Reserve currency

• LOS ANGELES, Oct. 29, 2020 /PRNewswire/ -- DoubleLine Capital LP has posted on DoubleLine.com a new paper titled "Bilateral Digital Currency Payments and the Twilight of the Dollar," written by Bill Campbell, co-Portfolio Manager of the DoubleLine Global Bond Strategy.
• "The world's central banks and the Bank of International Settlements (BIS) envision a network of multiple cross-border payment systems featuring direct bilateral exchanges in the world's different currencies.
• Such a regime would discard the decades-long mediation through the world's reserve currency, the U.S.
• DoubleLine is a registered trademark of DoubleLine Capital LP.

Foreword

• On balance, these developments resulted in a stabilisation in the international role of the euro.
• On the one hand, the euros share in outstanding international loans increased significantly.
• On the other hand, the share of the euro in outstanding international debt securities declined, albeit international debt issuance in euro continued to increase in volume.
• In doing so, these measures should in turn also serve to safeguard the attractiveness of the euro globally.
• The ECB will continue to monitor developments in and publish information on the international role of the euro on a regular basis.

1 Main findings

• On balance, adjusting for exchange rate valuation effects, a composite index of the euros international role remained essentially flat in the review period at a low level (see Chart1).
• The share of the euro across various indicators of international currency use averaged around 19% close to historical lows.
• The euro remained unchallenged as the second most important currency in the international monetary system (see Chart2).


Chart 2 The euro remains the second most important currency in the international monetary system Snapshot of the international monetary system (percentages)

• Other indicators suggest that developments in the global attractiveness of the euro were mixed in the review period.
  • On the one hand, issuance of international bonds denominated in euro rose, with the share of the euro increasing by more than 1 percentage point. Low interest rates in the euro area continued to support the use of the euro as a funding currency – even after adjusting for the cost of swapping euro proceeds into other currencies, such as the US dollar. This encouraged issuance by US borrowers and international borrowers from a broad range of economic sectors, such as manufacturing, construction and financial institutions. On the other hand, the share of the euro in the outstanding stock outstanding of international debt securities, which tends to adjust more gradually, and depends additionally on net redemptions and developments in money market instruments, declined by 0.3 percentage points.
  • The share of the euro in international loans by banks outside the euro area to non-euro area borrowers also increased in 2019, by a full percentage point. Volumes of euro-denominated loans by banks outside the euro area to non-euro area borrowers were twice as large as in the aftermath of the global financial crisis in 2009. Volumes of all outstanding cross-border loans denominated in euro were around 3% higher compared to 2018, suggesting that deleveraging by euro area banks, which had been a feature of developments in the years after the global financial crisis, no longer acted as a drag on the use of the euro in international loan markets.
  • The share of the euro as an invoicing currency for extra-euro area transactions in goods remained broadly unchanged relative to last year, while its share in transactions in services declined.
  • The share of the euro in outstanding international deposits remained broadly stable.
  • The stock of euro banknotes circulating outside the euro area was also broadly stable in 2019.
  • Large official reserve holders were among the main purchasers of euro-denominated assets.
  • Anecdotal evidence suggests that purchases of reserve assets could reflect various motives, including exchange rate management and currency diversification decisions.
  • The share of the US dollar, the leading global reserve currency, declined further to a two-decade low, suggesting that the trend towards gradual diversification of global reserve portfolios continued.
  • Accumulation of gold by official reserve holders grew unabated, which indicates that central banks are exploring alternatives to the traditional major currencies.
  • Almost50% of global foreign exchange turnover in the euro was undertaken in the United Kingdom, against approximately 13% in the euro area.
  • Table1 The international role of the euro from different perspectives Summary of data in this report

