The potential for a US-UAE swap line is putting new focus on a tool that is considered to be central to the plumbing of the global financial system.
When the Wall Street Journal first reported that the US and the UAE were in discussions about a potential swap line, it left observers wondering why the emirates, which has more than $2 trillion in sovereign investment assets and whose central bank holds more than $300 billion in foreign currency reserves, would need financial assistance during the Iran war.
Comparisons were initially drawn to Argentina, which entered a $20 billion currency swap line with the Treasury Department in October to stabilise the peso. Unlike the Argentinian episode, the UAE maintains it is not in need of external financial backing.
Yousef Al Otaiba, the UAE’s ambassador to the US and Minister of State, said any suggestion the UAE requires external financial backing “misreads the facts”. During a panel session at the Make It In The Emirates forum held in Abu Dhabi this week, Dr Thani Al Zeyoudi, Minister of Foreign Trade, said the idea of a UAE-US swap line is “not about bailing out”.
“It is an elite matter,” he said.
An exclusive hub
Only a few central banks hold standing US dollar swap line arrangements with the US: Canada, England, Japan, Switzerland and the European Central Bank.
As the UAE has made significant efforts to diversify its economy away from oil, Abu Dhabi and Dubai have established themselves as major financial hubs.
Derek Tang, an economist at MPA Macro in Washington, said a major component that differentiates these two cities from metropolises like New York or London is that they are not tied into the traditional financial establishment as those other players.
“These swap lines are missing pieces of the puzzle,” Mr Tang said.
These swap lines are missing pieces of the puzzle
Derek Tang,
MPA Macro
A swap line could have a signal effect for the UAE, whose dirham is tied to the greenback. Mr Tang said that should the US enter a swap line with the UAE, it would give investors confidence to place their assets in the country and in local currency.
“It also comes in the sort of competition and the dynamic within the region too because Saudi Arabia has been making a push for Riyadh to be a corporate hub. So Abu Dhabi and Dubai are in pole position … [and] I think they’re also quite aware that other countries also want a piece of the pie,” he said.
Swap line origins
Swap lines date back to the Bretton Woods agreement in the 1960s and are most commonly associated with the Federal Reserve, whose Federal Open Market Committee directs the Federal Reserve Bank of New York to maintain swap agreements with certain foreign central banks.
Because of the dollar-based system, the Federal Reserve is considered to be the indirect lender of last resort to foreign central banks during times of crisis.
They were used prominently to support US dollar liquidity during the 2008 global financial crisis and the outset of the Covid-19 pandemic.
Peak swap line usage surpassed $580 billion in December 2008 during the global financial crisis. Roughly $450 billion in dollar liquidity swaps with foreign central banks were used during the peak of the Covid-19 crisis, according to the Federal Reserve Bank of Dallas.
How do swap lines work?
Under a swap line agreement, the US and a foreign central bank exchange equivalent amounts of their currencies and swap back those quantities at a fixed end date, with the foreign central bank taking the credit risk. A theoretical US-UAE swap would mean the Federal Reserve lends US dollars to the Central Bank of the UAE, holding dirhams in return, with the transaction reversing in the future.
The Federal Reserve also has a tool called the Foreign International Monetary Authorities (FIMA) Repo Facility, which the UAE would be able to theoretically use to convert their US Treasury holdings to dollars without needing to establish a new dollar swap line.
However, the structure of the Federal Reserve could slow down any such process of a potential US-UAE swap line. Done this way, it would have to go through the seven members who sit on the Fed board in Washington, as well as the president of the New York Fed.
That would make a swap line with the Treasury a likelier scenario, as the Financial Times previously reported.
The Treasury implements swap lines through its Exchange Stabilisation Fund (ESF). The ESF consists of three components: US dollars, foreign currencies and special drawing rights (SDR), which are an international reserve asset created by the International Monetary Fund.
The Treasury secretary wields significant discretion over the ESF and can establish a currency swap without congressional approval. Such was the case when the US bailed out Argentina, which was considered part of an effort by President Donald Trump’s administration to support Argentinian President Javier Milei during the country’s midterm elections.
However, that flexibility has its own limitations. The ESF has a cap of roughly $43 billion, while The Fed’s standing arrangements are potentially unlimited.
New Fed chair, new expectations
The renewed focus on swap lines come during a leadership transition at the Federal Reserve, whose independence is under increasing strain by Mr Trump.
With Jerome Powell’s term as Fed chair set to expire this month, attention is turning towards the man who is expected to be his successor: Kevin Warsh.
In a written response to a Senate banking committee as part of his nomination hearing last month, Mr Warsh previewed a change in the Fed’s role over swap lines in which he arguing the central bank’s independence should be viewed through the lens of monetary policy.
“Fed officials are not entitled to the same special deference in areas affecting international finance, among other matters,” he wrote, suggesting the Fed would work with the Treasury and Congress.
Treasury Secretary Scott Bessent, who has pushed for a more expansive role of the US dollar, said a US-UAE swap line would benefit both countries and that other Gulf and Asian allies have made similar requests.
The renewed focus on swap lines also comes as the UAE exits Opec and receives advanced military technology from the US.
In a follow-up tweet last month, he said those talks “are part of continuing, routine conversations” the department has had with its partners for years and are a “testament to the US dollar’s primacy and the strength of America’s economic shield”.
Mr Tang argued that, for Mr Bessent and Mr Warsh, recalibrating the implementation of swap lines would help ensure the US dollar’s status as the world’s reserve currency remains unrivalled.
“It’s about the whole ecosystem, where you’re also tying the swap lines with military co-operation and economic ties and tech transfers and so on. You’re basically cleaving these allies closer to you,” he said.