The Credit Suisse Crisis and International Law II: We Live in a Swap Line World

Immediately after the public announcement of the emergency takeover of Credit Suisse (CS) by UBS on 19 March 2023, six of the world’s major central banks announced a coordinated action to prevent a global liquidity crisis in reaction to the CS collapse. The Federal Reserve (Fed), the European Central Bank (ECB), the Bank of England (BoE), the Bank of Japan (BoJ), the Swiss National Bank (SNB), and the Bank of Canada (BoC), together the “C6”, announced that the US-dollar drawing central banks among them had agreed to offer US dollar operations no longer on a weekly, but on a daily basis to commercial banks in their respective jurisdictions. They did so to improve the effectiveness of the swap arrangements between them.

A network of standing swap arrangements based on bilateral agreements between the C6 operates at the center of the international monetary system that has emerged in the aftermath of the 2008 global financial crisis (GFC). The renewed strengthening of this network on 19 March has so far been the main international response to the latest banking crisis. This has again shown that bilateral swap arrangements are of critical importance for stabilizing global financial markets.

The following blog post briefly discusses the swap arrangements between the Federal Reserve and other major central banks as an international crisis instrument that has been in (nearly) permanent use over the last 15 years. It argues that the bilateral agreements governing the standing swap arrangements between the C6 are best characterized as gentlemen’s agreements; at their core are binding moral rather than hard-wired legal commitments by the central bank(er)s involved who have pledged to (re-)purchase currency from each other to provide global liquidity in times of crisis. While these commitments have so far been able to sufficiently stabilize global financial markets, they have also allowed the Fed to unofficially act as the global lender of last resort and resulted in unequal access to global liquidity. This, in turn, has led to critical asymmetries in the ability of states to perform their financial obligations, including sovereign debt.

The Re-Use of Central Bank Swap Arrangements Since the 2008 Financial Crisis

While their rapid proliferation and increasing institutionalization are rather recent developments, central bank swap arrangements as such are nothing new. Their use as an international coordination mechanism in response to the GFC had a sustained pre-history from 1962-1998, surviving the transition from fixed to floating exchange rates. Back then, the Fed set up temporary swap arrangements with the then G10 members, Switzerland, and the Bank for International Settlements (BIS). These arrangements were both de jure and de facto reciprocal and involved the BIS as a multilateral mediator. In contrast thereto, the swap arrangements between the C6 set up over the last 15 years have operated only a parallel bilateralism. More precisely, they have been de jure but not de facto reciprocal. The Fed so far never drew on them, but arguably used the cooperation argument so as to avoid the stigma associated with de facto unilateral swap arrangements.

When pressures in global funding markets rapidly grew in late 2007, the Fed engaged in discussions with other central banks on using swap arrangements to address dysfunction occurring in global foreign exchange (FX) markets with the aim to enhance global financial stability and to support the implementation of US domestic monetary policy. In December 2007, the Fed set up temporary currency swap arrangements initially with the ECB and the SNB. By the end of October 2008, a total of 14 central banks entered into temporary swap agreements with the Fed. At the peak of their use, they provided over USD 580 billion in global liquidity and accounted for over 25% of the Fed’s total assets, marking the most significant use of central bank swap arrangements in history.

Upon several extensions, in particular in response to the European sovereign debt crisis, the C6 converted their temporary arrangements into standing arrangements at the end of October 2013. These standing arrangements have ever since allowed the C6 to permanently access in amount unlimited liquidity in each jurisdiction in any of the five currencies foreign to that jurisdiction. Despite this unprecedented conversion from temporary to standing “emergency” arrangements, suggestions to codify them were, unsurprisingly, not heard, and access thereto has hardly changed.

Unequal Access to Global Emergency Liquidity

Only a few select central banks in emerging market economies (EMEs), namely Brazil, Mexico, Singapore, and South Korea, got in response to the GFC temporary currency arrangements with the Fed, primarily due to the latter’s concern about significant spill-over effects and based on geopolitical considerations. According to the former Fed Chair Ben Bernanke, the US State Department had, after all, been involved in the choice of emerging market swap arrangements, which involved both an “economic perspective” and a “diplomatic perspective”. The President of the Federal Reserve Bank of Dallas, Richard Fisher, justified the four EMEs chosen on the grounds that Brazil was a “critical part of our hemisphere”, Mexico was a “national security risk”, Singapore was “unique”, and South Korea was “inordinately successful”. The Fed had been approached by a number of other EMEs that were rebuffed. In 2012, it declined a request from India.

In reaction to the March 2020 liquidity crisis caused by the Covid-19 crisis, the Fed both revived the currency swap arrangements established in response to the GFC as well as significantly strengthened and expanded them. The liquidity swaps for the C6 and a few others, on the one hand, and the newly introduced so-called FIMA Repo Facility, on the other hand, operated to backstop the collapsing global FX swap market. The FIMA Repo Facility allows foreign and international monetary authorities (notably the People’s Bank of China) to enter into repurchase agreements with the Fed to temporarily exchange their US Treasury securities held with the Fed for US dollars. Publicly available information on this facility is even scarcer than that on the swap lines. According to a March 2022 testimony by Fed Chair Jerome Powell, the Fed has “institutionalized” the provision of global liquidity between its currency swap arrangements and its FIMA Repo Facility.

