Global Money Notes #12

THIS IS NOT RESEARCH.
PLEASE REFER TO THE IMPORTANT INFORMATION FOR IMPORTANT DISCLOSURES

AND CONTACT YOUR CREDIT SUISSE REPRESENTATIVE FOR MORE INFORMATION.
22 March 2018
Investment Solutions & Products
Global
Credit Suisse Economics
Global Money Notes #12

BEAT, FRA-OIS and the Cross-Currency Basis
Since the global adoption of Basel III in 2015, dollar funding markets were CONTRIBUTORS
rattled by two events: money fund reform in 2016 and tax reform in 2018.
Banks have weathered the storm of 2016 and will weather the storm of 2018, Zoltan Pozsar
212 538 3779
thanks to their robust liquidity buffers. While Libor-OIS spreads look scary, zoltan.pozsar@credit-suisse.com
they are not systemic. Spreads have widened not because cash investors don’t
want to fund banks, but because external forces are changing their habitats.
During money fund reform, $800 billion went from prime to government funds.
Foreign banks lost their access to CD and CP markets which they quickly
replaced via FX swaps, pressuring cross-currency bases wider. Pressures on
bases persisted until the three-month FX swap-implied cost of dollar funding
got flat relative to 1-3 year funding, at which point banks started to term out.
Term issuance relieved pressure on cross-currency bases and the CD market.
Back then, the marginal buyers of term debt were corporate treasurers. But
now, tax reform is wreaking havoc with their investment patterns. Now that
offshore corporate savings are available for use onshore, corporate treasurers
are selling 1-3 year bank debt, forcing foreign banks to issue at those
segments of the unsecured bank funding curve that are not selling off:
barbelling by printing 3-month CD and CP and debt beyond the 3-year point.
Pressures due to repatriation will persist until the 1-3 year segment gets flat
relative to the 5-year point, where a deeper buyer base is waiting to roll down
the curve – at the right price. What corporate treasurers were to banks during
money fund reform, intermediate bond funds will be to banks as they replace
corporate treasurers as dedicated buyers of 1-3 year foreign bank debt.
Printing three-month CD and CP is not particularly helpful when the supply of
short-term unsecured funding is a lot less flexible on the margin due to the
legacy of money fund reform. Despite a steep Libor curve, inflows to prime
funds have been negligible. Bill supply also does not help. But there is more…
The base erosion and anti-abuse tax (BEAT) has also been driving markets.
BEAT is forcing foreign banks to substitute FX swaps with unsecured funding
and also leads to temporary overfunding on the margin. The only outlet for
excess funding is FX swaps. BEAT explains why cross-currency bases are
tighter while Libor-OIS is wider, and also introduces upside risks to FRA-OIS.
Important Information
This report represents the views of the Investment Strategy Department of Credit Suisse and has not been prepared in
accordance with the legal requirements designed to promote the independence of investment research. It is not a product of
the Credit Suisse Research Department and the view of the Investment Strategy Department may differ materially from the
views of the Credit Suisse Research Department and other divisions at Credit Suisse, even if it references published research
recommendations. Credit Suisse has a number of policies in place to promote the independence of Credit Suisse’s Research
Departments from Credit Suisse’s Investment Strategy and other departments and to manage conflicts of interest, including
policies relating to dealing ahead of the dissemination of investment research. These policies do not apply to the views of
Investment Strategists contained in this report.
22 March 2018
Certain aspects of tax reform constitute a re-boot in dollar funding markets, especially the
FX swap market. Repatriation and the base erosion and anti-abuse tax (BEAT) are
forcing banks to fund in three-month CD and CP markets and fund less via FX swaps.
BEAT impacts the FX swap market the most.
BEAT penalizes inter-affiliate funding by forcing the U.S. branches, broker-dealers and
intermediate holding companies (IHCs) of foreign banks to add back to their taxable
income base erosion payments like interest paid to headquarters or foreign affiliates.
To preserve the interest deductibility of all their liabilities, BEAT is forcing the branches
and IHCs of foreign banks to replace inter-affiliate funding with unsecured funding from
third parties. Banks are making adjustments already. Corporations, including banks, pay
taxes quarterly and the sooner inter-affiliate funding is reduced, the less the bite of BEAT.
BEAT-related issuance leads to a temporary state of overfunding at headquarters.
Excess funds are being lent in the FX swap market, which is the only segment of the
money market that trades at a positive spread – however small – to U.S. dollar Libor. The
spread that you make is not what you care about when your tax shield is at stake!
Excess dollars are keeping the cross-currency basis tight – for now, but not forever…
BEAT is also forcing banks to reduce their borrowing via FX swaps. Because local
currency can only be swapped for dollars at headquarters, but not in New York, at the
group level, foreign banks have to replace some FX swap funding with unsecured funding
BEAT thus leads to temporary overfunding and excess dollars in the FX swap market and
it also reduces the structural appeal of FX swaps and increases the structural appeal of
unsecured funding for global banks to fund their New York branches and broker-dealers.
This explains why cross-currency bases are tighter when Libor-OIS is wider. In a way,
BEAT is redistributing pressures from the cross-currency basis to the Libor-OIS basis. The
pressures we should be seeing in cross-currency bases from bill issuance are showing up in
the Libor-OIS basis instead. This suggests Libor-OIS could widen more from here.
Let’s consider some examples.
First, consider the New York branch of a foreign bank which receives funding from
headquarters to fill a funding gap in its loan portfolio (see Figure 1). Transitioning from
headquarters raising unsecured funding, to the branch raising unsecured funding directly
leads to overfunding on the margin. Now that the branch is raising funding on its own,
headquarters has some extra liquidity, which will be lent in the FX swap market.
Surplus liquidity will persist until the debt that used to fund inter-affiliate funding matures
– that could last from a week to a quarter. When that debt matures, excess funding
disappears from the FX swap market. Net demand for unsecured funding is unchanged.
Next, consider the example of an IHC which houses the broker-dealer of a foreign bank
(see Figure 2). The dealer’s HQLA portfolio has to be funded on an unsecured basis, and
the IHC currently receives the funding from headquarters. As before, the interest paid to
headquarters is no longer tax deductible and so the IHC is forced to raise unsecured
funding from third parties. At the headquarters level, this leads to overfunding as well,
with excess funding looking for an outlet, which here too will be the FX swap market.
As before, when the debt that used to fund headquarters’ loan to the IHC matures,
excess funding will disappear from the FX swap market. The bank shifted some portion of
its unsecured funding from headquarters to the IHC. Bid for unsecured funds increased
temporarily and the supply of dollars via FX swaps increased temporarily, but when
excess funding disappears, the bank’s need for unsecured funding is unchanged on net.
Global Money Notes #12 2

