAL CONSIDERATIONS

Annex I. Diversification Properties of the SDR Basket
The risk-return properties of a synthetic SDR bond are compared with those of three-month
Treasury bills in each of the component currencies, plus the Chinese renminbi (RMB) since itwill be included in the SDR basket effective October 1, 2016.30 The metrics analyzed include thestandard deviation of returns and the Sharpe ratio—the average return, divided by the standard
deviation of returns—which provides a measure of risk-adjusted returns.31 The returns are also
decomposed into the portions attributable to foreign exchange fluctuations and to interest income.
Returns are calculated from the perspective of investors in each of the component currenciesof the SDR basket. Each investor evaluates the returns in terms of her own currency. Following
Shimizu and Ogawa (2005), the returns are calculated as follows: The investor exchanges her basecurrency into a target currency (which can include the SDR basket), at a price in terms of the target
currency. The target currency is then used to purchase a three-month Treasury security of one of theother currencies in the SDR basket (or a hypothetical synthetic SDR bond whose yield is). She holds
the security for one or three months, sells it, and exchanges the revenue from the target currency tothe base currency. The formula for calculating the return, in terms of the base currency, is:where 𝐸𝑡 is the closing rate of the target currency against the base currency at month t, 𝑌𝑡
is the closing rate of bond yields on a monthly basis at month t, and 𝑘 = 1, 3 is the investment time
horizon of one or three months. The interest rate returns are calculated from the instruments
described in Table A1.1, and foreign exchange returns are calculated from ex post returns realized
when the bonds are converted to the base currency at the end of the month, and assuming thetransactions are not hedged. Reported annual bond yields are converted to monthly and quarterlycompounded rates. The data used for the analysis covers the period January 2005 throughDecember 2015.
The characteristics of the SDR basket have allowed returns on the synthetic SDR bond to be
more stable than those of the underlying instruments. Figure A1.1 compares the standard
deviation of one-month and three-month returns of a synthetic SDR bond with those of three-30

The synthetic SDR bond is a hypothetical instrument whose currency composition is equivalent to that of the
O-SDR, and whose yield is equivalent to a weighted average of the yields on the securities in the SDR interest
rate basket. The synthetic SDR bond is not subject to the interest rate floor of five basis points that has been
applied to the O-SDR since 2014.
31

Similar metrics are constructed in earlier studies (van den Boogaerde, 1984; Medeiros and Nocera, 1988; andHoguet and Tadessee, 2011).

INTERNATIONAL MONETARY FUND 19

THE ROLE OF THE SDR—INITIAL CONSIDERATIONS

month Treasury bills in each of the component currencies, plus the RMB. The returns on thesynthetic SDR bond have been consistently more stable than the single-foreign currency returns.32
This has been driven principally by lower fluctuations in the value of the SDR basket (Tables A1.2
and A1.3). The only exception would have been the U.S. dollar-RMB rate, since this currency pairexperienced low exchange rate volatility as a result of the latter being managed against the former
during much of the sample period. The synthetic SDR bond also would have lowered interest raterisk, though with only a small contribution since the global crisis due to the stability of mostcomponent interest rates near zero (Tables A1.2 and A1.3).
Figure A1.1 Stability of Returns by Type of Investor, 2006–15(standard deviation)
Total Risk Three-Month Investment

Total Risk One-Month Investment
5
Synthetic SDR

Dollar

Euro

Pound

Yen

Renminbi

10

4

8

3

6

2

4

1

2

0

Synthetic SDR

Dollar

Euro

Pound

Yen

Renminbi

0
U.S.

European

BritishJapanese

ChineseU.S.

European

BritishJapanese

Chinese

Source: IMF staff calculations.
Note: The box shows the range of the standard deviation of returns in different currencies for each type of investor. See
Tables A1.2 and A1.3 for further details on the calculations.

Risk-adjusted returns also would have typically outperformed the risk-adjusted returns ofinvestments in single-foreign currency securities. The synthetic SDR bond earned higher returns
per unit of risk, as measured by Sharpe ratios (average return, divided by the standard deviation of
returns) than for most single-currency instruments (Figure A1.2; Tables A1.2 and A1.3).33 This is a key
consideration for investors such as reserve managers who might prefer a conservative portfolio
management strategy.

32

Returns on the instrument denominated in the investor’s base currency are always the most stable, since there isno contribution to returns of currency fluctuations.
33

The main exception is that risk-adjusted returns on RMB-denominated securities have been higher for all investors
over this sample period. This is due to the appreciation of the RMB, which has outweighed its volatility (for European,
Japanese, and British investors). For this reason, RMB-denominated returns are not included in Figure A1.3.

