Cablegate: Uk Special Liquidity Facility Is a Success

DE RUEHLO #1655/01 1710939
R 190939Z JUN 08




E.O. 12958: N/A

1. (U) By ensuring broad participation, including the UK's five
largest banks, and by ensuring strict confidentiality, the Bank of
England's (BOE's) Special Liquidity Facility (SLF) has eliminated
the stigma associated with borrowing from the BOE. Because of this,
BOE contacts told Econoff that the SLF announced April 21, 2008 is a
success. The multi-year SLF facility was developed to inject
liquidity into the banking sector by swapping illiquid assets for
liquid ones. The BOE is not required to disclose such swaps so that
even aggregate bank usage remains strictly confidential. There is
no limit on the size of the facility, but estimates range from GBP
50 billion to more than GBP 90 billion. Swaps will remain
outstanding for three years, but must be entered before October 21,
2008 when the facility expires. Multi-year maturity is intended to
dampen recent financial market volatility. The BOE says it will
disclose the aggregate value of swaps outstanding after the SLF
expires on October 21. BOE Governor Mervyn King has said the BOE
will announce a new lending facility by year end 2008. Because of
the success of the SLF in dealing with the stigma issue, the new
facility is likely also to utilize asset swaps and will likely
permit shorter-term borrowings and be ongoing with no fixed
expiration. END SUMMARY

Mechanics Of The SLF

2. (U) The BOE announced the SLF on April 21, 2008. On June 17,
Econoff met with Sarah Breeden (protect), Head of the BOE's Risk
Management Division and Sarah John (protect), Manager Operations
Development at the BOE to discuss the SLF. It will be available for
six months, expiring on October 21, 2008. All banks and building
societies with assets greater than GBP 500 million are able to
participate in the SLF, but participation is voluntary. All
aggregate details of the SLF as well as details of each bank's
participation are strictly confidential. However, the BOE will
disclose the aggregate value of swaps outstanding at the time the
SLF expires on October 21 and annually thereafter until the last
swaps are settled by October 21, 2011. Industry estimates SLF
borrowing is in the range of GBP 50 billion to over GBP 90 billion.
Participation requires that an institution achieve a minimum level
of borrowings within a specified time. The minimum level is related
to the size of the institution. Elements of the facility include:

-Prepayment is permitted but only down to the specified minimum
-There is broad participation, including the top five UK banks.
-There is no cap on the value of swaps the BOE will enter as part of
the SLF.
-Swapped assets must be AAA rated and all credit and default risk
remains with the participating bank.
-The maturity of each swap is one year, automatically renewable
twice for one year for a final maturity of three years, after which
the swap is unwound. Breeden said the three-year maturity was
chosen specifically to provide longer term liquidity and stability
at a time of high volatility in the financial markets.
-Swapped assets must have been on the bank's balance sheet on
December 31, 2007.
-The per annum cost of using the facility is based on the spread
between the three-month LIBOR rate and the repo-rate for government
collateral (currently 75 basis points). The fee is re-set


3. (U) The value of government bonds for which a bank can swap
illiquid assets depends on the value of the assets as determined by
the BOE and the discount (haircut) attributable to the type of asset
being swapped.

-Valuation: The BOE relies on market prices where they are available
or in-house risk-adjusted discounted cash flow modeling. The BOE
relies solely on its own valuation of swap assets, even though a
bank may have used similar modeling techniques to value its illiquid

-Discounts (haircuts): The value of government bonds available in a
swap is determined by discounting the value of a bank's swap assets
by from 12 to 22 percent. The minimum discount of 12 percent
applies to securities that neither were created by the swapping bank
by bundling individual mortgage assets (called own name securities)
nor require BOE modeling to determine value. Own name securities
and securities that must be modeled each incur an additional 5
percent discount for a maximum discount of 22 percent.

Dealing With The Stigma Issue

LONDON 00001655 002 OF 002

4. (SBU) Although the BOE has long been available as a lender of
last resort, the UK financial markets have punished the share prices
of banks that approach the BOE for assistance. A request is taken
as a sign that a bank is in serious financial difficulty.
Accordingly, banks have been reluctant to utilize the BOE as a
funding source. Breeden said it took over four months to develop
the SLF and much attention was paid to avoiding the stigma
associated with borrowing from the BOE. The BOE chose to use asset
swaps because there is no requirement to disclose even aggregate
data on the number and size of swaps. The BOE hoped that
non-disclosure by the BOE combined with strict confidentiality
agreements with participating banks would eliminate the stigma
issue. While the SLF is still new, Breeden said that this key
objective of the SLF has been achieved. As a result, she said the
BOE considers the SLF a success.

Lessons Learned

5. (SBU) BOE Governor Mervyn King has announced that a liquidity
facility is being developed to succeed the current SLF facility.
Breeden said the new facility will be announced before the end of
the year. It will likely include the use of swaps due to the
success of this mechanism in the SLF. However, she said the new
facility may not mandate multi-year borrowings. The three-year
maturity of draw-downs under the SLF was selected in an attempt to
reduce short term volatility in the financial markets. The new
facility will likely facilitate shorter term borrowing to be used in
the ongoing ordinary course of business. Consistent with this
objective, the new facility is being developed to be an ongoing
facility with no expiration.


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