FINANCIAL ASSETS MANAGEMENT POLICY OF THE BANK OF LITHUANIA
I.
GENERAL PROVISIONS
1. The objective of the Financial Assets Management Policy of the Bank of Lithuania
(hereinafter – Policy) is to establish the key principles for the management of Bank of Lithuania’s
financial assets (hereinafter – financial assets), the requirements and restrictions applicable to the
financial assets and operations, reporting requirements and other aspects of the management of
financial assets. This document does not cover the principles and procedure of the management, use
and disposal of the financial assets related to monetary policy operations.
2. The financial assets governed by the Policy include the foreign currency reserves and
other financial assets of the Republic of Lithuania, whereas the latter consists of financial
instruments acquired via open market and credit operations executed by the Bank of Lithuania, other
national and foreign currency denominated investments not being classified as foreign reserves.
II.
THE PRINCIPLES OF FINANCIAL ASSETS MANAGEMENT
3. The main objective of holding financial assets is to ensure sufficient liquid financial assets
to maintain the fixed rate of exchange between the national currency and the anchor currency, and to
ensure that litas issued into circulation are fully backed by gold holdings and convertible currency
reserves. The Bank of Lithuania shall deploy its foreign reserves as needed to intervene in the
domestic currency market.
4. Given this objective, the criteria for investments are primarily liquidity and safety, with
due regard also to profitability, subject to liquidity and safety constraints.
5. Consistent with the principle of liquidity, investments are to be concentrated in liquid
assets with low transaction costs in order to meet contractual liabilities. As liquidity is generally
associated with relatively lower returns, financial assets should be managed based on reasonable
assumptions with respect to expected liquidity requirements.
6. Consistent with the principle of safety, financial assets are to be managed on a portfolio
basis so that the expected potential portfolio loss falls below the risk tolerance ceiling. There is no
absolutely risk-free investment in financial markets and all investment portfolios are exposed to
risks that may materialize to a lesser or greater extent. Changes in the investment value of the
portfolio can be driven by credit, market liquidity or other market developments. The objective of
financial assets management is to identify and manage such risks so that the level of the total
portfolio risk (potential negative change in market value over the investment horizon) is consistent
with the Board’s risk tolerance at a high degree of confidence. In this context, it is important to
reiterate that safety is to be evaluated with respect to the total portfolio rather than at the level of any
single investment. An investment that may be deemed risky on its own may be appropriate and may
reduce risk at the portfolio level through diversification when its correlation with other assets is
taken into consideration.
7. The principle of profitability in financial asset management is subject to the
aforementioned liquidity and safety constraints. Nevertheless, profitability remains an important
consideration as the Bank of Lithuania manages a substantial pool of foreign currency assets, with
the potential of generating substantial investment income both for the Bank of Lithuania and the
Republic of Lithuania. The investment return depends on the size of financial assets under
management and on the market yields of individual financial assets, aspects that the Bank of
Lithuania cannot control. In addition, the investment return depends directly on the level of the total
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portfolio risk assumed. Higher returns over time generally are associated with higher levels of risk,
as measured by the annualized volatility of the market value of the portfolio. Thus, implementing
the principle of profitability implies finding an acceptable balance between the additional return
associated with higher levels of risk and lower levels of risk at the cost of foregone return.
8. With respect to the profitability principle, the Bank of Lithuania seeks the highest
expected return, within the risk tolerance framework whereby the portfolio is structured and
managed so that the any portfolio loss would not exceed the Board’s risk tolerance. This risk
tolerance, hereafter referred to as the “risk budget”, is established based on several factors: the legal
requirement, established in Article 1 of the Law on the Credibility of the Litas of the Republic of
Lithuania, that litas issued into circulation be fully backed by gold and convertible foreign currency
reserves; the expected need to provide liquidity loans to credit institutions; and, the ability of the
Bank of Lithuania to absorb financial losses for a financial year through its accumulated capital
reserves. Based on these considerations, the risk budget is set as the maximum tolerable portfolio
loss over the certain horizon. The Bank of Lithuania, through its investment management, will seek
to generate higher investment returns on the financial assets over time, within the overall risk budget
and respecting the associated risk limits.
9. On the Bank of Lithuania’s balance sheet, its liabilities are denominated in national
currency – currency in circulation and reserve requirements of credit institutions with the central
bank, – while a significant portion of its assets corresponding to these liabilities is denominated in
foreign currency. Under the fixed exchange rate arrangement, the Bank of Lithuania adjusts its
financial asset currency composition to its liabilities to ensure that Bank of Lithuania liabilities are
fully backed by its foreign currency reserves at all times. As the anchor currency is the euro, the
absolute majority of financial assets are euro-denominated investments.
