Financial asset management and social responsibility
5.1 Bank of Finland financial asset management
The Bank of Finland invests and manages its financial assets in accordance with the central bank’s objectives, and taking into account the risks and responsibility aspects related to investment activities.
The objective of the Bank of Finland’s financial asset management is to meet the liquidity, security and return requirements placed on the central bank in respect of the assets managed.
In managing its financial assets, the Bank of Finland secures the value of its financial assets and its ability to support the liquidity of the banking system, whenever necessary. The liquidity of financial assets is ensured by minimum amounts of the most liquid government bonds, ensuring the Bank of Finland’s ability to offer liquidity in case of sudden monetary policy needs under all conditions.
The Bank of Finland manages its financial assets in a responsible manner and participates actively in social debate on responsibility in the financial markets and central banks’ investment activities (see for example Governor Olli Rehn’s speech in June 2018 on climate change and Bank of Finland Bulletin blog post on Bank of Finland's investment activities).
In addition, the Bank of Finland is a member of a network of central banks and supervisors which analyses topics related to green finance.
Responsible investment at the Bank of Finland
In its responsibility strategy for direct fixed-income investments, the Bank of Finland takes into account, by applying the method of exclusion, the principles of the UN Global Compact on corporate responsibility that is sustainable, anti-corruption and respects the protection of human rights.
In the execution and management of investment activities, the Bank of Finland utilises analyses by an external service provider on investment instruments that do not fulfil the responsibility criteria. Following the service provider’s analysis, the Bank of Finland takes the final decision on the instruments in which it will not invest. In addition to a company-level responsibility analysis, the Bank of Finland’s strategy for responsible investment is reflected in investment in green, social and sustainability bonds and bonds issued by development banks.
In accordance with the responsibility strategy for fund investments, the Bank of Finland invests only in funds that are managed by companies strongly and transparently committed to responsibility and to promoting responsibility. In addition, the Bank of Finland expects management companies to exert influence on the companies they invest in, so that the companies take into account the issue of responsibility.
The Bank of Finland manages financial assets totalling EUR 11,553 million. These assets consist of direct foreign currency-denominated and euro-denominated fixed-income investments, investments in equity and real estate funds and of gold holdings and items denominated in IMF Special Drawing Rights (SDRs).
The foreign currency-denominated fixed-income investments are composed of US dollars (USD), pound sterling (GBP) and Japanese yen (JPY). These, together with the items denominated in SDR rights, make up the Bank’s foreign reserves.
|The Bank of Finland's financial assets 31 Dec 2018||31.12.2018
|US dollar denominated fixed-income investments||4,271||4,053|
|Pound serling-denominated fixed-income investments||729||733|
|Japanese yen denominated fixed-income investments||482||449|
|Euro-denominated fixed-income investments||3,011||6,232|
|Real estate investments||106||10|
|Source: Bank of Finland.|
The Board of the Bank of Finland takes decisions on the amount of the Bank’s financial assets in accordance with the Agreement on Net Financial Assets (ANFA) between the Eurosystem central banks.
ANFA sets rules for such holdings of national central banks as are related to the discharge of their national tasks. Currently, ANFA does not impose a quantitative limit on the Bank of Finland’s assets; the amount depends on aspects related to central bank duties and investment policy considerations. The Bank of Finland reduced its financial assets by a total of EUR 3 billion in 2018. This was due to investment policy considerations and was done in two stages.
The Bank of Finland’s financial asset risks consist of market, credit and liquidity risks as well as operational risks involved in investment activity.
The limits set for investment risk ensure prudent management of the Bank’s financial assets.
The Bank of Finland’s fixed-income investment portfolios are held in government debt instruments (45%), government-related debt instruments (26%), covered bonds (9%), corporate bonds (9%) and cash (10%).
Of the fixed-income investments, 67% were in debt instruments with a rating of AAA- and AA+, and the lowest credit rating was BBB+ (0.7%). The modified duration of all the Bank’s fixed-income investments at the end of 2018 was 1.8 years.
In the fixed-income market, 2018 was mixed. In the early part of the year, the growth prospects for the economy were good, both for Europe and the United States. Volatility grew, however, and the economic outlook weakened towards the end of the year, as economic policy risks, the protectionist trade policy of the United States and difficulties in the United Kingdom’s Brexit negotiations added to uncertainty and pushed up risk premia in the fixed-income markets.
