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Swap history: Difference between revisions
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Swap agreements originated in the UK in the 1970s, days, when men were men and governments were suspicious of foreign speculators fannying around in their currencies<ref>A suspicion they would have done well to take more notice of in the 1980s, as it happens — isn’t that right, Mr Lawson?</ref>. Despite running a [[Noel Edmonds’ Multi-Coloured Swap Shop|swap shop]] in the 1970s, Noel Edmonds was not involved. [[HMRC]], for example, would [[tax]] foreign exchange transactions into and out of sterling, constraining capital flight, it was thought, and increasing domestic investment. | Swap agreements originated in the UK in the 1970s, days, when men were men and governments were suspicious of foreign speculators fannying around in their currencies<ref>A suspicion they would have done well to take more notice of in the 1980s, as it happens — isn’t that right, Mr Lawson?</ref>. Despite running a [[Noel Edmonds’ Multi-Coloured Swap Shop|swap shop]] in the 1970s, Noel Edmonds was not involved. [[HMRC]], for example, would [[tax]] foreign exchange transactions into and out of sterling, constraining capital flight, it was thought, and increasing domestic investment. | ||
Still, there was a whole world out there waiting for British money to chase it. So those financial wizards in the city had an idea. How about, simultaneously, ''I'' lend ''you'' a million pounds, at fixed sterling interest, and ''you'' lend ''me'' a million and a half dollars (being the prevailing value of a million sheets in USD), at fixed dollar interest, each of us to repay the other on the same day in 5 years’ time? | Still, there was a whole world out there waiting for British money to chase it. So those financial wizards in the city had an idea. How about, simultaneously, ''I'' lend ''you'' a million pounds, at fixed sterling interest, and ''you'' lend ''me'' a million and a half dollars (being the prevailing value of a million sheets in USD), at fixed dollar interest, each of us to pay interest in the currency of our respective loans and repay the other on the same day in 5 years’ time? | ||
Genius. | Genius. | ||
Thus, originally, swaps were offsetting [[loan]]s | Thus, originally, swaps were offsetting [[loan]]s in different currencies. This arrangement allowed each side to access the foreign exchange of the other country and avoid paying any foreign currency taxes. | ||
IBM and the World Bank entered into the first formalized swap agreement in 1981. The World Bank needed to borrow [[Deutschmark]]s and [[Swiss franc]]s to finance its operations, but the Swiss and German governments prohibited it from borrowing activities. IBM, on the other hand, already had large amounts of those currencies, but needed U.S. dollars at a time when interest rates were high. | IBM and the World Bank entered into the first formalized swap agreement in 1981. The World Bank needed to borrow [[Deutschmark]]s and [[Swiss franc]]s to finance its operations, but the Swiss and German governments prohibited it from borrowing activities. IBM, on the other hand, already had large amounts of those currencies, but needed U.S. dollars at a time when interest rates were high. | ||
Salomon Brothers came up with the idea for the two parties to swap their debts. IBM swapped its borrowed francs and marks for the World Bank’s dollars. This swaps market has since grown exponentially to trillions of dollars a year in size. | [[Salomon Brothers]] came up with the idea for the two parties to swap their debts. IBM swapped its borrowed francs and marks for the World Bank’s dollars. This swaps market has since grown exponentially to trillions of dollars a year in size. | ||
Banks around the world thought, “now, ''that’s'' a sweet idea”. But they encountered legal and financial reporting complications, however: Unsecured loans attract a lot of [[regulatory capital]] if you’re the sort of entity like a bank who has to hold regulatory capital. Was there some way the banks could offset the receivable on the loan they had made against the amount they had borrowed, to reduce the risk of the overall transaction and therefore reduce the regulatory capital charge? | Banks around the world thought, “now, ''that’s'' a sweet idea”. But they encountered legal and financial reporting complications, however: Unsecured loans attract a lot of [[regulatory capital]] if you’re the sort of entity like a bank who has to hold regulatory capital. Was there some way the banks could offset the receivable on the loan they had made against the amount they had borrowed, to reduce the risk of the overall transaction and therefore reduce the regulatory capital charge? | ||