2 Key developments

2.1 Use of the euro as an international reserve

• The share of the euro in global official holdings of foreign exchange reserves remained broadly stable in 2019.
• At constant exchange rates, the share of the euro in globally disclosed holdings of foreign exchange reserves rose modestly, by 0.2percentage point between the end of 2018 and the end of 2019 the second consecutive year of increase (see Chart3).
• Chart3 The share of the euro in global foreign exchange reserves remained broadly stable in 2019 Developments in the shares of the euro, US dollar and other currencies in global official holdings of foreign exchange reserves (percentages; at constant Q42019 exchange rates)
• The trend towards gradual diversification of global reserve portfolios also continued.
• At constant exchange rates, the share of currencies other than the euro and the US dollar increased by 0.7percentage point in the review period (see Chart4).
• The increase primarily reflected purchases of official reserve assets denominated in Japanese yen, often considered a safe haven currency, the share of which rose by 0.4percentage point to nearly a two-decade high.
• The share of other non-traditional reserve currencies was stable.
• Motives underlying the purchases in question varied across central banks, including exchange rate management, currency diversification decisions and, in some cases, perhaps geopolitical considerations.
• [4] In line with this interpretation, holdings of euro-denominated foreign exchange reserves by the SNB increased by over EUR20 billion in 2019.
• Together China and Russia sold a combined USD204 billion worth of US Treasury debt securities amid concerns about unilateral sanctions and international trade tensions in 2018.
• Several countries increased their exposures to US Treasury securities in 2019, such as Japan and some euro area countries.
• Chart5 China and Russia have reduced their exposures to US Treasury securities since 2018 Sales of US Treasury securities by selected countries (net amounts in USD billions)
• Accumulation of gold by official reserve holders continued unabated over the review period, suggesting that central banks globally are exploring alternatives to the major currencies.
• The share of gold in total global reserve holdings increased markedly, to 12% a six-year peak.
• Chart6 Accumulation of gold by official reserve holders continued unabated Changes in global official reserve holdings of gold and foreign currency (amounts in USD billions)
• Since gold prices increased by close to 18% last year, the increase in gold holdings partly reflects valuation effects.
• However, official reserve managers also increased their real physical holdings of gold in vaults and storage facilities by over 500tonnes in 2019 in line with a trend that started a decade ago with the global financial crisis (see Chart7).
• Chart7 Holdings of physical gold by official reserve managers continued to trend upwards Developments in global official holdings of gold (in metric tonnes)

2.2 The euro in global foreign exchange markets

• The BIS Triennial Central Bank Survey of Foreign Exchange and OTC Derivatives Markets in 2019 released by the Bank for International Settlements (BIS) indicates that trading in foreign exchange markets totalled USD6.6trillion per day in April2019, up from USD5.1trillion in April2016.
• More than half of the rise in foreign exchange trading is attributable to transactions in foreign exchange swaps.
• [8] In line with global reserves, transactions in global foreign exchange markets became more diversified.
• [9] Chart8 The share of the euro in global foreign exchange turnover increased somewhat in 2019 Share of the euro in global OTC foreign exchange transactions, on a net-net basis (percentages, in April of the corresponding year shown on the x-axis)
• Foreign exchange trading is increasingly concentrated in a small number of large financial hubs.
• In 2019, the top five trading locations accounted for 79% of global foreign exchange transactions.
• This largely reflects the role of the City of London, which plays a pivotal role across a range of financial markets, and is the worlds largest venue for foreign exchange trading.
• The role of the City of London was even more pronounced in foreign exchange transactions against the euro, with a share of almost 50% (see Chart9).
• Most foreign exchange transactions vis-a-vis the euro took place outside the euro area, i.e.in London or in other locations.
• Chart9 Most foreign exchange transactions in euro take place outside the euro area, notably in the City of London Share of selected countries in global foreign exchange transactions in euro in 2019 (percentages)


The primacy of the City of London as a trading venue for the euro is a long-standing phenomenon and has grown further still over the past three years, with its share increasing by almost 5 percentage points, against 14 percentage points since 2001 (see Chart 10). Chart 10 The importance of the City of London for foreign exchange transactions against the euro has grown over the past three years Developments in the share of selected countries in global foreign exchange transactions in euro, 2001‑2019 (percentages)