22 March 2018
Now consider the case of a branch that receives some dollar funding from headquarters,
which headquarters raised by swapping some local currency for dollars via FX swaps
(see Figure 3). Like before, the interest paid by the branch for the downstreamed dollars
is no longer tax deductible, so the branch has to raise unsecured funds from third parties.
As before, headquarters ends up with excess dollars which will be lent via FX swaps.
When it lends dollars via FX swaps, headquarters ends up with a matched book position:
headquarters went from a borrower to a matched book lender of dollars via FX swaps.
When the FX swap that was initially used to fund the branch matures, the matched book
goes away and excess funding disappears from the FX swap market.
Unlike before, the bank’s funding model also changed…
The bank shifted some funding from FX swaps to the unsecured market. That’s because
local currency can only be swapped for dollars at headquarters, but not in New York City
– a fact of life. Bid for unsecured funds increased structurally, the supply of dollars via FX
swaps increased temporarily, and the bid for dollars via FX swaps declined structurally.
Tracking the flows related to banks’ adjusting their funding models is not possible on a
high-frequency basis. The Fed’s weekly H.8 release has one related line item, which is
“net due to related foreign offices”. Net measures are a pity. Like the BIS, we wished the
Fed also embraced the virtue of gross measures more enthusiastically. On a net basis,
foreign banks’ New York offices owe $300 billion to related foreign offices. But this net
measure does not tell us whether net $300 billion is the net of gross $300 billion
borrowed and zero lent, or the net of gross $600 billion borrowed and $300 billion lent.
For gauging the impact of BEAT-related flows, it is gross, not net borrowing that matters.
That leaves us with having to work with the FFIEC002 and Y-9C reports of foreign banks
again. From earlier issues of Global Money Notes (see here and here) and our study,
Dollar Funding After the Storm, we know that specific branches of foreign banks either
lend dollars to headquarters or borrow dollars from headquarters. The statistical concept
“net due to related foreign offices” only exists at a “macro” level, not a single entity level.
The balance sheets of Deutsche Bank in Germany, Barclays in the UK, DNB in Norway,
BTMU and SMBC in Japan, UBS in Switzerland, and NBC, RBC and BNS in Canada all
suggest some heavy reliance on headquarters for dollar funding (see Figures 4-12).
Their funding would all have to be rejiggered so as to reduce their reliance on
headquarters for dollars. To the extent that the dollars from headquarters were raised via
FX swaps, replacing FX swaps with unsecured funding would explain why the basis
between the dollar and all major currencies (EUR, GBP, JPY, CHF, NOK and CAD)
have narrowed and are now borderline positive when the Libor-OIS basis has widened.
In the case of these banks, the aggregate amount of dollar funding received from
headquarters is $300 billion. In the EU there is an additional group of small banks that
downstream over $50 billion in funding to their branches in New York (see Figure 13). In
addition to these branches, broker-dealers receive about $100 billion from headquarters.
Re-calibrating the flows around $450 billion of funding could lead to considerable
amounts of overfunding, and to the extent that these funds were raised via FX swaps at
headquarters, it could also mean a meaningful decline in the bid for dollars via FX swaps.
In the case of Japan for example, megabanks roll about $200 billion in the FX swap
market compared to $1 trillion for life insurers (see Figure 14). Japanese megabanks
New York branches borrow about $70 billion from headquarters and their dealer arms
about $30 billion. That means that about $100 billion in borrowing via FX swaps in Tokyo
could be replaced with unsecured funding once the temporary glut of dollars disappears…
…and that’s from Tokyo alone!