10. Bank of Lithuania financial assets include approximately 5.8 tons of gold, which were
accumulated in the interwar period in Lithuania. Although gold is a low yielding asset with high
price volatility, it has the desirable characteristic of retaining its real consumption value and thus is a
good inflation hedge. In addition, gold contributes to portfolio diversification. Hence, at times of
global economic and political turmoil, gold can contribute to protecting the portfolio against the risk
of loss from fiat currencies. Gold reserves in the modern financial system meet the essential needs of
the country during periods of global unrest. Taking this into consideration, the Bank of Lithuania
does not intend to change the amount of its gold reserves, with the exception of the anticipated
transfer of a part of foreign reserves in gold to the European Central Bank.
11. Bank of Lithuania financial assets management is an on-going process in search of the
highest expected return over a constant investment horizon, subject to the specified risk budget and
constraints. For the purpose of foreign currency reserves management, the Bank of Lithuania has
adopted a constant (rolling) three-year investment horizon. The investment horizon differs from the
accounting horizon as the latter is based on a calendar year, which declines to one day at the end of
the year. The accounting cycle is thus not the appropriate investment management horizon for an
on-going enterprise. Moreover, investment management and the assessment of its results should be
based on the portfolio total return, rather than accounting profits. Accounting gains and losses, as
dictated by the European Central Bank accounting and financial reporting guidelines, are recorded
by applying the asymmetric method of their recognition.1 Therefore, accounting income and
expenses generated from the financial asset management and revealed on the income (loss)
statement do not reflect the total return on investments, where valuations are based on market prices
only. The accounting results therefore do not reflect the long-term strategies and objectives of
1
The essence of this method is that the revaluation gains of individual financial instruments are recorded in balance
sheet revaluation accounts, and the unrealised losses are recognised as expenses.
3
financial assets managements. The accounting results, however, are the official books and records of
the Bank of Lithuania, the annual performance of financial assets (total return on investment)
available at the year-end shall be reconciled with the financial reporting data, specifying the nature
and reasons for any differences.
12. The Bank of Lithuania financial asset management comprises two distinct levels of
decision making:
12.1. The strategic benchmark is established by the Board of the Bank of Lithuania and
reflects the Board’s risk tolerance and thus the expected return on investments;
12.2. Active investment management whereby deviations are allowed vis a vis the strategic
benchmark as long as the total portfolio risk remains within the given risk budget.
13. The objective of active management is to seek to achieve a higher investment return
relative to the strategic benchmark by taking tactical deviations consistent with the level of the
allocated risk budget. The allocated risk budget is expressed as a limit on the potential negative
investment performance generated by active management vis-a-vis the strategic benchmark over the
specified horizon. Active management cannot change the fundamental risk/return profile established
by the Board of the Bank of Lithuania for the management of the financial assets. The results
achieved by active management are to be evaluated in the context of the overall investment portfolio
and over the investment horizon no shorter than the specified three years. Active management, in
turn, comprises two layers of decisions:
13.1. Establishment of the tactical benchmark based on investment views and strategy over a
medium-term investment horizon;
13.2. Day-to-day decisions of portfolio managers, seeking to generate value added vis-a-vis
the tactical benchmark.
14. The Bank of Lithuania allocates its foreign reserve assets across three sub-portfolios:
short-term portfolio, investment portfolio and gold portfolio, each subject to distinct risk/return
parameters. The objective of the short-term portfolio is primarily to meet the immediate liquidity
needs required for Bank of Lithuania’s domestic currency operations and to serve the Treasury of
the Republic of Lithuania. The investment portfolio consists of relatively stable financial assets, for
which the profitability principle is of higher importance. For the investment portfolio, the
investments returns shall be evaluated over the three year rolling investment horizon, whereas the
risk budget is set over interim one year rolling periods. Taking into consideration the distinct
portfolio rationale and management of gold, gold investments are held in a separate sub-portfolio.
III.