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THE ROLE OF THE SDR—INITIAL CONSIDERATIONS

Figure A1.2 Total Risk-Adjusted Returns, 2006–15
Risk-Adjusted Three-Month Investment

Risk-Adjusted One-Month Investment
Synthetic SDR

Dollar

Euro

Pound

-0.10

0.10

Dollar

Euro

Pound

0.20

0.00

0.15

Synthetic SDR

Yen

Yen

0.0
-0.5

0.15

-0.20

-1.0
0.10

0.05
-0.30
0.00

-1.5
0.05

-0.40

-0.05

-0.50
U.S.

European

British

-2.0

0.00

Japanese

-2.5
U.S.

ChineseEuropean

BritishJapanese

Chinese

Source: IMF staff calculations.
Note: Each bar represents the range of the risk-adjusted return for investments in different currencies for each type ofinvestor. The risk-adjusted return has been adjusted to account for negative returns as suggested by Israelsen (2009) toaccount for cases where the return is negative. See Tables A1.2 and A1.3 for further details.

The stability of SDR returns has been robust over time. To illustrate, Figure A1.3 displays thevolatility of foreign exchange and interest rate risk for one-month investments since 2001 for a U.S.based investor. It shows that foreign exchange risk of the SDR basket has been consistently lower
than for the individual component currencies.34 Interest rate risk has also generally been lower,
except for Japan where rates were near zero through most of the period, and China where reserve
requirements have been heavily relied upon as an instrument of monetary policy. Other studies havefound similar stability in earlier periods (van den Boogaerde, 1984; Medeiros and Nocera, 1988; andHoguet and Tadessee, 2011).

Figure A1.3 SDR Returns, 2001–15
U.S. Based Investor: Foreign Exchange Risk

U.S. Based Investor: Interest Rate Risk

(60-month rolling volatility of one-month investment returns)(60-month rolling volatility of one-month investment returns)

4

0.20

3

0.15

2

0.10

1

0.05

0
Jan-01

Jan-03Euro

Jan-05Jan-07
Pound

Jan-09Jan-11

Yen

Renminbi

Jan-13SDR

Jan-150.00
Jan-01

Jan-03

Dollar

Jan-05Jan-07

Euro

Pound

Jan-09Yen

Jan-11

Jan-13Renminbi

Jan-15SDR

Source: IMF staff calculations.

34

As previously noted, the RMB has displayed lower volatility against the U.S. dollar, but it has been more volatile
than the SDR against the euro, yen, and pound.

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THE ROLE OF THE SDR—INITIAL CONSIDERATIONS

Returns on the SDR basket have also displayed lower systematic risk. So far, the total risk—i.e.,
the exposure to interest rate and exchange rate changes—has been assessed for each component
currency of the SDR basket and for a synthetic SDR bond. Fluctuations can reflect either a common
shock to all currencies, or idiosyncratic variation of an individual currency. The latter can be
mitigated through diversification—such as investing in the synthetic SDR bond—while retaining therisk attached to the efficiently diversified currency basket (i.e., systematic risk). If such a currency
basket existed, it would be preferred by risk-averse investors over alternative diversification
instruments. So it is natural to ask whether the synthetic SDR bond offers these efficient
diversification benefits. The beta coefficient, which captures the sensitivity of the currency’s total
return to movements of the basket (i.e., systematic risk) shows that the risk reduction offered by the
SDR is efficient in many instances, but not always (Table A1.1). 35 For instance, U.S.-based investors
could reduce systemic risk further by investing in Asian currencies rather than in a synthetic SDRdenominated instrument, or Chinese-based investors could do so by investing in dollars instead of
the synthetic SDR (a result driven by the RMB’s peg to the dollar). In these instances, for an investor
to hold the synthetic SDR, she would have to be compensated with a higher yield.

Table A1.1 Beta Coefficients, 2005–15
Currencies
InvestorType

One-month return
SDR

Dollar

Euro

Pound

Yen

Renminbi

SDR

2.13

1.28

0.61

0.10

1.00

0.84

1.79

1.62

1.00

1.73

1.54

1.12

1.00

1.17

0.81

0.94

1.00

0.93

1.26

1.33

1.00

0.16

1.91

1.42

U.S.

1.00

European

1.00

1.65

British

1.00

1.15

0.90

Japanese

1.00

0.90

1.35

1.24

2.04

1.20

1.00
0.11
Chinese
Source: IMF staff calculations.

Three-month return

0.73

Dollar

Euro

Pound

Yen

Renminbi

2.01

1.45

0.64

0.15

0.58

1.98

1.72

1.80

1.19
0.98

0.77

Note: The beta coefficient measures the sensitivity of the currencies return to movements in the SDR basket. That is, it is ameasure of systematic risk. A beta equal to one suggest the currency carries the same risk as the synthetic SDR. A beta below
one suggest a risk and return below the synthetic SDR. A beta above one suggest a risk and return above the SDR.