22 March 2018
In an era where prime money funds are a shadow of their former selves and the supply of
short-term unsecured funds is less flexible on the margin, that’s a considerable amount of
pressure on CD and CP rates and Libor fixings in general. BEAT-related issuance will add
to the pressures coming from repatriation which is also forcing the same foreign banks to
issue CD and CP (see the opening essay). Increased bill supply also does not help.
Where does all this leave us on the cross-currency basis and the hedging costs of the
marginal buyer of U.S. assets – Japanese life insurers and hundreds of regional banks?
The risk that increased supply of Treasury bills will drain o/n repo funding, which has
been the dominant source of dollars for Japan Inc.’s hedging needs (see Section 1 here),
still persists, but the impact that bill issuance was supposed to have on the basis is being
offset by banks in Tokyo and elsewhere stepping away from the FX swaps on the margin
and the temporary overfunding at headquarters leading to an excess lending of dollars in
FX swap markets. For now, the supply of dollars is greater than demand for dollars.
For now, but not forever…
As overfunding fades and banks’ structurally lower bid for dollars is absorbed by others
over time, cross-currency bases will widen again. Until then the pressure on marginal
buyers’ hedging costs will come not from the cross-currency basis (relative to Libor), but
the Libor-OIS basis. Either way, the hedging costs of marginal buyers of U.S. assets are
creeping higher. What matters is the FX swap implied cost of dollar funding and not
whether the pressures are coming from the cross-currency basis or the Libor-OIS basis.
From a hedging cost perspective, a cross-currency basis of positive 20 and a Libor-OIS
of 90 is the same as a cross-currency basis of negative 20 and a Libor-OIS basis of 50.
With hedging costs north of 2.5%, the U.S. Treasury curve is already flat from the
perspective of Japanese buyers (see Figure 15). One should always evaluate the flatness
of curves from the perspective of the marginal buyer, and the current marginal buyer does
not fund at the repo curve, but rather at curves that are driven by repatriation and BEAT.
Further pressures on Libor-OIS and, at some point, renewed pressure on cross-currency
bases could pressure U.S. dollar hedging costs to a point where Japanese and other
marginal buyers are forced to sell U.S. Treasuries, MBS and credit in the U.S. and shift
their portfolios to other regions – like Europe – where hedging costs are less of a drag.
We see marginal flows go the way of Europe already. Whether we will see a rotation out
of U.S. assets is down to U.S. dollar hedging costs, which in turn is down to the interplay
between and combined impact of taper, the echo-taper, BEAT and bill issuance. How
tight the front-end will get and where front-end spreads will settle is the ultimate arbiter
of where hedging costs settle and if they will trigger pressures on U.S. rates and credit…
As we have said before, the FX swap lines are not there to make life cheap for banks, but
to make sure life goes on if funding markets dry up. But if funding market dynamics are
going to turn the marginal buyer of U.S. assets into marginal sellers of U.S. assets, the
Fed has a bigger issue at hand and may want to use the FX swap lines to a greater end...