A significant corollary of this “institutionalization” is, however, the fact that the International Monetary Fund’s lending of last resort activity via its Special Drawing Rights system plays a subordinated role as it extends today de facto only to developing and smaller emerging economies with access to neither the Fed’s swap arrangements nor its FIMA Repo Facility. The resulting hierarchical order of global liquidity provision has grown out of (international) central bank usage and practices in pragmatic response to crisis over the last 15 years.

Gentlemen’s Agreements Are at the Centre of Today’s International Monetary System

The legal character of central bank swap arrangements was quite controversially discussed when they were last used in the second half of the 20^th century (see e.g. here, here, and here; in contrast thereto, current international legal scholarship has hardly dealt with post-GFC central bank swap arrangements). This does not come as a surprise as such arrangements are distinct not only from formal international treaties, but also from commercial FX swap agreements.

The latter becomes already apparent when one looks at the agreements’ length: While dealing with billions of dollars, euros, francs, pounds, or yens, the agreements governing the C6 swap arrangements comprise of only eight pages. In contrast thereto, commercial FX swap agreements are highly standardized agreements that cover hundreds of pages and are most often governed by a global industry-wide “constitution”, i.e. the ISDA Master Agreement. Central bank and commercial swap arrangements further fundamentally differ in respect to their pricing as the former’s “interest rate” is “negotiated rather than calculated from market prices”. Moreover, while commercial FX swap agreements of course include governing law and jurisdiction clauses, central bank swap agreements do, not least in view of the pivotal international legal principle of (monetary) sovereignty, not include any such clauses.

From an international legal point of view, the crucial question is whether, by entering into a swap arrangement, the central banks, acting as agents for and on behalf of the states involved, intended to create legally binding obligations in international law. A clear intention as to the legal character of the bilateral agreements that govern the standing swap arrangements between the C6 is, unsurprisingly, neither expressed therein nor in the publicly available transcript of the relevant meeting of the Federal Open Market Committee. In addition, the details on the drawings made under the agreements have remained largely confidential. Nonetheless, based on the agreements’ wording, purpose, and effects as well as in consideration of the already mentioned discussion of the legal character of central bank swap arrangements in the second half of the 20^th century, I suggest that the agreements that govern the standing swap arrangements between the C6 are best characterized as gentlemen’s agreements:

• The “commitments” (and not “obligations”) to (re-)purchase currency from each other, which are at the agreements’ core, and the fact that the actual entering into any swap transaction under them is still contingent on the parties’ mutual agreement as well as on their “full power and authority” to provide liquidity to other central banks speak in favor of binding moral rather than hard-wired legal obligations that the C6 have intended to create. A legally enforceable right to make drawings against the deposit under the domestic law of the other party only arises once the parties actually agreed to enter into a swap transaction. Moreover, the following statement by Charles A. Coombs, former Vice-President of the Federal Reserve Bank of New York, which, although concerning central bank cooperation through the so-called Roosa bonds and the swap network during the 1960s, is likely to still hold true: “I don’t give a damn whether it will stand up in court. In this business, no central bank is going to sue another one. What I want to know is whether acceptance of such a standing order is a binding moral commitment.” (Charles A. Coombs, The Arena of International Finance, John Wiley & Sons 1976, p. 40)
• By entering into the agreements, the central bank(er)s involved formulated shared expectations (both for them and crucially also for the participants in global funding markets) as to their modus vivendi with respect to the provision of global emergency liquidity. The agreements are largely self-regulatory as they depend mainly on central banking usage and practices. The degree of coordination with the IMF is, if at all existent, low.
• The entering into the legally non-binding swap agreements has allowed the C6 to address pressures in global funding markets, both in a timely manner and despite possible uncertainties about their domestic legal authority to provide liquidity to foreign central banks. It has further allowed the US dollar receiving central banks among them to avoid the formal acknowledgment of the US dollar’s (still) predominant role in the international monetary system and, related therewith, the Fed’s role as de facto global lender of last resort.

Indeed a “Rethinking Moment”

The above has hopefully made clear that gentlemen’s agreements between six of the world’s major central banks have been a (or maybe even the) key international response to instability in global financial markets over the last 15 years. They have institutionalized the provision of global emergency liquidity in a club-like form and allowed the Fed – in its role as de facto global lender of last resort – to set and adapt the format of the currency swap arrangements between the C6; the other central banks have more or less just followed, although they have been bearing the credit risk involved. The de jure but not de facto reciprocal currency swap arrangements between the C6 reflect the hierarchical structure of international central banking (both within and beyond the C6 club). Pledging in form of gentlemen’s agreements between central bank(er)s has been a key instrument to channel global relations of financial domination. The far-reaching structural and distributional effects resulting therefrom call for a rethinking of our conception of monetary sovereignty.

In response to the first blog post on “The Credit Suisse Crisis and International Law”, it is thus proposed that we should indeed embrace the newest banking crisis as a “rethinking moment”, but not by focusing only on the current relevance of multilateral legal instruments that deal with banking and financial crises (whether they form an undertheorized regime complex or not). Rather, we should draw our attention again on bilateral and much more informal instruments that not only complement, but also override multilateral legal instruments and that lie in the grey area between legal and extra-legal norm-making in international relations. This area seems to have largely fallen into oblivion in international financial and monetary legal scholarship, despite its crucial role in today’s (and most likely also tomorrow’s) international monetary system.