VZCZCXRO2997
RR RUEHBL RUEHED
DE RUEHLO #1655/01 1710939
ZNR UUUUU ZZH
R 190939Z JUN 08
FM AMEMBASSY LONDON
TO RUEHC/SECSTATE WASHDC 8969
INFO RUEHED/AMCONSUL EDINBURGH 0945
RUEHBL/AMCONSUL BELFAST 1075
RUEATRS/DEPT OF TREASURY WASHDC
RUENMEM/EU MEMBER STATES

UNCLAS SECTION 01 OF 02 LONDON 001655 
 
SENSITIVE 
 
SIPDIS 
 
E.O. 12958: N/A 
TAGS: ECON EFIN UK
SUBJECT: UK SPECIAL LIQUIDITY FACILITY IS A SUCCESS 
 
Summary 
------- 
¶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 
level. 
-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 
quarterly. 
 
Valuation 
--------- 
 
¶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 
securities. 
 
-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. 
 
TUTTLE