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Archived - Exchange Fund Account Annual Report 2000: 3
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Notes to Financial Statements
December 31, 2000
1. Authority and Objective
The Exchange Fund Account (the Account) is governed by Part II of the Currency Act. The Account is in the name of the Minister of Finance and is administered by the Bank of Canada as fiscal agent. The Financial Administration Act does not apply to the Account.
The legislative mandate of the Account is to aid in the control and protection of the external value of the Canadian dollar, and the Minister of Finance acquires or sells for the Account those assets which are deemed appropriate for this purpose in accordance with the Currency Act. The Account is empowered to invest in instruments approved by the Minister of Finance in accordance with the Act.
2. Significant Accounting Policies
Significant accounting policies of the Account are set out below. As required by the Currency Act, they conform to the stated accounting policies used by the Government of Canada to prepare its financial statements.
a) Valuation of assets
The estimated fair market value of cash and short-term deposits, which are recorded at cost and generally held to maturity, is deemed to be equal to their book value.
Marketable securities are adjusted for unamortized premiums or discounts, where applicable, and are reported at the lower of their amortized costs including accrued interest and year-end market values. Purchases and sales of securities are recorded at the settlement dates.
Marketable securities, short-term deposits and Special Drawing Rights (SDR) include accrued interest. The SDR is a unit of account issued by the International Monetary Fund (IMF), and its value is determined in terms of a basket of four major currencies.
Gold and gold loans include accrued interest. Gold and gold loans are carried in the Account at a value of 35 SDR per fine ounce, which approximates cost and conforms to the value used in the Public Accounts of Canada.
b) Revenue from investments
Revenue from investments is recorded on an accrual basis and includes interest earned, amortization of premiums and discounts, gains or losses on sales of securities, and revenues from securities lending activities. Write downs of securities to their year-end market values (if applicable) are recorded as a charge to investment revenue in the year in which they occur.
c) Gold
Gold sales and net gains on gold sales are recorded at settlement dates. Interest revenue from gold loans is recorded on an accrual basis and is included in revenue. Premiums received on the sales of call options on gold are recorded in revenue.
d) Translation of foreign currencies and SDRs
Assets and liabilities denominated in foreign currencies and SDRs are translated into Canadian and US dollar equivalents at year-end market exchange rates, which were as follows:
| Canadian dollars | ||
|---|---|---|
| 2000 | 1999 | |
| US dollar | 1.4995 | 1.4433 |
| Euro | 1.4086 | 1.4525 |
| Japanese yen | 0.01307 | 0.01416 |
| Special Drawing Rights | 1.95371 | 1.97869 |
Foreign exchange gains or losses result from the translation of assets and advances denominated in foreign currencies and SDRs, as well as transactions throughout the year. Unrealized foreign exchange gains or losses on short-term currency swap arrangements with the Bank of Canada and on currency hedges are recorded in revenue as Net foreign exchange gains (losses). See also Note 10.
Investment revenue in foreign currencies and SDRs is translated into Canadian dollars at the foreign exchange rates prevailing on the date the revenue is earned.
e) Disposition of revenue
Revenue for the year is payable to the Consolidated Revenue Fund of the Government of Canada within three months after the end of the year in accordance with the Currency Act.
f) Services received without charge
The Account receives without charge administrative, custodial and fiscal agency services from the Bank of Canada. Costs related to these services are not recognized in the financial statements.
g) Interest-free advances
The Account receives interest-free advances from the Consolidated Revenue Fund. Interest cost related to these advances is not recognized in the financial statements.
3. Official Government Operations
Official government operations involve purchases and sales of Canadian dollars against foreign currencies. These are undertaken to promote orderly conditions in the market for the Canadian dollar, or to meet net government requirements for foreign exchange. During the year 2000, official international reserves increased by US$3,778 million as a result of these operations (an increase of US$2,744 million in 1999). None of these transactions during 2000 and 1999 was aimed at moderating movements in the value of the Canadian dollar.
4. Risk Management and Financial Instruments
The role of the EFA as principal repository of Canada's official international reserves determines the nature of its assets and of its operations, as well as its use of financial instruments.