• The share of the euro in global foreign exchange settlements declined somewhat over the past year.
• Data on foreign exchange transactions settled in the CLS system provide additional quantity-based evidence on the role of the euro in the foreign exchange markets.
• [12] Chart11 The share of the euro in global foreign exchange settlements declined in 2019 Share of foreign exchange transactions settled in CLS (percentages)

2.3 Use of the euro in international debt and loan markets

2.3.1 The euro in international debt markets

• The share of the euro in the stock of international debt securities declined by 0.3percentage point in 2019, standing at around 22% at constant exchange rates (see Chart12 and TableA4).
• By contrast, the share of the euro declined by almost 9percentage points over the same period.
• [14] Chart12 The share of the euro in the stock of international debt securities declined in 2019 Currency composition of outstanding international debt securities (percentages; at Q42019 exchange rates)
• An examination of granular (i.e.security-by-security) data on international issuance of foreign currency-denominated debt securities suggests that the share of US dollar-denominated issuance was broadly stable, while the share of euro issuance increased for the second consecutive year.
• In 2019 the total volume of foreign currency-denominated debt issuance increased by almost 4%, to just under USD2trillion, thereby partly reversing the marked decline observed in 2018 (see the left panel of Chart13).
• Issuance of debt securities denominated in US dollars increased by just 2%, or USD26 billion, while issuance in euro increased by 10%, or USD44billion.
• Chart13 The share of the euro in international issuance of foreign currency-denominated debt securities further increased in 2019 Currency composition of foreign currency-denominated debt issuance (left panel: USD billions; right panel: percentages)
• By contrast with emerging markets, US dollar-denominated debt issuance in advanced economies declined in 2019.
• [19] US borrowers were among the most active issuers of euro-denominated debt securities in 2019, as in earlier years.
• The cost of synthetic dollar issuance via the euro remained therefore broadly unchanged, which might have supported issuance of international euro-denominated debt securities by US borrowers.
• [21] Overall, euro-denominated international bond issuance stood at over USD470 billion in 2019, its highest level since 2008.
• [22] Chart14 Emerging market borrowers drove US-dollar denominated international debt issuance in 2019, while US borrowers were the most dynamic issuers of euro-denominated debt Regional breakdown of US-dollar denominated (left panel) and euro denominated (right panel) international debt issuance (USD billions)
• The composition of international issuance of euro denominated debt by security type has changed substantially.
• Issuance of short-term debt, and asset- and mortgage-backed securities, which were widespread in the years preceding the global financial crisis, remained more limited in 2019.
• Chart15 International issuance of euro-denominated debt securities reached the highest level since the global financial crisis, driven by corporate borrowers International issuance of euro-denominated debt securities, by security type (USD billions)
• 2019 also saw a shift in the sectoral composition of international issuance of euro-denominated debt securities.
• [23] Sovereign issuance continued to account for approximately 10% of total international issuance of eurodenominated debt securities.
• Chart16 Construction and manufacturing firms accounted for a larger share of issuance of euro-denominated international debt securities in 2019, with financial institutions remaining the most active issuers Sector breakdown of euro-denominated (left panel) and US-denominated (right panel) international debt issuance (percentages)
• Box1 The role of the euro in global green bond markets Prepared by Lena Boneva and Fabio Tamburrini A green bond is a type of fixed-income security whose proceeds are earmarked to finance investment projects with an environmental benefit.
• [24] While the global green bond market is still relatively small, it has been growing rapidly in recent years.
• Global green bond issuance was only USD9.1billion or 0.2% of total bond issuance in 2014; that figure grew to approximately USD205billion or 2.85% of total issuance by 2019.
• In 2019 more than half of global issuance was concentrated in the EU and almost half of global green bond issuance was denominated in euro (see left panel of ChartA).
• The leading role of the euro does not simply reflect the prevalence of green bond issuers based in the euro area.
• ChartA Almost half of global green bond issuance is denominated in euro; issuance of euro-denominated green bonds breakdown by issuer residence Currency breakdown of green bond issuance in 2019 (left panel) and developments of the share of euro area and non-euro area issuers of green bonds in euro (right panel) (percentages)

