5.1 Management of financial assets

The Bank of Finland implements the Eurosystem’s common monetary policy in Finland. Being part of the Eurosystem means that the balance sheet has special features. The Bank of Finland has financial assets as matching entries to its balance sheet assets and liabilities. The Bank manages and invests these assets in accordance with central bank objectives, taking into account the risks and aspects of social responsibility associated with investment.

It is among the statutory tasks of the Bank of Finland to hold and manage foreign reserves. As a national central bank in the Eurosystem, this function is reflected in the concrete objectives of the Bank’s investment activities. These are security, liquidity and return.

When taking decisions on its investment assets and foreign reserves, the Bank of Finland takes account of the Anfa Agreement on Net Financial Assets between the Eurosystem central banks.

The volume of Bank of Finland foreign reserves is a policy decision

The volume of Bank of Finland foreign reserves is a policy decision based on considerations of preparedness.

If necessary, the national central banks in the Eurosystem must transfer their foreign reserves to the European Central Bank (ECB).

Furthermore, the Bank of Finland makes provision for events such as crises that can weaken Finland’s external solvency.

The management and investment of foreign reserves have a key role to play in the Bank of Finland’s endeavours to ensure that it is financially equipped to deal with future uncertainties and risks.

It is possible to identify some of the risks to the economy and financial system in advance, but, as history has shown, the risks that materialise are often completely unexpected and hard to anticipate.

A long-term investment policy that takes account of balance sheet risks as a whole ensures that the balance sheet is healthy and promotes the Bank of Finland’s target for steady profit distribution to the State.

Composition of financial assets

The Board of the Bank of Finland takes decisions on the volume of the Bank’s financial assets in accordance with the Agreement on Net Financial Assets (ANFA) between the Eurosystem central banks.

At the end of 2020, the Bank of Finland’s financial assets amounted to around EUR 10 billion (Table 5). These assets comprised direct investments in foreign-currency and euro-denominated fixed income investments, investments in equity and real estate, gold holdings and items denominated in IMF Special Drawing Rights (SDRs).

The volume of financial assets was reduced by approximately EUR 1.0 billion during the year, for investment policy reasons. After the COVID-19 pandemic broke out, in March the Bank of Finland began reinvesting in Finnish commercial papers, which increased its financial assets by the amount purchased.

As a result of these measures and changes to exchange rates and share prices, the value of the Bank’s financial assets fell by around EUR 1,045 million during the year.

The foreign currency-denominated fixed-income investments consist of US dollars (USD), 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 Board takes a decision every three years on the volume of the Bank's foreign reserves. The current targets for these reserves are set at USD 5 billion, GBP 650 million and JPY 95 billion, respectively.

Fixed-income portfolios

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. The policy sets a strategic allocation for the Bank’s investments and determines an appropriate level of interest rate risk for the various currencies. The investment policy sets out a strategic market-based index that serves as a benchmark for the Bank's investment activities.

In its investment activities, the Bank of Finland may deviate from the strategic index within a pre-set range and in accordance with the investment policy’s risk limits.

The Bank of Finland’s fixed-income portfolios comprise sovereign bonds and central bank deposits (56.67%), supranational or government-related bonds (25.93%), covered bonds (7.09%), corporate bonds (9.75%) and cash instruments (0.57%). Finnish commercial papers are not included here.

The lowest approved credit rating for the Bank’s investments was BBB, except for the unrated Finnish commercial papers, whose credit rating is assessed by the Bank with reference to financial indicators.

As a measure of interest rate risk, the average duration of the fixed-income portfolios at the end of 2020 was 2.13 years.

As a result of the COVID-19 pandemic, the economic outlook was bleak and interest rates fell to an all-time low on all the main markets.

The drop in interest rates yielded capital gains on fixed-income investments. Consequently, these investments generated positive returns in 2020 in spite of the low and partly negative interest rate environment.

The most income from interest came from US dollar-denominated bonds. These also earned significant capital gains as a result of the interest rate cuts.

