IMF (2001). “Guidelines for Foreign Exchange Reserve Management,” http://www.imf.org/external/np/mae/ferm/eng/index.htm
IMF (2011). “Sixth Edition of the IMF’s Balance of Payments and International Investment Position Manual,” http://www.imf.org/external/pubs/ft/bop/2007/bopman6.htm
IMF (1999). “Code of Good Practices on Transparency in Monetary and Financial Policies: Declaration of Principles,” http://www.imf.org/external/np/mae/mft/code/
IMF (2012). “International Reserves and Foreign Currency Liquidity: Guidelines for a Data Template,” http://www.imf.org/external/np/sta/ir/IRProcessWeb/colist.aspx
The word union is used to represent monetary or exchange management unions that also undertake reserve management.
These Guidelines primarily cover “other reserve assets” as defined in the sixth edition of the Balance of Payments and International Investment Position Manual (BPM6), paragraph 6.76. In particular, the BPM6, paragraph 6.76, states that reserve assets cover (i) monetary gold, (ii) SDR holdings, (iii) reserve position in the IMF, and (iv) other reserve assets, consisting of currency and deposits, securities, financial derivatives, and other claims.
Among countries, and among monetary or exchange management unions, the entity responsible for reserve management may be a central bank or monetary authority acting either as a principal or as an agent for another repository of reserves such as an exchange fund. These entities may also have a range of policy responsibilities and functions that extend beyond their reserve management responsibilities. For discussion purposes, the term reserve management entity is used throughout this paper to refer to the entity that is responsible for reserve management, and the term reserve manager is used to refer to the specific area within the entity that performs the actual reserve management function.
A number of countries also maintain separate stabilization or savings funds often related to nonrenewable resources. Such funds do not generally fall within the definition of reserve assets and are not specifically covered by these guidelines. They do, however, represent public sector assets that must be managed with due care and diligence. Accordingly, the principles contained in the guidelines may also have potential relevance for the sound management and stewardship of such foreign assets.
Low income countries with protracted balance of payments problems and lack of market access should pay special attention to reserve management practices as their overall risks are likely to be higher than those facing other countries.
In general, control is assured when reserve assets are owned by the reserve management entity. However, external assets held by another authority may also be considered as reserve assets when such assets are under the direct and effective control of the reserve management entity. Comprehensive guidance on definitional and other aspects of reserves and liquidity can be found in International Reserves and Foreign Currency Liquidity: Guidelines for a Data Template, International Monetary Fund, Statistics Department, pre-publication draft, January 2012 (available at http://www.imf.org/external/np/sta/ir/IRProcessWeb/dataguide.htm).
Reserve assets may also include holdings of gold (see footnote 7). Such holdings would need to be held by the authorities as monetary gold so as to ensure ready availability for sale and delivery on world bullion markets.
Examples of instruments used include swap, futures, and options contracts involving foreign currencies and interest rates. Risk aspects associated with these operations are discussed in Section 4.
A currency board arrangement may also have a direct implication for the currency composition of reserves, if there is a requirement for base money to be backed wholly, or predominantly, by the currency to which the local currency is pegged.
Arrangements in this regard would include conventional pegs, stabilized arrangements, crawling pegs, crawl-like arrangements, pegged exchange rates within horizontal bands, and other managed arrangements, as well as floating, free floating, and no separate legal tender arrangements. Further details on these arrangements can be found in the IMF’s Annual Report 2011 (Appendix II), which is available on the Fund’s website: http://www.imf.org/external/pubs/ft/ar/2011/eng/index.htm.
This may involve, for example, a policy coordination body such as a separate treasury council that oversees external debt management and coordinates borrowing programs having regard to advice from the reserve management entity on the desired level of reserves.
See MFP Transparency Code, 1.1.4 and 1.3.1.
See MFP Transparency Code, 1.3.1.
See MFP Transparency Code, 1.1 and 5.1.
See MFP Transparency Code, 2.1.2.
See MFP Transparency Code, 3.1 and 3.2.4.
It should be noted that this approach differs from more traditional entity-specific reporting regimes, in that it integrates the activities of all public authorities, including the reserve management entity, which may be responsible for, or involved in, responding to currency crises.
Further information on the SDDS and the data template, including data periodicity and timeliness, can be obtained from the Dissemination Standards Bulletin Board at http://dsbb.imf.org/sddsindex.htm.
