24 July 2014
Ousmène Jacques Mandeng, Global Institutional Relations Group, Prudential Investment Management
The establishments of a BRICS development bank (DB) and a contingency reserve arrangement (CRA) seem to indicate new momentum for change in intergovernmental finance and cooperation. It may mark a rebuttal of the existing framework dominated by the main multilateral institutions but also increasing confidence that China and leading emerging markets can do it on their own. It is only a modest start though.
The BRICS—Brazil, Russia, India, China and South Africa—decided at Durban, South Africa on 26 March 2013 and adopted at Fortaleza, Brazil on 15 July 2014 to form the DB and earlier on 21 June 2014 at Melbourne, Australia and adopted on 15 July 2014 to establish the CRA.
The establishment of the DB and CRA mark a novel albeit not radical approach to formal non-regional based intergovernmental financial coordination. Neither the financing mechanisms nor the finance objectives are new and CRA operations will be closely linked to IMF arrangements. The CRA is modelled to the ASEAN+3 Chiang Mai Initiative Multilateralisation (CMIM) and the DB is based more loosely on the World Bank and the Asian Development Bank (ADB). Irrespective of existing provisions, the critical question is to what extent the DB and CRA are or will become substitutes or complements of the existing multilateral framework.1
The success of the DB and CRA will naturally rest on their capacity to deploy their resources. The CRA is far too small to make a meaningful dent but signals an alternative approach to contribute to and strengthen the global financial safety net.2 The DB will struggle to contribute decisively to the vast array of development finance institutions. As they stand, neither the CRA nor the DB are likely to upset the existing intergovernmental finance framework. However, they must be seen as an initial effort only. The CRA is considered here to represent the more remarkable BRICS facility in concept but the DB is likely to have a more immediate impact.
This note will focus on access/lending and the governance structure of the two institutions. It will not debate the case for new intergovernmental institutions, effectiveness of the multilateral institutions generally, nor whether oversight at the CRA and DB is likely to be adequate to ensure adequate operations.
Contingency reserve arrangement
The CRA treaty specifies:3
Function: The CRA represents a reserve fund offering external liquidity support to help address short-term balance of payments pressures. In its function it is similar to the lending function of the IMF. CRA disbursements remain closely linked to the IMF and as such represent de facto add-on resources to IMF arrangements. Unlike the IMF, the CRA does not constitute an institution but is only a formal finance mechanism between constituent member countries on the basis of an inter-central bank agreement similar to the CMIM. As such, it is not a funded arrangement like the European Stability Mechanism (ESM) or the Fondo Latino Americano de Reservas (FLAR). The CRA will have yet to decide about whether it will establish a permanent secretariat and adopt a surveillance function similar to the IMF. The CRA is open to new countries.
The CRA is meant to “contribute to strengthening the global financial safety and complement existing international monetary and financial arrangements.” Assuming that countries’ foreign exchange reserves will act as a first line of defence, it will remain to be seen whether the CRA will be a second line or a third line of defence with the IMF.
Governance: The CRA adopted a similar governance structure to the IMF. The Council of CRA Governors like the IMF Board of Governors is the highest decision making body of the CRA.4 The Standing Committee (note the term reflecting the Chinese political system) similar to the IMF Executive Board approves lending operations. The Standing Committee is chaired by a rotating chair where the chairperson is designated by the country that chairs the BRICS.
Decisions at the Council level comprise changing member countries’ financial commitments to the CRA and provide broad orientations. Decisions are to be taken by consensus given every constituent de facto a veto right compared with the IMF where Board of Governor decisions are normally taken with an 85 percent majority.
The allocation of voting shares for the Standing Committee comprises a basic vote and a regular commitment based vote similar to the IMF. 5 percent of the total voting power is distributed equally among the constituents. The remainder 95 percent of the voting power is distributed pursuant the relative financial commitments of the constituents: China has 40.0 percent of the voting power, Brazil, Russia, India each have 18.1 percent and South Africa has 5.8 percent.
Decisions at the Standing Committee level require simple majorities for approvals and renewals of liquidity support. Consensus is required for the adoption of procedural rules. Consensus of the creditor constituents is required to approve certain waivers for granting support, approve the withdrawal of a creditor from lending (“encashment”) and confer sanctions on a constituent. The IMF requires simple majorities for the approval of financial arrangements, has no formal provisions for requiring consensus and does not distinguish between creditor and debtor member countries. The voting structure implies that China would need the support of at least one larger country to obtain a simple majority. Similarly the three larger countries can form a simple majority. Like the IMF, the CRA is expected to aim to take most decisions by consensus.
