5.1 Bank of Finland’s management of financial assets in 2021

The Bank of Finland’s asset performance in 2021 was favourable. Investments in equity and real estate saw especially good returns. It was, however, a challenging year for fixed-income investments. Considerable advances were made during the year in the area of responsible investing.

The Bank of Finland’s financial assets refer to its own invested items, which totalled approximately EUR 11 billion at the end of 2021. Financial assets do not include balance sheet items related to Eurosystem monetary policy measures, for example monetary policy asset purchase programmes or loans to banks.

The Bank of Finland decides on the volume of its financial assets within the framework of the ANFA Agreement (Agreement on Net Financial Assets).

The Bank of Finland’s financial assets are managed in line with central bank objectives, taking into account the returns on investment, the risks attached, and considerations of responsibility. In 2021, responsibility was added as a fourth pillar representing the objectives in investment activities, alongside security, liquidity and return. There was also major progress in other areas of responsible investment as well during the year.

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

Holding and managing foreign reserves are among the statutory tasks of the Bank of Finland. The size of Bank of Finland foreign reserves and the currency breakdown is a policy decision based on considerations of preparedness.

The decision is taken by the Board  at least once every three years. In 2021, a decision was taken on the currency-specific targets for the period 2022-2024. The current targets for these reserves are set at USD 5 billion, GBP 650 million and JPY 95 billion, respectively.

The corresponding sums in euros were EUR 4.4 billion for the US dollar, EUR 773 million for the British pound and EUR 726 million for the Japanese yen, at the exchange rate in effect at the end of 2021.

The management of foreign reserves has a key role in the Bank of Finland’s endeavours to ensure that it is financially equipped to deal with future uncertainties and risks. If necessary, the national central banks in the Eurosystem must transfer their foreign reserves to the European Central Bank (ECB). Moreover, the Bank of Finland makes provision for crises that can weaken Finland’s external solvency.

Composition of financial assets

At the end of 2021, the Bank of Finland’s financial assets amounted to around EUR 11 billion (Table 5). These assets comprised direct and indirect fixed-income investments, investments in equity and real estate, gold holdings and items denominated in IMF Special Drawing Rights (SDRs) (in Finnish).

Direct and indirect foreign currency-denominated fixed income investments and SDR items comprise the foreign reserves. The foreign currency-denominated fixed-income investments are in US dollars (USD), sterling (GBP) and Japanese yen (JPY).

The Bank of Finland's gold holdings amounted to EUR 2.5 billion at the end of 2021. No active investment decisions were made in regard to gold in 2021.

The Bank of Finland’s financial assets grew in 2021 by EUR 936 million, especially as a result of the rise in the market value of its stock portfolio and the strengthening US dollar.

Owing to the COVID outbreak, in 2020 the Bank of Finland began to re-invest in Finnish commercial papers. With the recovery of the market, these activities were put on hold, and the last commercial papers fell due in the first half of 2021. The Bank of Finland is prepared to recommence these activities if the market situation changes.

Policy on investment of financial assets

The Bank of Finland’s investments are guided by investment policy, which is decided annually by the Bank’s Board. The investment policy covers fixed-income investment policy, long-term investment policy and the responsible investment principles.

The policy on fixed-income investments sets a strategic allocation for the Bank’s investments and determines a strategic 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. Asset Management may deviate from the strategic index within a pre-set range and in accordance with the investment policy’s risk limits.

Long-term investment activity has a higher expected return and lower liquidity requirement than with other portfolios. The risk-return ratio improves across the whole balance sheet when the investment portfolio is diversified.

The Bank of Finland updates the responsible investment principles when necessary, and annually in connection with the investment policy update. The responsible investment principles and the practical measures taken in 2021 are described in their own section.

A long-term investment policy that takes into account 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, without endangering capital adequacy.

Fixed-income portfolios

At the end of 2021, the Bank of Finland had direct fixed-income investments worth EUR 5 765 million.

These comprised sovereign bonds and central bank deposits (55%), supranational or government-related bonds (27%), covered bonds (5%), corporate bonds (12%) and cash instruments (2%).

Fund-based fixed-income investments were worth EUR 264 million in total. They consisted entirely of an investment in the Bank for International Settlements (BIS) Green Bond fund.

As a measure of interest rate risk, the average duration of the fixed-income portfolios at the end of 2021 was 1.8 years. Fixed-income investments are made in debt securities with high credit ratings.

Long-term investment activities

In 2021, the Bank of Finland’s long-term investment activities consisted of equity and real-estate investments, handled indirectly through funds and ETFs. The value of the portfolio at the end of the year totalled EUR 1 688 million.

The equity investments have been diversified cost-effectively by investing in passive Exchange Traded Funds (ETFs) mirroring the global index for developed markets.

The real estate investments have been diversified across a number of unlisted European funds. Each fund owns real estate in central locations, which makes the properties easy to let. This ensures a steady return on investment over the long term in the form of rent.

Financial asset returns and risks

The Bank of Finland's financial assets yielded an overall return of 8.6%, or EUR 866 million in 2021 (Table 6).

The global economy recovered with the roll-out of the COVID-19 vaccine, and monetary accommodation continued to aid the recovery in 2021. The inflation rate rose with, for example, the higher cost of energy, with the result that interest rates increased, especially in the United States.

The rise in interest rates meant that the return on fixed-income investments was in negative territory. By denomination, the return on US dollar investments stood at EUR -28.7 million. For sterling it was EUR -5.9 million, for the yen EUR -0.4 million and for the euro EUR -0.1 million.

Equity prices rose in 2021 as a result of the general economic recovery and healthy business results. The stock market, however, at times showed signs of uncertainty, with increased expectations of a rise in interest rates and changing attitudes to the seriousness of the pandemic. The total return on the Bank of Finland’s equity investments in 2021 was 23.1%, i.e. EUR 273 million.

The annual return on real estate funds fluctuates with the rents received and changes in property values. In 2021, the real estate market recovered from the situation that prevailed the preceding year, which was reflected in an upswing in transactions, higher valuations and a normalisation of rent affordability. The return on the Bank of Finland’s real estate investments in 2021 was 6.5%, or EUR 10 million.

The strengthening of the dollar and sterling against the euro was experienced as a good currency revaluation, yielding a return of EUR 483 million. The value of fixed-income investment items denominated in foreign currency rose overall: the change in US dollar-denominated assets was EUR 349 million, for sterling-denominated assets it was EUR 52 million and for yen-denominated assets, EUR -23 million.

Currency revaluation related to the equity portfolio was EUR 105 million . This is included in the EUR 483 million currency revaluation figure.

The total market risk associated with the Bank’s financial assets (Value-at-Risk 99%, 1 day) varied between EUR 44 million and EUR 121 million in 2021 (Chart 24).

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 the level required for the functions of a central bank.

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 ECB foreign reserves at the end of 2021 stood at EUR 1,141 million.

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