TOTAL RISK BUDGET OF FINANCIAL ASSETS MANAGEMENT
15. The total risk budget for financial assets management specifies the acceptable level of
investment risk at the portfolio level and is defined as the potential total negative return under a
worst-case scenario over the specified horizon. The approved risk budget is set based on the
following requirements:
15.1. The backing of litas issued into circulation by gold and reserves of convertible foreign
currency shall be in excess of at least LTL 500 million;
15.2. The total negative return of financial assets over a rolling one-year horizon with a
confidence level of 95 per cent is not expected to exceed the ceiling of EUR 100 million. This risk
budget is allocated at two investment levels – the strategic benchmark and active management
relative to the strategic benchmark – as follows:
15.2.1. The Board of the Bank of Lithuania establishes the strategic benchmarks so that any
negative return over a rolling one-year horizon would not exceed EUR75 million on a worst-case
basis, at a 95% confidence level. At least once a year the strategic benchmark is stress-tested for
compliance with this requirement;
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15.2.2. Any underperformance from active management over a one-year rolling horizon shall
not exceed EUR 35 million level relative to the return of the strategic benchmark established by the
Board of the Bank of Lithuania at a 95% confidence level;
15.3. The average return from the financial asset management over a three-year investment
horizon shall be consistent with the return expectations of the strategic benchmark as approved by
the Board of the Bank of Lithuania;
15.4. The risk budget does not cover the exposure to potential price changes in the gold stock
held by Bank of Lithuania.
IV.
COMPOSITION OF THE FINANCIAL ASSETS
16. The financial assets are managed in three tranches as follows:
16.1. the investment tranche;
16.2. the short-term liquidity tranche;
16.3. the gold tranche.
17. The Bank of Lithuania allocates financial assets to each tranche based on the dynamics
of domestic foreign exchange operations and autonomous factors affecting the monetary base. In
allocating the financial assets across tranches, it is considered desirable to fully and effectively use
the risk budget.
18. The State Treasury accounts, denominated in euro, if managed actively, are allocated to
the short-term tranche.
19. The gold tranche is managed so that the amount of gold does not change by more than
500 troy ounces from the beginning of the current financial year.
V.
THE STRATEGIC ASSET ALLOCATION
20. The strategic asset allocation, applicable to the investment tranche is:
Sector
Cash and cash equivalents
Government bonds
Quasi-Government bonds
Corporate bonds
Equities
Index
1–6 month German treasury bills
1–10 year euro denominated bonds issued by euro zone governments
with AAA-A ratings
1–10 year euro denominated bonds issued by government agencies,
supranational organizations, local governments (lands/municipalities)
with AAA–AA ratings
1–10 year euro denominated corporate bonds with investment (AAA–
BBB-) grade ratings
World equities
Weight
(%)*
8
60
15
10
7
*To achieve this investment composition, a transitional period shall be applied.
21. The strategic asset allocation, applicable to the short-term portfolio, is:
Sector
Cash and cash equivalents
Index
1–6 month German treasury bills
Weight
(%)*
100
22. The funds of the Ministry of Finance of the Republic of Lithuania, comprising the shortterm portfolio, are managed relative to the benchmark, reflecting the duration of the corresponding
liabilities and liquidity carrying costs.
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23. The strategic asset allocation benchmark does not cover the gold tranche.
24. On the basis of the overall strategic asset allocation, strategic benchmarks shall be
constructed for the investment and short-term portfolios, respectively.
25. The investment portfolio strategic benchmark shall be rebalanced monthly when the
actual value of any one of the constituent weights of the strategic benchmark differs from its target
weight by more than five per cent at month-end.
26. The strategic benchmark of the short-term portfolio is rebalanced daily.
VI.
STRATEGIC BENCHMARK DEVIATIONS
27. Deviations from the strategic benchmark, subject to the overall risk budget, are
allowable within the following limits:
27.1. The modified duration (MD) of the investment portfolio cannot exceed the MD of the
respective strategic benchmark by more than 0.75 years;
27.2. The MD of the short term portfolio cannot exceed the MD of the respective strategic
benchmark by more than 0.3 years;
27.3. The market value of the equity share of the investment tranche cannot exceed the
market value of the equity share of the respective strategic benchmark by more than 0.5 percentage
points. Limits are not granted for any active management of equity investments.
28. Deviations from the strategic benchmarks are allowed at both the level of the tactical
benchmark and active portfolio management. These deviations shall be allocated according to the
procedure established by the Bank of Lithuania.
VII.
FINANCIAL INSTRUMENTS AND TRANSACTIONS
29. The financial instruments eligible for investment by the Bank of Lithuania are as
follows:
Asset class
Money market
instruments
Bonds
Acceptable instruments or criteria (any of those listed below fit)
treasury bills;
discount securities;
commercial paper (including commercial euro securities);
time deposits (including gold);
certificates of deposits;
transferable liabilities of the Bank for International Settlements;
repurchase agreement and reverse-repurchase agreement transactions
(including try-party repurchase agreements);
securities lending
Duration: unlimited, including perpetual;
coupon definition: fixed, floating, index-linked;
structure of capital redemption: callable, puttable, extendible, amortizing,
sinkable, convertible, index-linked,
priority of capital redemption: explicit or implicit government
guaranteed, not guaranteed, of any subordinate priority, based on the
long-term credit rating of the issuer or/and issuance.
