Financial asset management
4.1 Management of financial assets
The Bank of Finland has financial assets as matching entries to its balance sheet assets and liabilities. These assets are managed and invested in accordance with central bank objectives, taking into account the risks and social responsibility aspects inherent in 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 pursuing these requirements, the Bank takes into account the risks and social responsibility aspects of its investment activities.
In managing its financial assets, the Bank of Finland secures the value of the assets and its ability to support the liquidity of the banking system whenever necessary. The limits set for investment risk ensure prudent management of the Bank’s financial assets. The Bank of Finland’s capital adequacy is sufficient to cover the risks arising from the performance of its tasks.
Volume of financial assets
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. The volume of the Bank of Finland’s financial assets is determined by its central bank tasks and investment policy considerations.
In 2019, the Bank of Finland reduced its volume of financial assets in two stages by a total of EUR 1.5 billion for investment policy reasons. However, because of currency and equity appreciations the value of the Bank's financial assets only declined by EUR 500 million during the year.
The Bank of Finland Board takes a decision every three years on the volume of the Bank's foreign reserves by setting target levels for its fixed-income investments denominated in US dollars, Pounds sterling and Japanese yen. In 2019, new targets for these reserves were set at USD 5 billion, GBP 650 million and JPY 95 billion, respectively. In the spring of 2019, the amount of foreign reserves was adjusted to meet these targets.
Composition of financial assets
At the end of 2019, the Bank of Finland’s financial assets amounted to around EUR 11 billion (Table 2). These assets comprised direct investments in foreign and euro-denominated fixed income, investments in equity and real estate, and gold holdings and items denominated in IMF Special Drawing Rights (SDRs).
The foreign currency-denominated fixed-income investments consist of US dollars (USD), Pounds sterling (GBP) and Japanese yen (JPY). These, together with the items denominated in SDR rights, make up the Bank’s foreign reserves.
Table 2. The Bank of Finland's financial assets, EUR million.
|The Bank of Finland's financial assets, EUR million||31 Dec 2019||31 Dec 2018|
|US dollar-denominated fixed-income||4,641||4,270|
|Real estate investments||127||106|
|Source: Bank of Finland.|
Fixed-income asset investment policy
The Bank of Finland’s fixed-income portfolios are managed in accordance with the investment policy decided by the Bank of Finland Board each year. It sets a strategic allocation for these investments and determines an appropriate level of interest rate risk for each currency.
The investment policy sets out a strategic market-based index that serves as a benchmark for the Bank's investment activities. The fixed-income investments carried out by Bank of Finland portfolio managers are direct investments.
Investments may deviate from the strategic index within a pre-set range as long as they remain within the investment policy’s risk limits. This range is necessary as certain assets featured in the index may not be available for purchase on the market. Furthermore, the investment portfolios are allowed to target additional returns while remaining within the constraints of the risk limits.
Fixed-income markets in 2019
The global economy's deteriorating outlook was reflected in fixed-income markets in 2019. The largest uncertainty factors were the trade war between the United States and, for the most part, China as well as the United Kingdom's withdrawal process from the European Union.
In the United States, yields on Treasury bills declined from 2.6% early in the year to 1.5% by the end of the year. In Europe, yields on French short-term sovereign bonds remained at about -0.5%, but longer-maturity yields such as those on German 10-year sovereign bonds fell from 0.25% to -0.20%. The European Central Bank's decision in September to restart net asset purchases as from November 2019 pushed down yields even further into negative territory.
In May 2019, the US Federal Reverse lowered its main interest rate in response to escalating trade war tensions and the deteriorating economic outlook. Further interest rate cuts in September and October eventually lowered the interest rate corridor by 0.75 percentage points from the beginning of the year, to 1.50–1.75% at year-end. In September, the ECB Governing Council also lowered the interest rate on the ECB's deposit facility by 0.10 percentage points, to -0.5%. The Bank of England (0.75%) and Bank of Japan (-0.10%) held their respective policy rates unchanged in 2019.
