MAS FOREX RESERVES & ACCOUNTING FOR FOREIGN CURRENCY ISSUES

Following the news of the massive loss on foreign exchange translation by the MAS for y/e 31 Mar 2022 there was much discussion in social media on the confusion of the accounting. For me, it's all basic accounting. The only issue I was not clear about at the time was whether the RMGS (Reserve Management  Government Securities are denominated in SGD or foreign currency.

In July/August I had a lengthy discussion with Jamus Lim on the topic. We had several exchanges on Facebook which is not really a good platform for serious discussion. I was pleased Jamus had the interest, concern and patience to spend time with me for mutual sharing of opinions. We parried over a few issues mainly on MAS' exposure to foreign currency and how losses are accounted for. On RMGS, Jamus eventually believed it is SGD-denominated according to his contacts. I too have come to this conclusion.

From various comments in social media, it is apparent most folks, including accounting professionals, do not really appreciate foreign currency revaluation and translation treatment in financial institutions, including central banks. For these institutions, money is a stock-in-trade, and their accounting for currency P&L is somewhat different from legacy methods. 

MAS and movement of currency reserves.

Assume functional (base) currency is SGD.

1.     As a central bank, the job of MAS is managing monetary policies. Unlike for-profit companies that can hedge their currency risks, MAS has to take the market risks. That means it is exposed to the vagaries of currency rate volatilities. Its huge forex reserves expose it to risks of huge forex losses if SGD continues to appreciate.
2.     Persistent trade surplus puts upward pressure on the SGD. MAS forced to buy foreign currencies, thus accumulates huge fx reserves.
3.     When MAS buys GBP (as an example) it involves a foreign exchange transaction. Asset (Cash-GBP) and (Spot position - GBP) both increase. Asset (Banks reserve a/c - SGD) and Liability (Spot position - SGD) both decrease. The GBP spot position is exposed to daily revaluation.

4.     When MAS sells GBP it involves a foreign exchange transaction. Asset (Cash-GBP) and (Spot position - GBP) both decrease. Asset (Banks reserve a/c - SGD) and Liability (Spot position - SGD) both increase. The GBP spot position is exposed to daily revaluation.

5.     When rates go up, the GDP positions is valued less in SGD terms, thus creating a currency loss.  On day-to-day basis, exchange rates go up and down, thus daily revaluation gains or losses more or less evens out.
6.     Trend line of SGD appreciation means over longer term, MAS makes loss in GBP reserves. 

7.     Forex P&L are cumulative from daily revaluation of open USD spot position. 

MAS and transfer of currency reserves to GIC 
Assume functional (base) currency is SGD. The term 'government' here means the Accountant General Office.

8.     MAS has GBP (as example) reserves far in access of its needs for monetary policy management purposes. It seeks to transfer access forex reserves out to GIC to be better invested.

9.     Government SGD receipts are all funnelled into their cash account at MAS. The government maintains an optimum cash balance for their needs. Some SGD funds are invested in liquid short term securities, excess is transferred to GIC for long term investment.

10.    In the past, the needs in (8) and (9) are met by MAS transfering GBP to GIC. This is in effect, government converting at spot rate to change the excess SGD to GBP. 
11.    When MAS transfers out GBP using govt SGD cash balances :
- In govt books, the funds move from Cash (SGD) to Investments (SGD). A change of one asset to another form of asset, same currency. There is no forex exposure.
- In MAS book, it involves a currency exchange transaction. Asset (Cash - GBP) and Liability (Spot position - GBP) are both reduced; its Asset (Spot position - SGD) and Liability (Govt Cash a/c - SGD) are reduced. The GBP spot position is exposed to rate volatility..
- In GIC books, it takes on asset (Cash - GBP) and liability (capital - GBP), thus no currency risks. (If GIC uses the foreign currency to invest in a different currency asset, then it creates currency risks -- but that is a different issue).
12.    This mechanism of (10) works but the problem is MAS accumulates forex reserves at a rate much faster than the government SGD cash balance can build up. 
13.    Thus the introduction of RMGS. There is no need for the Govt cash balance to build up. Govt issues RMGS which is SGD-denominated. MAS subscribes to the issue. 
14.    On issuance of RMGS, MAS pays for the subscription in  foreign currency based on spot rates per RMGS Act:
- In Govt books, Liability (Securities Fund - SGD) and Asset (Investment - SGD) both increase. There is no foreign currency risk.
- In MAS books it involves a currency transaction.  Asset (Cash - GBP) and Liability (Spot position - GBP) both decrease; its  Asset (RMGS securities - SGD) and Liability (Spot position - SGD) both increase. GBP spot position is exposed to rate volatility.
- In GIC books Asset (Cash - GBP) and Liability (capital - GBP) both increase. There is no currency risk. (If GIC uses the foreign currency to invest in a different currency asset, then it creates currency risks -- but that is a different issue).
15.   On redemption of RMGS, the govt has to pay back MAS in foreign currencies based on spot rate per the RMGS Act.
- In govt books Asset (Cash at MAS - SGD) and Liability (Securities Fund - SGD) both decrease. No foreign exchange involved.
- In MAS books it involves a currency transaction.  Asset (Cash - GBP) and Liability (Spot position - GBP) both increase; its  Asset (RMGS securities - SGD) and Liability (Spot position - SGD) both decrease. GBP spot position is exposed to rate volatility.