2.3.2 The euro in international loan and deposit markets

• The share of the euro in international loan markets continued to rise in 2019.
• [29] At the same time, the share of the US dollar in international loan markets declined by more than 1percentage point, albeit it remained the leading currency in international loan markets by a large margin.
• Chart17 The share of the euro in outstanding international loans increased in 2019 Currency composition of outstanding amounts of international loans (percentages; at Q42019 exchange rates)
• The ECBs accommodative monetary policy stance may have continued to support the euro in international loan markets.
• Similarly, volumes of all outstanding cross-border loans denominated in euro were around 3% higher compared to 2018.
• [31] The increase in the supply of euro-denominated funding outside the euro area is also likely to have boosted euro lending by banks outside the euro area.
• Chart18 Volumes of international loans denominated in euro continued to increase in 2019 Amounts outstanding of international loans denominated in euro (billions of US dollars; at current exchange rates)
• An examination of granular (i.e.security-by-security) data on international issuance of foreign currency-denominated debt securities suggest that international loan issuance declined in 2019, primarily due to a fall in US dollar-denominated loans (see Chart19).
• By contrast, euro-denominated investment-grade loan issuance increased by more than 40% in 2019, to almost USD90 billion, the highest level observed since 2011.
• As a consequence, the share of the euro in total investment-grade loan issuance increased from 10% in 2018, to almost 17% in 2019.
• Overall, the share of euro-denominated international loan issuance remained well behind that of the US dollar, which accounted for around 80% of both investment grade and leveraged loan issuance.
• Chart19 Volumes of US dollar-denominated international loans declined in 2019, unlike euro-denominated loans Breakdown of US dollar-denominated (left panel) and euro-denominated (right panel) international loans by type (USD billions)
• The share of the euro in outstanding international deposits remained stable in 2019.
• The share of the euro in the stock of international deposits stood at just under 19% in 2019, at constant exchange rates (see Chart20 and TableA7).
• Chart20 The share of the euro in outstanding international deposits remained stable in 2019 Currency composition of outstanding amounts of international deposits (percentages; at Q42019 exchange rates)

2.4 Use of the euro as an invoicing currency

• The share of the euro as an invoicing or settlement currency for extra-euro area trade remained broadly unchanged in 2019 for transactions in goods, but declined for those in services.
• 61% of extra-euro area exports and 51% of extra-euro area imports of goods were invoiced in euro in 2019 (see the left panel of Chart21 and TableA8).62% of extra-euro area services exports were invoiced in euro in 2019, down from 64% the previous year.
• [33] Chart21 The share of the euro in the invoicing of extra-euro area transactions in goods remained broadly stable in 2019, but declined for those in services Share of the euro in the invoicing of extra-euro area trade in goods (left panel) and in the invoicing of extra-euro area trade in services (right panel) (percentages)
• Patterns across euro area countries point to a positive correlation between invoicing transactions in goods and invoicing transaction in services in euro (see Chart22).
• The correlation between the shares of international transactions in goods invoiced in euro and international transactions in services invoiced in euro is positive, albeit stronger for exports than for imports.
• Chart22 Euro invoicing in external transactions of euro area members goods versus services Share of the euro in the invoicing of extra-euro area trade in services and goods: exports (left panel) and imports (right panel) (percentages of total exports)

2.5 Use of euro cash outside the euro area

• The stock of euro banknotes shipped to destinations outside the euro area remained broadly stable in 2019.
• [34] This suggests that foreign demand for euro cash outside the euro area has remained resilient, much as it is in the euro area.
• Entities in euro area neighbouring countries remained the main exporters and importers of euro banknotes, accounting for around 64% of both sales and purchases.
• Chart23 Foreign demand for euro banknotes remained broadly stable in 2019 Net monthly shipments of euro banknotes to destinations outside the euro area (EUR billions; adjusted for seasonal effects)