The Bank of Finland’s fixed-income portfolios comprise sovereign bonds and central bank deposits (61%), supranational or government-related bonds (21%), covered bonds issued by credit institutions (9%), corporate bonds (8%) and cash instruments (1%).
In volume terms, 68% of these investments were in bonds rated AAA- or AA+, and the lowest credit rating was BBB+ (0.7%). Serving as a measure of interest rate risk, the average duration of the fixed-income portfolios at the end of 2019 was 2.05 years.
The lowering of central bank interest rates yielded capital gains on fixed-income investments. Consequently, these investments generated positive returns in 2019 in spite of the low and partly negative interest rate environment. By far the most interest income was generated on the largest portfolio item, dollar-denominated bonds. These had the highest coupon rate at the beginning of the year, and they also earned capital gains as a result of the interest rate cuts.
The total return on the fixed-income portfolios amounted to EUR 210.7 million in 2019. By denomination, the return on US dollar investments stood at EUR 202.8 million, euro-denominated at EUR -2.1 million, sterling-denominated at EUR 10.6 million and yen-denominated at EUR -0.5 million.
The depreciation of the euro resulted in a positive revaluation of the foreign reserves. The foreign-currency denominated fixed-income portfolios appreciated by a total of EUR 141.6 million. The change in US dollar-denominated assets was EUR 81.7 million, sterling-denominated, EUR 21.7 million and yen-denominated, EUR 23.1 million.
Exchange rate risk is the most significant risk in euro terms related to the Bank of Finland’s fixed-income investment portfolios. The volume 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 tasks.
Long-term investment activities
In addition to its fixed income investments, the Bank of Finland manages a long-term investment portfolio, which has lower liquidity requirements and a higher expected return than its other portfolios. This portfolio has been devised so that the Bank’s own financial assets may be invested in asset classes with a better return than traditional central bank fixed-income investments.
In 2019 these long-term investment activities consisted of equity and real-estate investments, handled indirectly through mutual funds.
The Bank of Finland has diversified its equities portfolio in a cost-effective manner by investing in a passive advanced economies index fund. Its real-estate investments, in turn, are diversified across a number of European funds. Each of the funds owns real estate in desirable locations, which makes the properties easy to rent and ensures a steady return.
Equity and real-estate markets performed favourably in 2019 despite the risks posed by the trade war and Brexit. The return on the Bank of Finland’s equity investments amounted to EUR 227 million in 2019, and on real-estate investments, EUR 12 million.
Financial asset returns and risks
The Bank of Finland's financial assets yielded an overall return of 9.3% or EUR 971 million in 2019 (Table 3). The Bank’s fixed income returns are regularly checked against strategic benchmark indices that are based on the completion of central bank tasks. In 2019, the Bank of Finland's fixed income investments yielded 0.14%, or EUR 10 million of additional returns compared with these benchmarks.
Table 3. Return on the Bank of Finland's own financial assets in 2019 and 2018
|Return on the Bank of Finland's own financial assets in 2019 and 2018||2019||2018|
|%||EUR m||%||EUR m|
|Excluding gold and SDR||7.3||592||3.0||225|
|Source: Bank of Finland.|
The total market risk related to financial assets (Value-at-Risk 99%, 1 day) varied between EUR 41 million and EUR 99 million in 2019 (Chart 20).
Share of the European Central Bank’s foreign reserves
The European Central Bank (ECB) has foreign reserves of its own. Management of the foreign reserves of the ECB has been distributed among the Eurosystem national central banks according to their respective capital keys. The Bank of Finland manages part of the ECB's foreign reserves together with the Estonian central bank, Eesti Pank.
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 monetary policy operations.
The main objective of the Eurosystem's monetary policy is price stability, nor does the Eurosystem have an exchange rate objective.
The value of Finland’s and Estonia’s pooled US dollar-denominated portfolio of the ECB’s foreign reserves at the end of 2019 stood at EUR 1,124 million.
For additional information on the management of the ECB’s foreign reserves, see the ECB’s Annual Report.