𝜌

35

𝜎𝜎

The beta coefficient is calculated as; 𝛽𝑖,𝑆𝐷𝑅 = 𝑖𝑆𝐷𝑅2 𝑖 𝑆𝐷𝑅, where i is the corresponding currency, 𝜌𝑖𝑆𝐷𝑅 the correlation
𝜎𝑆𝐷𝑅
coefficient, and 𝜎𝑖 the standard deviation. The beta coefficient for the synthetic SDR is therefore set equal to one. If
the beta coefficient of a currency is equal to one, the return on that currency varies proportionally with the return on
the SDR, and therefore that currency would have the same systematic (or unavoidable) risk than the synthetic SDR. A
beta greater than one implies that the currency return varies more than proportionally with the return on the SDR. A
beta coefficient less than one implies that the currency has less systematic risk than the synthetic SDR and therefore
investors would incur less risk by holding that currency.

22

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Table A1.2 One-Month Bond Value of Investments in SDR or SDR-Basket Currencies, 2005–15
Bond Value
Investor
perspective

SDR

DollarEuro

Interest rate return

Pound

Yen

Renminbi

SDR

DollarReturn (µ-100)/100 (%)

Euro

Pound

Foreign Exchange Return
Yen

Renminbi

SDR

DollarEuro

Average (µ)

Pound

Yen

Renminbi

Average (µ)

U.S.

0.068

0.091

0.068

-0.002

0.030

0.659

0.096

0.091

0.106

0.143

0.016

0.487

-0.029…

-0.038-0.145

0.014

0.172

European

0.162

0.226

0.105

0.081

0.159

0.793

0.096

0.090

0.105

0.143

0.016

0.488

0.066

0.136

…

-0.061

0.143

0.305

British

0.254

0.302

0.228

0.143

0.244

0.869

0.096

0.090

0.106

0.143

0.016

0.489

0.158

0.212

0.122

…

0.227

0.381

Japanese

0.116

0.150

0.118

0.057

0.016

0.720

0.096

0.090

0.105

0.142

0.016

0.487

0.020

0.060

0.013

-0.085…

0.233

Chinese-0.102-0.078-0.103-0.173-0.137

0.486

0.096

0.090

0.105

0.142

0.016

0.486

-0.198-0.168-0.208-0.316-0.153Standard deviation (σ)

Standard deviation (σ)…

Standard deviation (σ)

U.S.

1.410

0.150

3.143

2.558

2.730

0.646

0.128

0.150

0.133

0.171

0.018

0.057

1.389

…

3.130

2.558

2.725

0.616

European

1.878

3.172

0.133

2.414

4.061

3.167

0.127

0.149

0.133

0.171

0.018

0.060

1.882

3.188

…

2.431

4.058

3.144

British

1.921

2.597

2.552

0.172

3.872

2.593

0.128

0.149

0.134

0.172

0.018

0.061

1.904

2.606

2.525

…

3.867

2.563

Japanese

2.647

2.742

3.895

3.709

0.017

2.859

0.127

0.150

0.132

0.170

0.017

0.057

2.655

2.751

3.902

3.725

…

2.844

Chinese

1.415

0.603

3.090

2.500

2.815

0.056

0.127

0.149

0.132

0.170

0.017

0.056

1.414

0.626

3.088

2.514

2.813

Adjusted Return (µ)/σ 1/

Adjusted µ/σ 1/…

Adjusted µ/σ 1/

0.048

0.604

0.022

-0.006

0.011

1.020

0.754

0.604

0.795

0.834

0.927

8.495

-0.040…

-0.118-0.371

0.005

0.279

European

0.086

0.071

0.794

0.034

0.039

0.250

0.756

0.605

0.794

0.836

0.925

8.105

0.035

0.043

…

-0.149

0.035

0.097

British

0.132

0.116

0.089

0.835

0.063

0.335

0.756

0.606

0.792

0.835

0.919

7.953

0.083

0.081

0.048

…

0.059

0.148

Japanese

0.044

0.055

0.030

0.015

0.932

0.252

0.753

0.603

0.796

0.836

0.932

8.492

0.007

0.022

0.003

-0.316…

0.082

Chinese-0.144-0.047-0.319-0.433-0.385

8.703

0.754

0.604

0.796

0.836

0.928

8.703

-0.280-0.105-0.643-0.793-0.430…

Source: IMF staff calculations.
Note: Bond value for 1-month is starting from 100 at the beginning of the month. Then it is invested into every currency for 1 month and converted into the investor based
currency using the local currency against the base currency. Interest returns are calculated by every bond yield. Foreign exchange returns are the actual ex-post foreignexchange related returns, which are uncovered by forward transactions at the beginning of period and realized when the bond value is converted to the base currency at theend of period. Shade areas correspond to return values for each investor type ranging between the 33rd and 66th percentiles, and to standard deviations for each investor typebelow the 33rd percentile.
1/ The risk-adjusted return has been adjusted as suggested by Israelsen (2009) to properly account for cases where the return is negative.

