5.1 Bank of Finland’s management of financial assets in 2022

Market conditions were exceptionally challenging in 2022, as the returns globally on both equity and fixed-income investments were mostly negative. However, the return on the Bank of Finland’s own financial assets was close to zero in 2022, which was attributable particularly to the strengthening US dollar and the rise in the price of gold.

The Bank of Finland’s financial assets consist of the balance sheet items which fall under the Bank’s investment activities. At the end of 2022, these assets totalled approximately EUR 11 billion. The Bank’s financial assets do not include 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 Agreement on Net Financial Assets (ANFA). ANFA is an agreement between the national central banks in the Eurosystem and the European Central Bank (ECB). It sets rules for the holdings of financial assets that are related to the domestic tasks of the national central banks.

The Bank of Finland’s financial assets are managed in line with the central bank objectives, taking into account the returns on investment, the risks attached and the responsibility considerations. Further emphasis was put on responsibility and on reporting of this during 2022.

Bank of Finland’s foreign reserves play a key role in preparing for risks

Holding and managing foreign reserves are among the statutory tasks of the Bank of Finland. The volume of the Bank of Finland’s foreign reserves and the currency composition is a strategic decision based on considerations of preparedness.

The decision is taken by the Bank’s Board as and when necessary, and at least once every three years. The currency-specific targets for the period 2022–2024 are set at USD 5 billion, GBP 650 million and JPY 95 billion, respectively.

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 can be required to transfer some of their foreign reserves to the ECB. Furthermore, the Bank of Finland makes provision for crises that can weaken Finland’s external solvency.

Composition of financial assets

At the end of 2022, the Bank of Finland’s financial assets amounted to around EUR 11 billion (Table 5). These assets comprised direct and indirect fixed-income investments, equity and real estate fund investments, gold holdings and items denominated in IMF Special Drawing Rights (SDRs).

Direct and indirect foreign currency-denominated fixed-income investments and SDR items comprise the foreign reserves. The Bank of Finland’s gold holdings amounted to EUR 2.7 billion at the end of 2022. The Bank did not engage in active investment activity in gold in 2022.

Policy on investment in financial assets

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

The policy on fixed-income investments sets a strategic allocation for the Bank’s investments by asset class and determines an appropriate level of interest rate risk for the various currencies.

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

The Bank of Finland updates the principles of responsible investment every year in connection with its investment policy, and at other times as necessary. The principles of responsible investment and the practical measures taken in 2022 are described in their own section.

The investment policy, including the responsible investment principles, establishes a strategic market-based index that serves as a benchmark for the Bank’s investment activities. The Bank’s Asset Management Division may deviate from the strategic index within a pre-set range and in accordance with the investment policy’s risk limits.

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, without endangering capital adequacy.

Fixed-income portfolios in 2022

At the end of 2022, the Bank of Finland had direct fixed-income investments worth EUR 5,676 million.

These comprised sovereign bonds and central bank deposits (58.9 %), multinational or government-related bonds (25.3%), covered bonds (4.1%), corporate bonds (11.4%) and cash instruments (0.3%).

Fund-based fixed-income investments were worth EUR 269 million in total. They consisted entirely of an investment in the Green Bond fund of the Bank for International Settlements (BIS).

As a measure of interest rate risk, the average duration of the fixed-income portfolios at the end of 2022 was 1.7 years. Fixed-income investments are made in debt securities with high credit ratings.

Long-term investment

In 2022, the Bank of Finland’s long-term investment consisted of equity and real-estate investments handled indirectly through funds. The value of the portfolio at the end of the year totalled EUR 1,484 million.

Equity investments were made in index funds that mirror the global index for developed markets and which take account of sustainability and climate issues. The equity investments were made cost-effectively by means of passive exchange traded funds (ETFs).

The Bank of Finland’s real estate investments are diversified across a number of unlisted European funds. Each of the funds owns real estate in desirable locations, which makes the properties easy to let. This ensures a steady return on investment over the long term in the form of rental income.

Financial asset returns and risks

The Bank of Finland’s financial assets yielded an overall return of -0.18%, or EUR -24.3 million, in 2022 (Table 6).

The global economy grew in 2022, although uncertainty about economic growth put pressure on valuations of higher risk asset categories. Inflation persisted globally, and this forced central banks to raise policy rates at a brisk pace, which was reflected in interest rate increases worldwide.

The rise in interest rates meant that the return on fixed-income investments was negative, at EUR -192.9 million. The return on fixed-income investments denominated in US dollars stood at EUR -175.1 million, in pounds sterling at EUR -17.6 million and in yen at EUR -0.4 million.

Listed shares saw their all-time high valuation at the start of the year return to a longer term average value at the end of the year. Such issues as uncertainty concerning future economic growth, increased interest rates and geopolitical risks all contributed to the fall in share prices in 2022.

But despite the stock market decline, companies were still able to make a reasonable profit, although in future it may be challenging for businesses to maintain their profit margin due to economic growth showing signs of fading. The total return on the Bank of Finland’s equity investments in 2022 was -17.7%, or EUR -269 million.

The annual return on real estate funds fluctuates with the rents received and the changes in value of property. The year 2022 was a challenging one for the real estate market. The rise in interest rates and prices combined with the uncertain outlook for the economy put pressure on valuations, even though tenants were still reasonably able to pay their rent as normal. The return on the Bank of Finland’s real estate investments in 2022, at 6.7%, or EUR 10 million, was reasonable given the market situation.

The Bank’s real estate investments were in unlisted real estate funds investing in the lowest risk section of the market, i.e. core funds. The change in their values lags behind the market for listed real estate funds. Consequently, 2023 may turn out to be a more challenging year for the Bank of Finland’s real estate portfolios.

The year 2022 was an exceptional one for investment, as the values of both fixed-income and higher risk investments fell considerably and the conventional benefits of diversification were not available. Nevertheless, the Bank of Finland’s financial assets increased in value, especially as the dollar strengthened and the price of gold rose.

The appreciation of the dollar against the euro was evident as a positive revaluation gain of EUR 263 million. The value of fixed-income investment items denominated in foreign currency rose overall by EUR 179 million. This comprised a change of EUR 286 million in US dollar-denominated assets, EUR -29 million in sterling-denominated assets and EUR -78 million in yen-denominated assets. Currency revaluation related to the equity portfolio in 2022 was EUR 84 million.

The total market risk associated with the Bank’s financial assets (Value-at-Risk 99%, 1 day) varied between EUR 73 million and EUR 202 million in 2022 (Chart 19).

Exchange rate risk is the Bank of Finland’s most significant 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 in 2022

The European Central Bank has foreign reserves of its own. Management of the foreign reserves of the ECB is distributed among the national central banks in the Eurosystem 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 2022 stood at EUR 1,178 million.

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