Chart 24 In 2019 euro banknotes were mainly exported to, and imported from, euro area neighbouring regions Sales (exports, left panel) and purchases (imports, right panel) of euro banknotes – breakdown by destination (percentages)

• Prepared by Livia Chiu, Joaquim Gomes and Rolf Pauli This article begins with a review of the global trends in central banks foreign currency reserve holdings in terms of their size, adequacy and composition, and follows on to examine the ECBs foreign currency reserves.
• Global foreign currency reserves grew markedly after the Asian financial crisis of the late 1990s, with emerging markets accumulating large reserves to self-insure against potential shocks.
• While global foreign currency reserves have traditionally been invested primarily in US dollar-denominated financial assets, in recent years holdings have become more diversified in terms of both currency and asset classes.
• The way in which the framework involves the national central banks (NCBs) of the Eurosystem in the active management of the ECBs foreign currency reserves is both unique and intricate.

1 Trends in central banks’ foreign reserve holdings

• Foreign currency reserves generally refer to readily available holdings in monetary authorities safe external assets.
• Total official reserves are the broadest definition of international reserves, including both foreign currency reserves and non-currency reserves.
• Foreign currency reserves, which comprise external assets generally controlled by national monetary authorities, consist of securities and deposits.
• They are established by way of foreign reserve policy decisions on, for example, foreign exchange market interventions or the management of reserve portfolios.

1.1 Main objectives of holding foreign currency reserves

• A number of countries developed the practice of holding foreign currency reserves in the mid-nineteenth century to back their liabilities and domestic currency with a view to supplementing their gold and silver reserves.
• [2] Since then, the reasons for holding foreign currency reserves have evolved over time and across countries.
• One possible use of foreign currency reserves, common to both advanced and emerging market economies, is to enable them to carry out foreign exchange interventions, if deemed necessary.
• Foreign currency reserves are generally held for traditional operational purposes as well as for precautionary and non-precautionary policy objectives.
• [6] As for the ECB, the main purpose of holding foreign currency reserves is to ensure that the Eurosystem has a sufficient amount of liquid resources, whenever needed, for its foreign exchange policy operations involving non-EU currencies.
• The ECBs foreign currency reserves were therefore only used to fund interventions in September/November 2000 and in March 2011.

1.2 Size of global foreign currency reserves

• Around two-thirds of global foreign currency reserves are held by emerging and developing economies.
• After the Bretton Woods system was brought to an end, global foreign currency reserve holdings grew sharply, particularly among advanced economies, despite the fact that it was widely expected that the shift to floating exchange rates would reduce the appeal of holding foreign currency reserves.
• [9] Following the Asian crisis, emerging market and commodity-exporting economies also began accumulating sizeable foreign currency reserves, with China accounting for the largest share of that increase.
• Global foreign currency reserve holdings continued to grow in the wake of the global financial crisis, as some countries were reluctant to use their reserves, fearing that doing so might send a negative signal about potential exchange rate pressures.
• [10] More recent developments suggest that foreign currency reserves have levelled off since 2015 (see Chart 1).
• [14] Chart 1 Developments in global holdings of foreign currency reserves and breakdown by main country groups (USD trillions)
• In the case of the ECB, its total official reserve assets, including both foreign currency and non-foreign currency reserves, were equivalent to around EUR 68.6 billion at the end of 2018.
• [15] These reserves comprise around EUR 49 billion in foreign currencies (US dollar, Japanese yen and onshore Chinese renminbi) and around EUR 18.2 billion in gold, with the remaining assets held in IMF SDRs.
• Official reserves were initially transferred to the ECB by the NCBs of those EU Member States that had adopted the euro,[16] in proportion to their share in the ECBs capital subscription[17].
• At the end of 2018, the entire Eurosystem held EUR 719 billion in total official reserve assets, including the ECBs official reserve assets.
• As this figure indicates, the NCBs hold significant additional official reserves on top of those held by the ECB.