22 March 2018
Figure 1: BEAT and New York Branches

NY HQ
1 Loan interoffice interoffice Debt The way it used to be.
NY HQ
2 Loan interoffice interoffice Debt BEAT
$ CD
NY HQ
3 Loan interoffice interoffice Debt Excess funding.
$ CD $
NY HQ
4 Loan CD $ Debt Release via FXS.
FXS
NY HQ
5 Loan CD FXS Debt The way it will be.
(unsecured to unsecured)
Source: Credit Suisse
Figure 2: BEAT and Broker-Dealers

IHC HQ
1 HQLA interoffice interoffice Debt The way it used to be.
IHC HQ
2 HQLA interoffice interoffice Debt BEAT
$ CP
IHC HQ
3 HQLA interoffice interoffice Debt Excess funding.
$ CP $
IHC HQ
4 HQLA CP $ Debt Release via FXS.
FXS
IHC HQ
5 HQLA CP FXS Debt The way it will be.
(unsecured to unsecured)

22 March 2018
Figure 3: BEAT and Banks’ Demand for FX Swaps

NY HQ
1 HQLA interoffice interoffice FXS The way it used to be.
NY HQ
2 HQLA interoffice interoffice FXS BEAT
$ CD
NY HQ
3 HQLA interoffice interoffice FXS Excess funding.
$ CD $
NY HQ
4 HQLA CD $ FXS Release via FXS.
FXS (borrower to matched book)
NY HQ
5 HQLA CD FXS FXS The way it will be.
(FX swap to unsecured)
Figure 4: Deutsche Bank’s New York Branch

$ billion
180
160
140 53
120 97
Interoffice funding (dollars from HQ)
5
Deposits (operating)
15 Money market funding (unsecured - fed funds purchased)
100
0 Money market funding (unsecured - o/n TDs and CDs)
Money market funding (unsecured - CP and term debt)
Money market funding (repos)
80
Other
Derivative payables
16 HQLA (reserves)
60
0 HQLA (reverses)
4
1 HQLA (bonds)
54
40 19 Money market lending (dollars to HQ)
Money market lending (fed funds sold)
Money market lending (interbank deposits)
20 20 Capital market lending (corporate bonds, ABS, etc.)
0 Loans (traditional lending)
22 0 3 2
0
1
4 9 0 9
8 8 0 Derivative receivables
10
0 0 Total change
-4 -3
-1
-1
-1 -6
(20) -6
(40)
Assets Liabilities Assets Liabilities Assets Liabilities
Balance sheet "Into the Storm" "Dollar Funding Conditions Ease"
snapshot as of 3/31/17 (change from 6/30/16 to 12/31/16) (change from 12/31/16 to 3/31/17)
Deutsche Bank NY branch
Source: FFIEC002, Credit Suisse