- In GIC books asset (Cash - GBP) and liability (capital - GBP) decrease. No foreign exchange involved. 

The transfer of forex reserves to GIC is always explained away as moving funds in excess of needs to GIC where it can be better invested in longer term assets to earn better ROI. There are 2 other benefits. First, huge forex reserves in MAS attracts criticism and complaints of state currency manipulation. Transferring out and reducing the numbers in the books of MAS helps to allay the criticism. Second, it reduces currency risk exposure of the MAS. Sort of killing three birds with one stone.

The RMGS Act does not specify the currency denomination except that settlement for both subscription and redemption is in foreign currency. I sought the input of the AGO for confirmation, solely for academic interest purpose, as to whether RMGS is SGD-denominated. My request went unanswered. I don't understand what is so secretive about this.  Finally, I concluded RMGS are indeed SGD-denominated by comparing the numbers in both MAS and govt financial statements.

It seems to me there is a lack of literature written from a practical point of view, not an academic discourse,on how banks handle foreign exchange accounting. It is an esoteric subject even accounting professionals not in the banking sector would probably be hesitant. This is not to say they are any less intelligent, but that they have no practical experience.

The above description pre-supposes MAS uses multicurrency system with daily revaluation. It is inconceivable that MAS, with balance sheet size of S$697b (2022), is still using antiquated single currency system.

"In the multi-currency systems of banks, the accounting treatment of foreign currency transactions and currency translation do not apply. It is a revelation to many outside the industry".... Pat Low

Multi-currency systems in brief:

- Each currency has a self-balancing ledger.
- Other than the functional currency, all other currencies are considered foreign currencies.
- Transactions in respect of a single foreign currency (example making foreign currency payments) do not involve forex gains or losses.
- Only foreign exchange transactions involve forex P&L.
- Umatured forward FX transactions are revalued daily and taken into unrealised currency P&L..
- Matured FX transactions are revalued on settlement and taken into realised currency P&L.
- Matured FX transactions are settled which creates spot positions..
- Brought forward foreign currency spot positions are revalued daily and taken into Revaluation P&L. .
- Financial reporting is the consolidation of all currency ledgers into a reporting currency. There is no translation P&L in converting to a reporting currency.

From the above, it can be seen that on transfer of foreign currencies to GIC, ie on date of disposal, there is no exchange loss on the part of MAS. There were a lot of socmed discussion talking about realised currency losses on disposal of foreign currency assets. The computation of realised losses is made on the settlement of foreign exchange contracts. For spot contracts, the currency P&L is not significant as the book rate is likely to be very close to the spot rate used for the transaction. The huge losses of MAS for the year 2022 was cumulative daily revaluation of currency spot positions built up over over time.  Similarly, in the future should RMGS be redeemed, govt will return foreign currencies to MAS based on spot rates. There will be very little currency P&L as the spot and book rates will be very similar. 

To demonstrate my point about difficulty of understanding multi-currency accounting in banks, check this article by a top public accounting firm in Singapore that wrote on the subject matter for the Central Bank of Cambodia. It contains flawed fundamentals as indicated in the notations I made on the document. After going through it, I am certain most readers would be none the wiser.

If pros like this article creators cannot even explain it right, you can appreciate how confusing it is. I decided to write a technical ebook to fill what seems to me a knowledge gap. I have now completed the content and currently studying which is the best digital platform to monetise it. Currently looking at how to self-publish since I do not even have a shoestring budget.

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