1.3 Adequacy of foreign currency reserves

• Whether the level of foreign currency reserve holdings is deemed to be adequate hinges on several factors.
• As a result, countries with open financial markets should hold foreign currency reserves proportionate to the size of their banking systems.
• One common metric used in this context is that foreign currency reserves should cover at least 20% of broad money to account for capital flights.
• [22] Advanced economies, particularly major reserve currency issuers, have a less pressing need to hold reserves.
• Given the free-floating currency regime, the traditional metrics mentioned above, developed essentially for emerging market economies, are less suited to assessing reserve adequacy in advanced economies.
• Although it is difficult to assess the optimal level of foreign currency reserves to be held for conducting effective foreign exchange interventions, recent research has found that the average daily intervention volume in the foreign exchange markets (of 33 emerging and advanced economies) equals around 0.02-0.05% of a countrys GDP, depending on the currency regime (higher for narrow-band regimes, lower for floating regimes).
• Under floating currency regimes, the baseline success rate of the foreign exchange interventions is around 60%, considering the intended objective of the intervention as identified.
• For example, they can use foreign exchange swaps without immediate depletion of foreign currency reserves.

1.4 Global trends in the currency composition of global foreign reserves

• Global foreign currency reserves are mainly invested in US dollar-denominated financial assets, while the euro is the second most-used reserve currency.
• Based on IMF Currency Composition of Official Foreign Exchange Reserves (COFER) data[26], at constant exchange rates, the US dollars share of globally disclosed holdings of foreign exchange reserves stood at around 62% at the end of 2018, against 69% in 2007 (i.e.
• The euro accounted for roughly 20% of global foreign exchange reserves at the end of 2018, against 22% in 2007 and 19% in 1999.
• The share of the Chinese renminbi reached almost 2% of global foreign currency reserves at the end of 2018, double that of early 2017 (see Chart 3).
• Chart 3 Currency composition of global foreign currency reserves Developments in the shares of the euro, US dollar, non-traditional currencies and other currencies in global official holdings of foreign exchange reserves (percentages; at constant Q4 2018 exchange rates)
• [31] Anecdotal evidence aside, recent research on the role of economic and geopolitical considerations in the currency composition of foreign exchange reserves found support for both.
• [32] The ECBs official reserves are currently invested in US dollars, Japanese yen, Chinese renminbi, gold and SDRs.
• The currency composition of the ECBs official reserves reflects policy considerations, in other words, the ability to conduct and fund effective interventions in euro against other major currencies.
• [33] Where the ECB engages in foreign exchange transactions to adjust the composition of the foreign currency reserves, it is to ensure compliance with the Foreign Exchange Global Code (FXGC).
• Chart 4 Composition of the ECBs official reserves
• The CBGAs signatories included the Eurosystem and the central banks of Sweden, Switzerland and initially the United Kingdom.
• The first CBGA[36] was set up in 1999 for a five-year period, when concerns about the negative market impact of uncoordinated gold sales by central banks were evident, and increasing, in the gold market.
• The terms of the last two CBGAs became less and less stringent, reflecting the improving conditions in the gold market.
• The market impact on gold prices in CBGA announcements, including the one on the expiry of the last CBGA, was negligible.
• Chart A Gold sales by CBGA signatories and gold price developments (Tonnes; US dollar per troy ounce)
• Since 1999 the gold market has grown and matured in terms of liquidity and investor base.
• [37] The structure of the gold market differs from that of other financial assets, as gold does not only serve investment purposes, but also has practical uses.
• These flexible and liquid investment vehicles helped broaden the range of investors by easing the access of retail and pension funds to gold exposure.
• [39] Market liquidity and its ability to absorb large-volume gold transactions have improved continuously, thereby lowering the need for the CBGA.
• Central banks and other official institutions have become net buyers of gold over the current decade, mainly as a result of demand from emerging markets.
• Several factors may have supported this renewed interest in gold, mainly from developing countries[40] (see Chart C).
• First, gold has benefited from its status as a safe-haven asset with the ability to preserve wealth over the long term with no risk of default.
• Other supporting factors are the low or negative interest rate environment in major reserve currencies, the reshaping of the global geopolitical landscape and the authorities efforts, in some countries, to back the national currency with physical assets.