22 March 2018
Figure 5: Barclays New York Branch

$ billion
45
40
35
21
30
29 Interoffice funding (dollars from HQ)
25
Money market funding (unsecured - fed funds purchased)
0 Money market funding (unsecured - o/n TDs and CDs)
20 Money market funding (unsecured - CP and term debt)
Other
15 Derivative payables
HQLA (reserves)
20 3
0 HQLA (reverses)
10
HQLA (bonds)
Money market lending (dollars to HQ)
10 Money market lending (fed funds sold)
5
0
2 0 Capital market lending (corporate bonds, ABS, etc.)
0 0 1
0 0 0
0 0 Loans (traditional lending)
-3 -2
Derivative receivables
0 -5
-6
-5 Total change
(5) -5 -5
-7
(10) -10 -5 -10
(15)
Barclays Bank NY branch
Figure 6: Bank of Tokyo-Mitsubishi New York Branch

$ billion
180
160 33 33
0
140 7 11
0
3

120
Money market funding (unsecured - o/n TDs and CDs)
100
75 Money market funding (repos)
Other
HQLA (reserves)
HQLA (reverses)
60 HQLA (bonds)
111 Money market lending (dollars to HQ)
40 Money market lending (interbank deposits)

35
Capital market lending (corporate bonds, ABS, etc.)
Loans (traditional lending)
20 2
0
6 2
0 Total change
3
4 1
2 4
1 4 2
0 0 1
1 2
0
0 -6 -3 -6 -4
-7
-7
(20)
Bank of Tokyo-Mitsubishi NY, LA and Chicago branches (including the NY branch of the Trust Bank)

22 March 2018
Figure 7: Sumitomo Mitsui New York Branch

$ billion
120
22
100 29
0
4
0
80 12 Interoffice funding (dollars from HQ)

0
60
Other
Derivative payables
56 HQLA (reserves)
83
40 HQLA (reverses)
HQLA (bonds)
6
20
Capital market lending (corporate bonds, ABS, etc.)
3
7
14
15
10 3 6 6 Total change
3 5 5 0 0
0 4 5
0 1
-1 -1
-9
-18 -2
-2
(20)
Sumitomo Mitsui NY branch
Figure 8: UBS New York Branch

$ billion
30
25
17
20

15
10 4 10 10 Money market funding (repos)
Other
0
Derivative payables
12
10 HQLA (reserves)
5 4
HQLA (reverses)
2
0 HQLA (bonds)
0
1
0 0 0 0 0
0
0
-1 Capital market lending (corporate bonds, ABS, etc.)
(5) -9 Derivative receivables
-13 Total change
(10) -10 -10
(15)
UBS NY branch

22 March 2018
Figure 9: DNB Bank New York Branch

$ billion
25
20
4

7 Deposits (operating)
12 12 Money market funding (unsecured - o/n TDs and CDs)
21
21 Money market funding (unsecured - CP and term debt)
10 4
Other
Derivative payables
9 3 HQLA (reserves)
5 0 HQLA (reverses)
HQLA (bonds)
5
1 1
0 0 Money market lending (interbank deposits)
0 1 1
0 0 0 0
0 Capital market lending (corporate bonds, ABS, etc.)
-2 Loans (traditional lending)

-3 -2
-6 Total change
-9
(5)
0
(10)
DNB BK ASA NY BR
Figure 10: Royal Bank of Canada New York Branch

$ billion
50
13
40 20
0
5
0
30 0 Interoffice funding (dollars from HQ)
20
Other
29
Derivative payables
26
HQLA (reserves)
10 HQLA (reverses)
HQLA (bonds)
0
0 5
2 Money market lending (interbank deposits)
0 0 0
0 0 1 1
0 -1 0 Capital market lending (corporate bonds, ABS, etc.)
-2
-4
-1 -4 Loans (traditional lending)
-12 Total change
-8
(10)
-11 -11
(20)
Royal Bank of Canada NY branch

22 March 2018
Figure 11: National Bank of Canada New York Branch

$ billion
12
10
4
4

0
6 2 Money market funding (repos)
Other
Derivative payables
5 5
1 HQLA (reserves)
1
4 HQLA (reverses)
5 2 0
0 HQLA (bonds)
2 3 3
4 1
2
0
1
0
0 Derivative receivables
2
1 Total change
0 0
0 0 0 0
0
-1
(2)
National Bank of Canada NY branch
Figure 12: Bank of Nova Scotia New York Agency