The return on the fixed-income portfolios amounted to EUR 213.3 million in 2020. By denomination, the return on US dollar investments stood at EUR 199.1 million, euro-denominated at EUR 1.7 million, sterling-denominated at EUR 13 million and yen-denominated at EUR -0.4 million.

The strengthening of the euro against other currencies resulted in a negative revaluation of the foreign reserves.

Overall, the value of the foreign currency-denominated fixed-income portfolios fell by EUR 455.9 million. The change in US dollar-denominated assets was EUR -367.3 million, sterling-denominated, EUR -43.3 million and yen-denominated, EUR -45.3 million.

Exchange rate risk is the Bank of Finland’s major risk associated with its foreign currency-denominated fixed-income investment portfolios. The volume of the Bank’s foreign reserves has been scaled to a level required by the tasks of a central bank.

Valuation changes in the foreign reserves reflect the open currency position, which supports the successful discharge of central bank tasks.

Recommencement of investment on the commercial paper market

In any normal situation, the issue of commercial papers for Finnish companies is a reliable way to manage their cash requirements. However, the COVID-19 pandemic resulted in a partial withdrawal from the Finnish commercial paper market on the part of traditional investors in the spring.

On 15 March 2020, the Board of the Bank of Finland responded to the gloomy market situation by deciding to recommence investment in commercial papers to the tune of EUR 500 million.

This was not a monetary policy measure in an attempt to affect inflation: the goal was to take a reasonable additional risk to generate some additional return on investment and, at the same time, support the Finnish commercial paper market.

In response to an increase in market supply, on 19 March 2020 the Board decided to raise the value of the portfolio to a maximum of EUR 1 billion.

Within the context of the Bank of Finland’s risk management framework, companies are assessed on the basis of their public credit rating and financial indicators linked to their credit risk.

The credit risk indicators reflect, for example, an issuer’s indebtedness, debt management capability and modelled probability of bankruptcy.

During the year, the Bank of Finland purchased a considerable number of Finnish commercial papers from creditworthy issuers that met the investment criteria under its risk management framework. The largest number of purchases took place during the weeks following the start of the process, after which the numbers steadily fell.

The Bank of Finland is subject to a regulatory constraint regarding purchase of the debts of public issuers. This has had an impact on the Bank’s overall potential for purchasing generally.

Long-term investment activities

In addition to its fixed income investments, the Bank of Finland manages a long-term investment portfolio that has lower liquidity requirements and a higher expected return than its other portfolios.

This portfolio has been devised so that the Bank’s own long-term financial assets might be invested in asset classes with a better return than traditional central bank fixed-income investments. Moreover, the risk associated with the investments diminishes if the portfolio of investments is diversified.

In 2020, 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 cost-effectively by investing in passive Exchange Traded Funds mirroring the global index for advanced economies.

Its real-estate investments 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 out. This ensures a steady return from letting property.

The equity market performed favourably in 2020, despite the substantial drop in share prices caused by the COVID-19 pandemic in the spring.

The performance of real estate funds was less consistent, as certain sectors, such as the retail and the office sectors, experienced difficulties on account of the pandemic.

Financial asset returns and risks

The Bank of Finland's financial assets yielded an overall return of 0.5% or EUR 76 million in 2020 (Table 6). The Bank’s fixed income returns are regularly checked against strategic benchmark indices that are based on the completion of central bank tasks. In 2020, the Bank of Finland's fixed income investments yielded 0.11%, or EUR 6.4 million more than these benchmarks.

The return on equity investments was 17.4% or EUR 177 million, and that on real estate investments was -1.6%, or EUR -2 million.

The total market risk associated with the Bank’s financial assets (Value-at-Risk 99%, 1 day) varied between EUR 52 million and EUR 176 million in 2020 (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 is 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 foreign exchange operations.

The value of Finland and Estonia’s pooled US dollar-denominated portfolio of the ECB’s foreign reserves at the end of 2020 stood at EUR 1,044 million.

For additional information on the management of the ECB’s foreign reserves, see the ECB Annual Report.