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capital coverage: secured, unsecured, asset-backed, including mortgage
loan-backed
Equities
Exchange listed equity and equity funds.
Currency
transactions
Foreign currency and gold transactions
Investment funds
Mutual funds (including index and exchange traded funds) as long as the
funds’ allowable investments fall within the universe of allowable
investments of the Bank of Lithuania
Financial
derivatives
Futures (interest rate and bond);
swaps (currency, interest rate, cross currency, inflation index, credit
spread, total return, credit default);
forwards (bond, interest rate, currency, exchange traded fund);
options (bond, interest rate, currency, exchange traded fund);
foreign exchange rate derivatives
30. Financial derivatives shall be used for risk hedging purposes or efficient implementation
of the investment strategies, permissible within this investment Policy, and shall not be used to take
positions otherwise not allowable by the Investment Policy.
31. The market value of corporate investments (including indirect investments via exchange
traded funds or other mutual funds or derivatives) shall not exceed 20 per cent of the Bank of
Lithuania financial assets, net of foreign currency liabilities.
32. Investments in any financial instruments can become operational only after all
preparations are accomplished, including but not limited to: identification of investment
characteristics and risk factors, information requirements, valuation and accounting modalities;
settlement and custodian procedures and incorporation of the instrument into the trade processing,
recording and risk systems.
VIII.
FOREIGN CURRENCY POSITIONS
33. Financial assets may be transacted and invested in euros, gold and the national currency
of countries with a credit rating not lower than the long-term investment grade rating.
34. The required currency composition of financial assets shall be implemented by investing
directly in assets denominated in the target currency or, if necessary, through forward cover
operations to achieve the desired foreign currency exposure using currency swaps or other allowable
transactions
35. The total open currency position (except the euro) cannot exceed 10 per cent of financial
assets, net of foreign currency liabilities.
36. The open single currency position (except the euro) cannot exceed 2.5 per cent of
financial assets, net of foreign liabilities
IX.
ISSUERS AND COUNTERPARTY LIMITS
37. Investments can be made only in securities issued by an entity with a long-term
investment grade rating. Bank of Lithuania can use only broker/dealers, custodians and other
financial counterparts with a long-term investment grade rating.
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38. Bank of Lithuania can use only investment fund managers, including fund issuers with
respect to exchange-traded funds (ETFs), with a long-term investment grade rating. Moreover,
investment funds are allowed only when the average rating of the fund’s individual investments is
investment grade.
39. Central banks of OECD countries, the International Monetary Fund and the Bank for
International Settlements are exempt from rating requirements.
40. Investments in equities, including indirect investments via funds, derivatives, etc. shall
be exempt from rating requirements.
41. The total amount of investments with a long-term rating lower than A- (A3) shall not
exceed 20 per cent of financial assets, net of foreign currency liabilities.
42. The combined credit risk exposure to any single institution or counterpart with a longterm rating lower than A- (A3) to the Bank of Lithuania shall not exceed EUR 100 million.
X.
LIQUIDITY REQUIREMENTS
43. Investments in highly liquid or short-term financial assets shall account for at least 30
per cent of financial assets, net of foreign currency liabilities. Such securities must mature within 90
calendar days and conform to stringent safety and liquidity requirements to be established by the
Bank of Lithuania.
XI.
EXTERNAL ASSET MANAGERS
44. Financial assets may be delegated to external asset managers, the risk assumed by
external asset managers shall be included in the total risk budget allocated for management of
financial assets. The Board of the Bank of Lithuania must approve the size of assets to be delegated
to any external asset manager and the terms and conditions of the governing investment
management agreement. The requirement for prior Board approval with respect to external asset
managers does not apply to index and exchange traded funds.
XII.
INTERNAL GOVERNANCE AND CONTROLS
45. The Board of the Bank of Lithuania delegates the authority to the Banking Service of the
Bank of Lithuania to manage, dispose and handle, within its competence, the financial assets of the
Republic of Lithuania subject to the limits established in the Policy and the approved risk budget as
expressed by the strategic asset allocation.
46. The Director of the Banking Service must report to the Board of the Bank of Lithuania
when the negative return on the strategic benchmark tests or breaches the EUR 75 million ceiling
and/or the negative return on total financial assets tests or breaches the EUR 100 million ceiling
over the calendar year to date. In such a case, the Board of the Bank of Lithuania shall consider the
source of the loss and possible need to reduce the risks inherent in the strategic composition of the
investments.