Financial resources: The CRA will have resources of US$100 billion with contributions from China of US$41 billion, Brazil, Russia and India of US$18 billion each and South Africa of US$5 billion.
Resources are committed under an inter-central bank agreement. Resources are provided through a currency swap transactions whereby the debtor (requesting party) obtains (purchases) dollars from the creditor (providing party) in exchange of the debtor’s currency. This implies that the creditor makes temporarily available its foreign exchange reserves. The swap is reversed upon termination of the agreement. This is a similar mechanism to the IMF but the financial commitments are to the IMF and actual financial operations are conducted by the IMF.
Access and IMF link: The CRA extends external liquidity support only to its constituent members. The CRA, similar to the CMIM but unlike the IMF, sets maximum drawing limits as a function of the constituent countries’ commitments. China can draw 50 percent of its committed resources, Brazil, Russia and India 100 percent and South Africa 200 percent. The maximum drawings are a function of whether the debtor country has an arrangement with the IMF, similar to the CMIM. The limits imply that except for South Africa constituent countries can draw up to their commitment or in the case of China less. Access at the IMF can be multiples of countries’ financial commitments to the IMF (quotas).
The IMF delinked portion, the maximum access a country can obtain without having also an arrangement with the IMF, is 30 percent of its maximum access, that is, e.g. for South Africa US$3.0 billion and for Brazil US$5.4 billion.5 The IMF-linked portion, granted upon an existing arrangement with the IMF that is on-track, can constitute up to 70 percent of the maximum access, that is, e.g. for South Africa US$7.0 billion and for Brazil US$12.6 billion. The speed with which access is granted will be a decisive success factor.
Total access under the CRA is US$20.5 billion for China, US$18.0 billion for Brazil, Russia and India and US$10.0 billion for South Africa representing a total lending capacity of US$84.5 billion.
The Council may review and change the IMF-delinked portion.
Instruments: The CRA offers a liquidity and a precautionary facility. For the IMF delinked portion, the liquidity facility has a maturity of six months and can be renewed up to three times. For the IMF linked portion, the liquidity facility has a maturity of twelve months and can be renewed up to two times. The precautionary facility has a tenor of six months under the IMF delinked portion and cannot be renewed and a tenor of twelve months under the IMF linked portion and can be renewed up to two times. The access limits are binding for the sum of both facilities. The relatively short duration of the facilities seem to affirm their character as central bank swaps rather than adjustment lending facilities.
The claims arising from the facilities “constitute direct, unsubordinated and unsecured obligations ranking at least pari passu [...] with [the debtor country’s] present or future direct, unsubordinated and unsecured foreign-currency denominated external indebtedness.” The CRA ranks similar to commercial creditors and as such is junior to the IMF.
The access under the CRA shows that the CRA is a small facility relative to the constituents’ foreign exchange reserves. The low proportion of the IMF delinked portion illustrates BRICS’ reluctance to act outside the surveillance framework and capacity of the IMF. This is likely to have at least two effects: The facility’s small access reduces leverage of the CRA over its borrowers; the facility produces coordination with the IMF but is reduced to a small near negligible add-on to IMF lending. To conduct lending outside the IMF will require some surveillance and enforcement mechanism. The CMIM with the establishment of the ASEAN+3 Macroeconomic Research Office (AMRO) has been trying to create an autonomous surveillance capacity.
The conventional central bank swap approach marks the limited capacity of the facility. Actual and future lending capacity, similar to supporting the IMF, will depend on countries’ foreign exchange reserves. The treaty makes no reference to the possibility of mobilising local currency resources. As such it risks merely perpetuating prevailing conditions guiding access to external liquidity support. The treaty offers though the possibility to alter access and other conditions.
The governance structure of the CRA maintains an approach similar to the IMF but offers important deviations. Voting power at the CRA is a function of economic potency (“power of the purse”) like at the IMF. The imposition of consensus voting though ensures that every constituent can exercise a veto unlike at the IMF where the U.S. is the only country that can exercise that right for important decisions requiring an 85 percent majority (the Eurozone that is not a member of the IMF, also has in aggregate a blocking minority). This implies a much flatter voting power structure for Governing Council and some Standing Committee decisions. At the same time the distinction between creditors and debtors for some voting items appears to foster a creditor-debtor divide which was seen as one of the greatest governance challenges at the IMF. The creditor-debtor divide may unduly undermine building a sense of mutual and like-minded interests that marked the success of the early IMF.
The DB treaty specifies:6
Function: The DB represents a development bank with the objective to mobilise resources for infrastructure and development projects in the BRICS countries and other emerging markets. The DB will focus inter alia on projects involving more than one country. The DB will have its headquarters in Shanghai and a regional office in Johannesburg.
