De Nederlandsche Bank Investing in government securities: central - PowerPoint PPT Presentation

De Nederlandsche Bank Investing in government securities: central bank perspective Risk & Asset Management Pieter Moore, Oct. 2016

Central bank - policy objectives Financial stability   Allow people to save, borrow, invest and hedge financial risks that they are unwilling to bear themselves  Price stability ( protect purchasing power )  Smooth and safe payment system ( everybody is able to pay )  Reliable and robust financial institutions ( rely on your savings, insurance policies, pensions and investments ) Independent (economic) advisor to the government  Academic and policy-related scientific research  2 Sovereign Debt Management Forum 2016 - DNB Oct. 2016

Reasons to invest Ability to credibly intervene   High quality and liquid assets in multpile currencies at is disposal Generate return   Supporting financial and therefore operational independence Understanding the markets   Build a network of market participants to gather market intelligence. 3 Sovereign Debt Management Forum 2016 - DNB Oct. 2016

Determining portfolio characteristics Institutional framework   Strong central bank  Central bank objectives trump all other tasks  Balance sheet is one of the main drivers of its reputation  Therefore we need to be  Big and liquid enough  Risk averse enough  Financial risk  Reputational risk (i.e., headline risk) 4 Sovereign Debt Management Forum 2016 - DNB Oct. 2016

But also (mostly) exogenous factors Credit crisis • Solvency crisis • Sovereign debt crisis • Low growth, shrinking credit supply and no inflation • 5 Sovereign Debt Management Forum 2016 - DNB Oct. 2016

Required policy responses  Policy rates have been lowered to (below) 0,00%  Long-term refinancing operations  Massive assets purchases 6 Sovereign Debt Management Forum 2016 - DNB Oct. 2016

Which shaped our balance sheet 7 Sovereign Debt Management Forum 2016 - DNB Oct. 2016

Which shaped our balance sheet (triple in size) Mostly government debt securities (>90%) 8 Sovereign Debt Management Forum 2016 - DNB Oct. 2016

Reduced our profit outlook  Interest rates are the main driver of our profitability 9 Sovereign Debt Management Forum 2016 - DNB Oct. 2016

And our willingness/ ability to take investment risks 10 Sovereign Debt Management Forum 2016 - DNB Oct. 2016

And our willingness/ ability to take investment risks 11 Sovereign Debt Management Forum 2016 - DNB Oct. 2016

And our willingness/ ability to take investment risks  No tolerance for FX risk  Interest rate risk (duration) significantly lowered  95% of portfolio is Fixed Income; 5% is equities  Little tolerance for credit risk; 95% > AA-rating 12 Sovereign Debt Management Forum 2016 - DNB Oct. 2016

Which puts further preasure on our profitability  Yields have dropped below the deposit facility rate  This is our minimum cost of funding  This implies that if yields do not drop any further  The marginal cost of our investment portfolio will be greater that its return  Which necessitates us to explore other investment opportunities 13 Sovereign Debt Management Forum 2016 - DNB Oct. 2016

Actions to improve the risk-/return characteristics of the investment portfolio  Introduction of new asset classes  Invest in corporate bonds in both EUR and US  Through external managers Pay attention to Socially Responsible Investing and Environmental Social  Governance principles 14 Sovereign Debt Management Forum 2016 - DNB Oct. 2016

Actions to improve the risk-/return characteristics of the investment portfolio  Introduction of new assets  Invest in government bonds outside EUR and US  Pay attention to cost of hedge Cross currency basis swap important driver of returns!  15 Sovereign Debt Management Forum 2016 - DNB Oct. 2016

Cross currency basis swap  Spot and future exchange rates should be explained by the difference in intererst between the two countries  If interest in country A > country B; currency B should appreciate  Else we could profit by borrowing in country B and investing it in country A Explained by:   Diverging monetary policy (EUR liq)  Banking regulation  Shrinking balance sheets (FX swaps)  Money markets reform (USD commercial paper) 16 Sovereign Debt Management Forum 2016 - DNB Oct. 2016

Current themes  Determining appropriate size and risk of investment portfolio  One integrated balance sheet approach  Own investments treated separately  Taking financing costs into account  How to determine when to increase strategic duration  ‘ Valuing ’ SRI and ESG principles  Sustainability of CCBS investments 17 Sovereign Debt Management Forum 2016 - DNB Oct. 2016