To ensure that the EFA asset portfolio is prudently diversified with respect to credit risk, the investment guidelines specify limits on holdings by class of issuer (sovereign, agency, supranational or commercial financial institution) and type of instrument, while there are further limits on exposure to any one issuer or counter-party.
Interest rate and foreign currency risks are minimized by matching the duration structure and the currency of the EFA's assets and the related foreign currency borrowings of the government of Canada.
5. Marketable Securities Denominated in US Dollars
| 2000 | 1999 | |||||
|---|---|---|---|---|---|---|
| (in millions of dollars) | ||||||
|
|
||||||
| Securities | Par value | Amortized cost | Par value | Amortized cost | ||
| US | US | Canadian | US | US | Canadian | |
| US Government | $3,022 | $3,046 | $4,567 | $4,617 | $4,736 | $6,837 |
| US Federal Agencies | 4,655 | 4,611 | 6,915 | 3,800 | 3,762 | 5,430 |
| Sovereign paper and International Institutions | 8,244 | 8,146 | 12,214 | 3,283 | 3,251 | 4,692 |
| Accrued interest | - | 286 | 430 | - | 203 | 292 |
| $15,921 | $16,089 | $24,126 | $11,700 | $11,952 | $17,251 | |
| Estimated market value at year-end: | $16,319 | $24,471 | $11,696 | $16,881 | ||
Estimated market values are based on quoted market prices.
At year-end, the value of securities was not written down (versus a write down of US $256 million or C$370 million from their amortized cost in 1999).
Loans of securities are effected on behalf of the Account by agents who guarantee the loans and obtain collateral of equal or greater value from their approved counter-parties in these transactions. At year-end, a portion of the Account's holdings of US Government securities consisting of US $2,825 million (par value) in Treasury Notes (nil in 1999) was being used in securities lending operations with financial institutions.
6. Assets Denominated in Other Foreign Currencies
| Cash and Short-term Deposits | ||||
|---|---|---|---|---|
| 2000 | 1999 | |||
| (in millions of dollars) | ||||
| US | Canadian | US | Canadian | |
| Euro | $76 | $114 | $24 | $35 |
| Japanese yen | 70 | 105 | - | - |
| $146 | $219 | $24 | $35 | |
| Marketable Securities | ||||
| 2000 | 1999 | |||
| (in millions of dollars) | ||||
| US | Canadian | US | Canadian | |
| Euro | $6,729 | $10,091 | $5,259 | $7,590 |
| Japanese Government | 438 | 656 | 493 | 711 |
| Amortized cost at year-end: | $7,167 | $10,747 | $5,752 | $8,301 |
| Estimated market value at year-end: | $7,174 | $10,757 | $5,564 | $8,030 |
Estimated market values are based on quoted market prices.
At year-end, the value of securities was not written down (versus a write down of US $188 million or C$271 million from their amortized cost in 1999).
7. Special Drawing Rights (SDR)
| 2000 | 1999 | |||
|---|---|---|---|---|
| (in millions of dollars) | ||||
| US | Canadian | US | Canadian | |
| Held at year-end | $574 | $861 | $526 | $759 |
| Accrued interest | 5 | 7 | 3 | 5 |
| $579 | $868 | $529 | $764 | |
8. Gold and Gold Loans
During the year, the Account sold 621,745 fine ounces of gold (681,289 fine ounces in 1999).
