Archived - Departmental Response to the Evaluation of the Exchange Fund Account
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The Department of Finance thanks Fischer Francis Trees & Watts (FFTW) for their work on this evaluation.
The Department is pleased to note that the report states that the Exchange Fund Account (EFA) is being managed prudently, effectively and with due regard for the three key objectives: liquidity, capital preservation and return enhancement. The report also notes that by realizing a moderate positive return over the cost of funding the EFA, Canada has met all stated key objectives, and despite a conservative approach to managing the EFA, has also managed to achieve a contribution to the public purse.
The recommendations contained in the evaluation focus on ways in which Canada could enhance the investment return from the EFA, should it wish in the future to reconsider its current low-risk tolerance policy. The recommendations focus on two areas: broadening the EFA's range of investments to include new asset classes, country exposure and currencies, and seeking additional return by taking on exposures to movements in interest rates.
The following are FFTW's main recommendations to the Government:
- Re-evaluate the currency allocation and increase the number of eligible currencies;
- Broaden the list of eligible countries in which the EFA invests;
- Consider adding new asset classes that are less liquid than most existing eligible investments but provide incremental yield;
- Consider allowing the EFA to have substantial unmatched duration (interest rate) exposure; and,
- Evaluate the impact of yield curve exposure that would result from unmatched duration exposure.
The Department periodically reviews the possibility of introducing new investments in the EFA that would expose the EFA to new asset classes, currencies and countries, Potential investments are evaluated against the three objectives guiding the management of the EFA: liquidity, capital preservation and cost-effectiveness. FFTW's recommendations in these areas will be considered in reviews of investment strategy that will be conducted over the 2007-08 and 2008-09 planning periods.
The recommendations to consider increasing the EFA's exposure to movements in interest rates in order to generate additional investment returns represent a departure from the Government's current policy with regards to market risk. Currently, EFA assets and the liabilities funding them are matched in duration and currency to the extent possible in an integrated asset-liability management framework to minimize the government's exposure to market risks. Allowing more exposure to market risk through duration or currency mismatches would potentially increase both return and risk. A thorough analysis would need to be undertaken to determine whether the potential enhanced returns would outweigh the increase in risk. Currently, an analysis of this scope is not a priority for the Government.