THE ROLE OF THE SDR—INITIAL CONSIDERATIONSINTERNATIONAL MONETARY FUND 23

U.S.

INTERNATIONAL MONETARY FUND

Bond Value

Interest rate return

Foreign Exchange Return

Investor perspective
SDR

Dollar

Euro

Pound

Yen

Renminbi

SDR

DollarReturn (µ-100)/100 (%)

Euro

Pound

Yen

Renminbi

SDR

DollarEuro

Average (µ)

Pound

Yen

Renminbi

Average (µ)

U.S.

0.230

0.272

0.243

0.031

0.219

2.004

0.291

0.272

0.319

0.427

0.049

1.475

-0.060…

-0.076-0.396

0.170

0.530

European

0.454

0.616

0.317

0.190

0.548

2.346

0.288

0.268

0.317

0.424

0.049

1.481

0.166

0.349

…

-0.234

0.499

0.865

British

0.806

0.934

0.725

0.431

0.936

2.673

0.293

0.271

0.324

0.431

0.050

1.487

0.513

0.663

0.401

…

0.886

1.186

Japanese

0.295

0.374

0.313

0.159

0.048

2.111

0.286

0.269

0.313

0.421

0.048

1.476

0.009

0.105

0.000

-0.262…

0.635

Chinese-0.290-0.242-0.286-0.492-0.293

1.466

0.287

0.269

0.315

0.421

0.049

1.466

-0.577-0.510-0.601-0.913-0.342Standard deviation (σ)

Standard deviation (σ)…

Standard deviation (σ)

U.S.

2.500

0.451

5.204

5.024

5.297

1.403

0.387

0.451

0.402

0.512

0.054

0.181

2.391

…

5.129

5.023

5.278

1.285

European

3.001

5.299

0.400

3.900

7.453

5.394

0.380

0.440

0.400

0.505

0.054

0.209

3.027

5.379

…

4.011

7.439

5.263

British

4.077

5.325

4.376

0.517

8.579

5.486

0.388

0.444

0.413

0.517

0.057

0.225

3.976

5.349

4.209

…

8.553

5.323

Japanese

5.041

5.240

6.811

7.354

0.052

5.545

0.381

0.449

0.392

0.503

0.052

0.188

5.072

5.282

6.830

7.414

…

5.454

Chinese

2.452

1.180

5.003

4.934

5.409

0.169

0.381

0.445

0.395

0.503

0.053

0.169

2.443

1.285

4.984

4.994

5.397

Adjusted Return/σ 1/

Adjusted µ/σ 1/…

Adjusted µ/σ 1/

U.S.

0.092

0.604

0.047

0.006

0.041

1.429

0.751

0.604

0.794

0.834

0.912

8.143

-0.144…

-0.389-1.987

0.032

0.412

European

0.151

0.116

0.794

0.049

0.074

0.435

0.757

0.607

0.794

0.840

0.905

7.093

0.055

0.065

…

-0.937

0.067

0.164

British

0.198

0.175

0.166

0.834

0.109

0.487

0.755

0.611

0.784

0.834

0.883

6.615

0.129

0.124

0.095

…

0.104

0.223

Japanese

0.059

0.071

0.046

0.022

0.932

0.381

0.751

0.600

0.798

0.837

0.932

7.867

0.002

0.020

-0.001-1.943…

0.116

Chinese-0.712-0.285-1.431-2.425-1.586

8.660

0.753

0.604

0.796

0.838

0.916

8.660

-1.410-0.656-2.993-4.560-1.845…

Source: IMF staff calculations.
Note: The Bond value is 100 at the beginning of the 3-month period. Then it is invested into every currency for 3 months and converted into the investor based currency using the local
currency against the base currency. Interest returns are calculated by every bond yield. Foreign exchange returns are the actual ex-post foreign exchange related returns, which areuncovered by forward transactions at the beginning of period and realized when the bond value is converted to the base currency at the end of period. Shade areas correspond toreturn values for each investor type ranging between the 33rd and 66th percentiles, and to standard deviations for each investor type below the 33rd percentile.
1/ The risk-adjusted return has been adjusted as suggested by Israelsen (2009) to account for cases where the return is negative.

THE ROLE OF THE SDR—INITIAL CONSIDERATIONS

24

Table A1.3 Three-Month Bond Value of Investments in SDR or SDR-Basket Currencies, 2005–15