47. The Banking Service strictly segregates the functions of investment transactions from
trade processing and settlements/payments through separation of personnel, segregation of duties
and access to the respective IT systems.
48. The Investment Management Department strictly segregates the functions of risk
management and control from the active management of investments. The front office assumes risk
through deviations from the strategic benchmark. The middle office ex ante stress-tests the scale of
assumed risk relative to the allowable risk budget at a 95% confidence level by using tactical
8
iterations of different market scenarios. The middle office controls compliance of active
management investment decisions with the limits proscribed by the Policy.
49. The Director of the Investment Management Department shall report to the Director of
the Banking Service when the negative return on actively managed investment positions tests or
breaches the EUR 35 million ceiling relative to the strategic benchmark. In such a case, the Director
of the Banking Service shall consider the source of the underperformance, likelihood of recovery
and the possible need to reduce the position.
50. The Payment Services Department is responsible for the processing, settlement and
management of trades, including: confirmation, payment, settlement, management of correspondent
and custodian accounts, collateral management and the monitoring and management of investment
(post-transactional and non-transactional) positions. The Payments Services Departments, in its
negotiation of any international agreements under its authority, is to take into consideration the best
interests of the Bank of Lithuania.
XIII. ACCOUNTABILITY AND REPORTING
51. The Banking Service shall provide a quarterly report to the Board of the Bank of
Lithuania providing the results of the financial assets investment and benchmark indices, the risks
incurred, the portfolio total return and sources of risk.
52. On an annual basis, the Banking Service conducts and provides to the Board an
assessment of whether the financial assets management strategy and the risk level assumed are
appropriate to achieve the financial assets management policy objectives.
53. In the management of financial assets, the principles of transparency and accountability
to the public shall be followed. To implement such principles, the Bank of Lithuania shall
communicate to the public the key aspects of the financial assets management policy and
periodically publish financial assets data. The Bank of Lithuania shall present information on the
management and accounting of foreign reserves and total financial assets in its Annual Report,
which is published on the Bank of Lithuania’s website www.lb.lt.
XIV. FINAL PROVISIONS
54. Upon the adoption of the euro in Lithuania, the Bank of Lithuania will no longer need to
ensure the stability of the fixed exchange rate of the national currency. As the euro will no longer be
considered as a foreign currency, the foreign currency portion of the financial assets will thus
decrease.
55. The investment portfolio strategic benchmark established by the Policy differs
significantly from the investment structure in effect at the time of the Policy adoption. To avoid
undue risks and exposure to market timing, the transition from the existing portfolio to the strategic
benchmark will be implemented gradually over a three-year period, beginning November 30, 2013
and ending November 30, 2016. The weights of the strategic benchmark shall be gradually increased
until, at the end of the transitional period, they reach the final weights of the strategic index
established in the Policy. The transitional weights of the strategic benchmark are presented in the
Annex to the Policy.
55.1. During the transitional period, the sizes of the equity and corporate bond investments
shall not be reduced until they reach the final weights of the strategic benchmark.
___________________________
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Annex to the Financial Assets Management
Policy of the Bank of Lithuania
The transitional weights of the strategic benchmark of the investment portfolio, effective
from 30 November 2013 to 30 November 2016
Date
1–6 m. German
treasury bills,
%
1–10 y. euro
denominated
euro area
government
bonds rated
AAA–A,
%
30/11/2013
68,0
19,0
1–10 y. euro
denominated
bonds issued by
government
agencies,
supranational
organizations and
local
governments,
rated AAA–AA,
%
7,5
28/02/2014
66,2
19,0
8,1
5,6
1,1
31/05/2014
64,3
19,0
8,8
6,3
1,6
31/08/2014
62,5
19,0
9,4
6,9
2,2
30/11/2014
60,8
19,0
10,0
7,5
2,7
28/02/2015
56,5
21,6
10,6
8,1
3,2
31/05/2015
51,7
24,4
11,3
8,8
3,8
31/08/2015
47,2
27,2
11,9
9,4
4,3
30/11/2015
42,7
30,0
12,5
10,0
4,8
29/02/2016
34,0
37,5
13,1
10,0
5,4
31/05/2016
25,3
45,0
13,8
10,0
5,9
31/08/2016
16,6
52,5
14,4
10,0
6,5
30/11/2016
8,0
60,0
15,0
10,0
7,0
1–10 y. euro
denominated
corporate
bonds with
investment
(AAA–BBB-)
grade ratings,
%
Global
equities,
%
5,0
0,5
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