See MFP Transparency Code, 4.2.1 and 8.2.1.
See MFP Transparency Code, 4.2.2 and 8.2.2.
IFRS are promulgated by the International Accounting Standards Board, London. The publication of annual financial statements that are prepared in accordance with such standards, or equivalent national standards, and are independently audited, is also a key element of the Fund’s Safeguards Assessment framework. This framework has been adopted to ensure that central banks responsible for managing resources obtained from the Fund have adequate control, accounting, reporting, and auditing systems in place to manage funds and to ensure the integrity of operations. The Supporting Document of the MFP Transparency Code also suggests an approach to good accountability practices based on the adoption of internationally recognized accounting and auditing standards.
While IFRS do not contain any prescriptions relating specifically to international reserves, disclosures by a reserve management entity, on its reserve-related assets and liabilities, would likely form a large part of the more general annual financial statement disclosures required by IFRS. Two relevant standards in this regard are IFRS 7, Financial Instruments: Disclosure, and IFRS 13, Fair Value Measurement. These standards require, inter alia, financial statement disclosures relating to exposures to interest rate and credit risks, and the fair or market-based valuation of financial assets.
Responsibilities in this regard are usually allocated among the ministry of finance, central bank, or a central repository such as an exchange fund.
Following, for example, Guideline 2.1.
Typically a separate area, such as the internal audit unit, within the reserve management entity performs this function. In some cases, particularly those involving smaller entities with a limited resource base, consideration might also be given to contracting out internal audit work associated with specialized operations such as reserve management.
See MFP Transparency Code, 4.4 and 8.4.
Particular operational risks that might need to be addressed in the context of reserve management activities include control system failures associated with (1) dealing risks; (2) settlement risk; (3) custodial risk; (4) legal risk; (5) information technology risk; and (6) financial error or misstatement risk. Further details on each of these risks are contained in the glossary to these Guidelines.
The strategic asset allocation is reflected in these documents. Typically, these documents specify the legal mandate for reserve management, the objectives for reserves, the risk, eligible asset classes, benchmarks (see also Box 3), limits on exposures to control credit and transfer risks, allowable deviations from the benchmarks, rebalancing rules, and key reporting requirements.
The parameters most commonly used to assess risks and performances are Value-at-Risk (VaR), Expected Shortfall (ES), and duration. VaR methodologies can be a useful tool and component of risk management systems for the measurement of exposure to risks emanating from movements in market prices. Nevertheless, VaR and ES have limitations and require careful attention to the development, application, and analysis of results.
The definition of a benchmark portfolio may be based on, or similar to, recognized investment “industry” benchmarks such as those used and published by major investment houses. Many reserve managers, while drawing on such industry measures, choose to define and construct their benchmarks with more specific regard for the objectives, operations, and risks of the reserve management entity.
Sometimes the liquidity tranche is split into a transaction tranche and a liquidity tranche, where the transaction tranche reflects the needs for day-to-day transactions. Such transactions are frequent in some countries where the central bank plays a significant role in setting the exchange rate through intervention, or when government debt in foreign currency requires frequent foreign currency outlays.
Transition managers support reserve managers to transfer the portfolio between two external managers at a lower cost than what could be done internally.
All benchmark portfolios, for example, reflect tolerance for risk that can, and will, vary among reserve management entities.
Reserve management strategies can reflect varying choices between approaches that are generally described as either active or passive management. These terms, however, can be understood in different ways. Sometimes, a buy-and-hold-only strategy is viewed as passive management. The more generally accepted view of passive management is one where the risk characteristics of the portfolio replicate those of the benchmark. In this case, portfolio managers take no view on the direction of the market (i.e., the rate of return provided by the benchmark is accepted). However, over time, transactions would be necessary to maintain the alignment of the portfolio with the predetermined benchmark. This is the kind of passive management discussed here. Active management implies that the actual portfolio deviates from the benchmark as managers take views on the direction of the market or some of its components.
Examples of other foreign currency activities include the issue of foreign-currency-denominated securities to fund lending to domestic entities, facilities to support exporter access to pre- and post-shipment finance, placement of deposits with foreign subsidiaries of the reserve management entity, guarantees, and letter of credit facilities. In some cases, commitments have also been given to foreign supervisory authorities to support the capital and liquidity of the reserve management entity’s foreign subsidiaries.