| 2000 | 1999 | |||
|---|---|---|---|---|
| (in millions of dollars) | ||||
| US | Canadian | US | Canadian | |
| Held at year-end | ||||
| Gold loans | $49 | $74 | $82 | $117 |
| Gold | 5 | 7 | 5 | 8 |
| Accrued interest on gold loans | - | - | 1 | 2 |
| $54 | $81 | $88 | $127 | |
The year-end carrying values and market values (based on London fixings) of gold and gold loans, excluding accrued interest, are:
| 2000 | 1999 | ||||
|---|---|---|---|---|---|
| Price per fine ounce | Total value in millions | Price per fine ounce | Total value in millions | ||
| Carrying value | - US | $45.60 | $54 | $47.98 | $87 |
| - Canadian | 68.38 | 81 | 69.25 | 125 | |
| Market value | - US | 272.65 | 323 | 290.25 | 524 |
| - Canadian | 408.84 | 484 | 418.92 | 756 | |
9. Due to the Consolidated Revenue Fund (CRF) - Advances
The Account is funded by advances from the CRF. These were limited to C$40 billion by Order in Council dated December 30, 1999. On March 2, 2000, the Order in Council was revised to read "the aggregate amount of advances outstanding as of December 31 of each calendar year shall not exceed $50,000,000,000". At year-end, advances from (deposits with) the CRF consisted of:
| 2000 | 1999 | |
|---|---|---|
| (in millions of Canadian dollars) | ||
| US dollars | $41,242 | $41,686 |
| Canadian dollars | (10,798) | (19,598) |
| Euro | 9,860 | 7,473 |
| Japanese yen | 758 | 708 |
| Special Drawing Rights | (1,192) | (1,207) |
| $39,870 | $29,062 | |
The proceeds of Canada's borrowings in foreign currencies and allocations of SDR by the IMF have been advanced from the CRF to the Account. Subsequent repayments of foreign currency debt are made using the assets of the Account and result in reductions in the level of foreign currency advances. Interest payable by Canada on borrowings in foreign currencies and charges on SDR allocations to Canada are charged directly to the CRF.
Canadian dollar advances are required by the Account for the settlement of its purchases of foreign currencies. Sales of foreign currencies result in receipts of Canadian dollars that are remitted to the CRF, causing reductions in the level of outstanding Canadian dollar advances. Cumulative net sales of foreign currencies can result in overall net deposits of Canadian dollars by the Account with the CRF.
10. Commitments
a) Currency swaps
The Account enters into short-term currency swap arrangements with the Bank of Canada. The objective of these swaps is to assist the Bank in its cash management operations. The Account sells US dollars for Canadian dollars, with simultaneous agreements to repurchase these US dollars from the Bank on future dates at the same exchange rates in effect at the time the swaps were entered into. The maximum term of the swaps is equivalent to the term of the underlying securities; however, they are generally reversed earlier based on operational requirements of the Bank.
These swaps result in receipts of Canadian dollars by the Account, which are remitted to the Consolidated Revenue Fund. These transactions are reversed when the swaps are unwound.
At year-end, the Account had commitments to repurchase US dollars under swap arrangements with the Bank of Canada of US $1,004 million (US $3,534 million in 1999). The Canadian dollar equivalent at the year-end exchange rate was $1,506 million ($5,101 million in 1999).
b) Gold options and forward contracts
The Minister of Finance has authorized the sale of call options, as well as forward sales, on part of the Account's gold holdings.
Under gold options, the Account receives a premium against commitments to sell gold at predetermined prices. No gold is sold unless the holders of the options exercise their rights by the expiry dates. At year-end, the Account had no outstanding commitments to sell gold (50,000 fine ounces of gold under call option contracts with a potential total value of US$ 14 million in 1999).
Under forward contracts, the Account is committed to sell gold at predetermined prices on future dates. At year-end, the Account had outstanding commitments to sell 20,000 fine ounces of gold (622,000 fine ounces of gold in 1999) for a total value of US$ 6 million (US$ 164 million in 1999). The value date of these contracts is February 23, 2001.
Notes:
1 See the 1996 and 1998 Budgets for statements on the government's policy to increase the level of reserves.
2 Actual credit exposure represents the loss to the government if the counterparty defaults today.
3 Potential credit exposure represents the potential loss to the government if the counterparty defaults at some time in the future.
4 The C6 index includes the United States, the Euro-11, Japan, the United Kingdom, Switzerland and Sweden.
5 Official intervention is separate from net purchases of foreign currency for government foreign exchange requirements and for additions to reserves.
6 Interest earned on assets includes actual and accrued interest, it does not include amortization of principal; Interest earned on unmatched U.S. dollar assets is the U.S. dollar equivalent of the year-end Canadian dollar advance to the CRF multiplied by a weighted average of Government of Canada treasury bill rates prevailing in 2000; Interest paid on matched U.S. dollar liabilities is total interest paid on U.S. dollar liabilities multiplied by the ratio of U.S. dollar assets to liabilities; The remaining interest paid is assigned to the unmatched portion of the U.S. dollar portfolio; Year-end amortized book value of assets are used to calculate net interest earned (paid) as percent of assets.
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