The increase in uncertainty and the accommodative monetary policy of the ECB kept euro area interest rates at low levels, and the interest rate on government bonds with a high rating remained negative. This was reflected in the return on the Bank of Finland's euro-denominated fixed-income investments, which totalled EUR –17.3 million in 2018.
In the United States, inflation picked up and the unemployment rate fell below 4% in 2018, driven by strong economic growth. The Federal Reserve continued to raise interest rates gradually, but the general level of interest rates started to decline towards the end of the year as market participants became worried about the prospects for economic growth.
Changes in the interest rate in late 2018 reflected positively in the return on the Bank of Finland’s US dollar-denominated investments. In 2018, it totalled EUR 70.6 million. Interest income from pound sterling-denominated investments totalled EUR 2.5 million and that from Japanese yen-denominated was EUR 0.0 million.
The exchange rate of the euro appreciated in early 2018 particularly against the US dollar. The trend turned in the spring, however, as euro area growth showed signs of weakening and the US Federal Reserve changed its monetary policy communication towards tightening.
The most significant impact of the depreciation of the euro against the US dollar was witnessed in the revaluation of the Bank of Finland's foreign reserves, which was positive in the amount of EUR 215 million.
Of the other currencies in the foreign reserves, the euro depreciated against the Japanese yen and appreciated marginally against the pound sterling in 2018.
Exchange rate risk is the most significant risk related to the Bank of Finland’s foreign currency-denominated fixed income investment portfolio, and the amount of the Bank’s foreign reserves has been dimensioned to a level required by central bank tasks. Valuation changes in the foreign reserves reflect the open currency position, which supports the successful discharge of central bank task. The targeted size and currency composition of the foreign reserve portfolio is, as a rule, assessed by the Bank of Finland at three-year intervals.
The Bank of Finland applies to financial asset investments an Asset Liability Management (ALM) framework, which recognises the different types of assets and liabilities on the Bank's balance sheet.
The Bank of Finland's fund investments are part of long-term investment activity, where investments are expected to yield a higher return and have a lower liquidity requirement than other financial assets.
The fund investments are in an advanced economies stock index fund, European real estate funds and ETF real estate funds. The Bank of Finland increased the allocation of equity and real estate investments as planned in 2018.
In the equity markets, the protectionist trade policy of the United States and the Federal Reserve's tighter monetary policy were reflected as subdued developments in global stock indices particularly in the latter part of 2018. The rise in share prices in the early 2018 was reversed in Europe in the second half of the year, and share prices also declined in the United States towards the end of the year.
In 2018, the return on the Bank of Finland's equity fund investments was EUR –43 million. The decline in share prices and the uncertain economic outlook were reflected also in the Bank of Finland's real estate investments, which generated a return of EUR –3 million in 2018.
The total return on and risks of financial assets
In 2018, the return on the Bank of Finland’s financial assets totalled 2.9%, or EUR 224 million. Fixed-income investment portfolios are subject to strategic allocation and currency-specific target durations. The Bank’s Investment division is allowed to deviate from these by making active investment decisions within pre-set bounds for permitted leeway and strict risk limits.
The returns on the fixed-income investment portfolios are benchmarked against indices that are in line with central bank objectives. In 2018, the investments generated a return of 0.08%, i.e. EUR 5.7 million above the benchmark indices.
|Return on the Bank of Finland's own financial assets* in 2018 and 2017||2018||2017|
|%||EUR m||%||EUR m|
|Interest rate return||0.8||56||0.2||24|
|Return on real estate investments||−0.2||−3||−0.1||0|
|* Excluding gold and SDR.
Source: Bank of Finland.
The total market risk related to financial assets (VaR 99%, 1 day) varied between EUR 47 million and EUR 87 million in 2018.
Share of the ECB’s foreign reserves managed by the Bank of Finland
The Bank of Finland manages part of the ECB’s foreign reserves together with the Estonian central bank. Management of the foreign reserves of the ECB has been distributed among the Eurosystem national central banks according to their respective capital keys.
In the management of the ECB’s foreign reserves, the emphasis is on security and liquidity, as the key purpose of the reserves is to ensure the availability of sufficient resources for the Eurosystem’s potential foreign exchange interventions.
The value of Finland’s and Estonia’s pooled portfolio in US dollars of the ECB’s foreign reserves was EUR 1,036 million at the end of 2018. (For additional information on the management of the ECB’s foreign reserves, see the ECB’s Annual Report).