$ billion
80
70
17 17
60
0
5
50
6 Deposits (operating)
40
30
Other
6 35 Derivative payables
0 HQLA (reserves)
20
HQLA (reverses)
HQLA (bonds)
7
0
1
0 0 0 0
-1
-1
0
-1 -1
-4 Derivative receivables
-7
(10) -6 -4 Total change
-11 -11
-1
0
0
-10 -12
(20)
-23 -23
(30)
BANK OF NOVA SCOTIA NY AGY

22 March 2018
Figure 13: New York Branches of Various Eurozone Banks

$ billion, excluding Deutsche Bank New York branch
90
80
70
34

60
56
50 1
0
Other
HQLA (reserves)
HQLA (reverses)
30 HQLA (bonds)
0
20 36 Money market lending (interbank deposits)

13 13
16 Derivative receivables
10
9 Total change
6
0
0 0 3
0
0 2 0 1
0
0 0
-7 -5
-9 -1
0
-7 0 -7
(10)
U.S. branches of Eurozone banks that take U.S. dollars from HQ
Figure 14: Japanese Megabanks’ Dollar Needs in the FX Swap Market

$ billion
Source: Bank of Japan

22 March 2018
Figure 15: Getting Expensive (for Changing Reasons)

%
2.75
2.50
2.25
2.00
1.75
1.50
1.25
1.00
0.75
0.50
0.25
0.00
15 16 17 18
U.S. dollar OIS Libor-OIS $/¥ cross-currency basis (to U.S. dollar Libor)

22 March 2018
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THIS IS NOT RESEARCH.

PLEASE REFER TO THE IMPORTANT INFORMATION FOR IMPORTANT DISCLOSURES

Credit Suisse Economics

Global Money Notes #12

Global Money Notes #12 2

Global Money Notes #12 3

Global Money Notes #12 4

Figure 1: BEAT and New York Branches

Source: Credit Suisse

Figure 2: BEAT and Broker-Dealers

Source: Credit Suisse

Global Money Notes #12 5

Figure 3: BEAT and Banks’ Demand for FX Swaps

Source: Credit Suisse

Figure 4: Deutsche Bank’s New York Branch

Source: FFIEC002, Credit Suisse

Global Money Notes #12 6

Figure 5: Barclays New York Branch

(10) -10 -5 -10

Source: FFIEC002, Credit Suisse

Figure 6: Bank of Tokyo-Mitsubishi New York Branch

Interoffice funding (dollars from HQ)

40 Money market lending (interbank deposits)

Source: FFIEC002, Credit Suisse

Global Money Notes #12 7

Figure 7: Sumitomo Mitsui New York Branch

80 12 Interoffice funding (dollars from HQ)

Source: FFIEC002, Credit Suisse

Figure 8: UBS New York Branch

25 Interoffice funding (dollars from HQ)

(10) -10 -10

Source: FFIEC002, Credit Suisse

Global Money Notes #12 8

Figure 9: DNB Bank New York Branch

15 Interoffice funding (dollars from HQ)

-2 Loans (traditional lending)

Source: FFIEC002, Credit Suisse

Figure 10: Royal Bank of Canada New York Branch

Source: FFIEC002, Credit Suisse

Global Money Notes #12 9

Figure 11: National Bank of Canada New York Branch

8 Interoffice funding (dollars from HQ)

Source: FFIEC002, Credit Suisse

Figure 12: Bank of Nova Scotia New York Agency

Source: FFIEC002, Credit Suisse

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Figure 13: New York Branches of Various Eurozone Banks

Interoffice funding (dollars from HQ)

20 36 Money market lending (interbank deposits)

Source: FFIEC002, Credit Suisse

Figure 14: Japanese Megabanks’ Dollar Needs in the FX Swap Market

Source: Bank of Japan

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Figure 15: Getting Expensive (for Changing Reasons)

Source: Credit Suisse

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Additional Important Information

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