2 The management of the ECB’s foreign currency reserves

The investment framework for the management of the ECB’s foreign currency reserves is designed to ensure that they are readily available for policy purposes.[44]

2.1 From high-level objective to concrete investment principles

• The main investment principles for the portfolio management of the ECBs foreign currency reserves are, in order of importance, liquidity, security and return.
• This means that it must be possible to convert the portfolio into cash balances in a short time frame and at minimal cost.
• To achieve this, a large share of the foreign reserves is invested in US and Japanese government bonds with a relatively short residual maturity.
• Subject to the principles of liquidity and security, the investment framework is designed to maximise investment returns.

2.2 The organisational structure of foreign reserve management

• The management of the ECBs foreign currency reserves is organised in three layers: i) a strategic benchmark; ii) a tactical benchmark; and iii) day-to-day portfolio management by NCBs (Figure 1).
• Figure 1 The three layers for the management of the ECBs foreign currency reserves
• A through-the-cycle component identifies efficient portfolio allocations based on long-term expectations of risks and returns through the economic cycle.
• modified duration, allocation per maturity bucket and asset class) for each currency, the ECBs risk management unit translates those characteristics into an investment portfolio, providing security-level detail.
• This committee has members from the investment, risk management and compliance units of the ECB.
• The management of the ECB portfolio by NCBs constitutes the second active layer, the investment returns of which are measured against the tactical benchmark.
• Unlike the internally maintained strategic and tactical benchmarks, the actual management of the investment portfolios is organised in a decentralised manner within the Eurosystem.
• Subject to the rules set by a guideline governing the NCBs management of the ECBs foreign currency reserves, the NCBs act as agents of the ECB.
• The Eurosystem has a dedicated working group which regularly discusses all issues related to the foreign currency reserve management framework and the actual management of the ECBs foreign currency reserves.
• Every three years the Governing Council reviews the allocation of portfolios and may decide to change the currency allocation.

2.3 The active management of the ECB’s foreign currency reserves – incentives and management styles

• Active management, competition between NCB portfolio managers and diversification of portfolio management styles are key characteristics of the ECBs foreign currency reserve management framework, which is intended to generate a steady stream of additional investment returns compared with the strategic benchmark.
• Over time, all active layers have made a positive contribution to the strategic benchmark returns for all reserve currencies.
• As illustrated in Chart 5, for the US dollar portfolios, all individual NCB portfolios have, on average, contributed positively.
• Chart 5 Risk and return in NCB portfolios for the USD portfolio (percentage points, annual averages 2006-18)
• Active portfolio management takes place within a specific risk budget for both the tactical benchmark and the actual portfolios.
• The ECBs independent risk management function is responsible for defining and maintaining the parameters within which portfolio managers can actively take risk.
• The risk budget allocated to the tactical benchmark typically exceeds that of the NCBs portfolios by a factor of 2.
• The role of the NCB portfolio managers (anticipating day-to-day developments in markets) can be expected to involve more moderate risk adjustments, but with greater flexibility.
• In addition, the investment framework includes incentives for the active layers to actively use the risk budget.
• At the tactical benchmark level, the incentive consists of an internal target, set by the ICO, for outperforming the strategic benchmark.
• This is in line with best asset management practices, which allow portfolio managers to better calibrate their positions in order to reach the target.

Conclusion

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