The DB is meant to “complement the existing efforts of multilateral and regional financial institutions for global growth and development.” The DB is thus meant to cooperate with other institutions. It will remain to be seen of whether there will be some explicit or implicit division of labour by type of project or strict hierarchy in the deployment of resources with regard to national, regional and multilateral institutions. The DB can operate mostly autonomously from the other multilateral development agencies and is expected to do so at least over the medium term.
Governance: The DB adopted a similar governance structure to the World Bank and imposed limits on the distribution of voting power like the ADB. The Board of Governors like the World Bank Board of Governors is the highest decision making body of the DB. The Board of Directors Committee similar to the World Bank Board of Directors is responsible for the normal conduct of operations. However, the treaty provides for the Board of Directors to be a non-resident board that meets quarterly. This is interpreted here to offer greater autonomy for the operations of the DB. The President is elected by the Board of Governors and has to be from a founding constituent country and is the chief operating officer. There are at least one Vice-President from each founding constituent country except from the country that represents the President. President and Vice-Presidents are elected for a five-year non-renewable term.7 The DB will have a permanent staff.
The voting power of each constituent country is equal to its subscribed shares in the capital stock of the DB. Given that the initial subscriptions are equal among the constituents, constituents hold equal voting power of 20 percent each. Most decisions are by simple majorities (lending operations) with some qualified majorities (treaty amendments) requiring a two third majority and some special majorities (to authorise some operations in non-constituent countries, suspension of membership) requiring an affirmative vote of four of the five founding constituents represents two thirds of the voting power. The implied equiproportionate distribution of the initial voting power distribution is novel among regional and multilateral institutions. Relative voting power could change with the increase in capital subscription and integration of new constituents over time.
The subscription of shares imposes limits for additional members. Additional subscriptions cannot have the effect of reducing the voting power of the founding constituents to below 55 percent, increasing the voting power of non-borrowing constituent countries above 20 percent and increasing the voting power of a non-founding constituent country to above 7 percent of the total voting power. The voting power limits are similar to the minimum regional representations protected at the ADB and are meant to ensure that the founding constituents remain dominant in the institutions. The voting limits will discourage large economies to join the DB including advanced economies. The pre-determined origins of the President and Vice-Presidents will also likely similarly dissuade larger economies to join.
Financial resources: The DB has authorised capital of US$100 billion and subscribed capital of US$50 billion. The latter is divided into paid-in capital and callable capital similar to other development banks. Total paid-in capital will be US$10 billion. The DB can conduct borrowings in constituent countries and elsewhere. Specific provisions are made for borrowing in local currencies. The total amount of lending cannot exceed its subscribed capital, reserves and other ordinary capital resources including inter alia borrowing. Any borrowing will be the strict obligation of the DB and not of the constituent governments. There is no clarity as to the seniority of the DB relative to the World Bank.
Lending operations: The DB offers very broad based operations and can issue guarantees, loans, participate in loans and offer co-guarantees, in public and private projects including in public-private partnerships and can invest in the equity of any business with projects in the borrowing constituents. Lending operations can occur in local currency.
The DB holds a broad remit and can engage on a large range of projects both public and private. The broad remit may offer important flexibility in deploying resources and in combination with a very flat governance structure, aided by the small membership, may convey greater nimbleness and adaptability of the new institution compared with its established peers. The latter may well represent its strongest comparative advantage. The voting structure, voting limits and provisions for senior staff appointments are seen here to limit incorporations of other large countries and will prevent the DB to become more universal in its membership.
1 The BRICS are considered here to be based on similar principles and concerns as the Group of Five (G5) and later Group of Seven (G7). The G5 and G7 were the outcome of increasing apprehensions about the effectiveness of the main multilateral fora, notably the International Monetary Fund (IMF). However, the G5 and G7 have remained informal arrangements, maintained only ad hoc policy coordination but relied in particular on the IMF as a de facto secretariat.
2 The global financial safety net is generally understood to provide external emergency assistance in the event of severe balance of payments pressures.
3 All CRA references are from the Treaty for the establishment of the BRICS contingent reserve arrangement, Melbourne, 21 June 2014.
4 The IMF Articles of Agreement have a provision for a Council to maintain a specific focus on the international monetary system but a Council was never adopted.
5 The delinked portion for the CMIM is 20 percent with a pending proposal to increase it to 40 percent.
6 All DB references are from the Articles of Agreement of the New Development Bank, Fortaleza, 15 July 2014.
7 Except for the first term of the first Vice-Presidents whose mandate is for 6 years.