Annex 1: Statement of Investment Policy for the Government of Canada (August 2018)
1. Purpose of Policy
The Statement of Investment Policy for the Government of Canada (SIP) sets out the policy governing the acquisition, management, and divestiture of assets held in the Exchange Fund Account (EFA). The Minister of Finance establishes the SIP under the Currency Act.
2. Purposes of Exchange Fund Account
The EFA is the principal repository of Canada’s official international reserves. As stated in the Currency Act, the purposes of the EFA are to aid in the control and protection of the external value of the Canadian dollar and provide a source of liquidity to the Government. Assets held in the EFA shall be managed to provide liquidity to the Government and to promote orderly conditions for the Canadian dollar in the foreign exchange markets, if required. The liquid foreign currency assets held in the EFA also form a key component of the Government of Canada’s prudential liquidity, which is available to meet financial requirements in situations where normal access to funding markets may be disrupted or delayed.
The EFA also facilitates Government of Canada transactions with the International Monetary Fund (IMF) under the IMF Articles of Agreement. These transactions include the provision of freely usable currencies to the IMF, through the purchase and sale of special drawing rights, as well as various transactions relating to Canada’s reserve position in the IMF (which does not form part of the EFA).
Part II of the Currency Act governs the management of the EFA and allows the Minister of Finance to establish an investment policy for EFA assets. The Minister of Finance may delegate the responsibility for the implementation of the approved policy to officials of the Department of Finance Canada.
The Bank of Canada Act provides statutory authority for the Bank of Canada to act as the Government’s fiscal agent in the management of the Government of Canada's EFA.
Within the Minister of Finance’s delegated authorities, the Funds Management Committee (FMC), composed of senior officials from the Department of Finance Canada and the Bank of Canada (together, “EFA officials”), prepares recommendations for the Minister of Finance and oversees the management of the EFA.
The FMC is supported by a Foreign Reserves Committee (FRC) and a Risk Committee (RC). The FRC oversees the funding of and investment of the foreign reserves and provides strategic and policy advice to the FMC related to the management of foreign reserves. The RC is an advisory body to the FMC that reviews and reports on risk exposures, highlights strategic risk issues the FMC should be aware of and identifies measures to mitigate these risks, and advises on broad risk considerations relevant to funds management activities.
Further information regarding oversight and governance is available within the Funds Management Governance Framework.
4. Alignment of EFA Activities with Government of Canada Policy Priorities
4.1 Guiding Principles
The SIP is based on principles that a person of ordinary prudence would apply in dealing with the property of others. The EFA shall be managed according to the fundamental principles of fiscal prudence, transparency and accountability, risk management, effectiveness and efficiency, and financial stability in order to protect the interests of Canadians.
4.2 Fiscal Prudence
The EFA is an account that forms part of the Government of Canada’s balance sheet. Recognizing the importance of fiscal prudence and sustainability in public finances, the EFA shall be managed in a cost effective manner under an asset-liability matching framework, whereby the market value of assets and liabilities are matched to the extent possible by currency, term and/or duration, to mitigate the potentially negative impacts of movements in interest rates and foreign exchange rates on the Government’s fiscal position. Credit risks associated with assets and liabilities are not offset under this framework and are therefore addressed by other means (see the appendix).
4.3 Promoting Financial Stability
Canada’s international commitments and global regulatory initiatives to support financial stability will be taken into account in conducting EFA activity.
5. Investment Objectives
Consistent with the purpose of the EFA as defined in section 2, maintaining liquidity and preserving capital are the primary objectives for managing the EFA. Accordingly, the EFA shall hold assets that can be sold or otherwise deployed on very short notice with minimal market impact and loss of value in order to maintain a high standard of liquidity. The EFA shall hold a diversified portfolio of fixed-income assets of high credit quality, and follow leading risk management practices in order to meet the objective of preserving capital value. The EFA shall be managed to maximize return on investments once the objectives of liquidity and capital preservation are clearly met.
6. Investment Process
The EFA shall be governed by a framework that includes a formalized, top-down investment management style that provides clarity on roles, decision-making authority, and accountability to facilitate the achievement of the EFA’s objectives. The Minister of Finance shall establish the risk tolerances of the portfolio through approvals of the Strategic Portfolio Parameters. The FMC shall establish the risk preferences of the portfolio through approval of the Strategic Asset Allocation. The FRC shall establish a benchmark that details asset allocations to individual counterparties deemed eligible for investment.
6.1 Strategic Portfolio Parameters
Strategic Portfolio Parameters for the EFA shall include, but are not limited to, the level of reserves, criteria for currency and asset class eligibility based on liquidity and capital preservation considerations, and portfolio risk limits. The Strategic Portfolio Parameters are included in the appendix. The Minister of Finance may except the liquid assets held in the EFA from the application of some or all the Strategic Portfolio Parameters where any of these assets are: (i) sold to provide foreign currency liquidity to the Government; (ii) sold to promote orderly conditions for the Canadian dollar in the foreign exchange markets; or (iii) sold in other similar circumstances.
6.2 Strategic Asset Allocation
The Strategic Asset Allocation shall direct the asset allocation of the portfolio in a manner that is consistent with meeting the EFA’s objectives. The Strategic Asset Allocation shall provide a framework to inform the investment decision-making process and to measure progress toward achieving the EFA’s objectives of maintaining liquidity and preserving capital.
6.3 Investment Benchmark
The Investment Benchmark shall be established by the FRC. It will specify investment exposures to eligible counterparties while adhering to the Strategic Portfolio Parameters (6.1) and in a manner consistent with achieving the Strategic Asset Allocation (6.2).
7. Securities Lending and Use of Derivatives
In order to meet the objectives of the EFA, officials may acquire or borrow assets, sell or lend those assets, and undertake related activities for the purposes of executing those transactions. Short sales are prohibited.
EFA officials shall only use derivatives and undertake related activities in a manner that is consistent with the objectives of the EFA of preserving capital value, maintaining a high standard of liquidity and, subject to these, optimizing returns.
8. Performance Assessment and Risk Management Reporting
EFA officials shall be responsible for measuring and monitoring the performance and risk exposures of the EFA and tracking these positions against the Strategic Asset Allocation and other appropriate indices, and providing regular reports to senior officials and the Minister of Finance.
Performance and risk measures shall be consistent with leading practices and provide timely and accurate information on the returns on EFA assets, the cost of associated liabilities and the relevant financial risks. An explanation of these measures can be found in the Government of Canada Treasury Risk Management Framework.
8.1 Public Reporting
The Currency Act requires annual reporting to Parliament on whether the objectives of the EFA have been met. This is accomplished through the annual reporting of the EFA’s performance in the Report on the Management of Canada’s Official International Reserves. In addition, the Minister of Finance provides monthly updates on the performance of the EFA, in accordance with the IMF’s General Data Dissemination System standards.
The Financial Administration Act requires annual reporting to Parliament on the funding associated with the investments.
8.2 Commercial Confidentiality
Notwithstanding the requirement to provide timely and comprehensive information on the EFA to Canadians, the names of individual counterparties or the securities held in the EFA shall not be disclosed for reasons of financial stability and commercial confidentiality.
The SIP shall be reviewed regularly. Until the Minister of Finance otherwise amends and approves the SIP and the governance and risk management frameworks, they shall remain in effect.
Appendix: Strategic Portfolio Parameters (August 2018)
The following Strategic Portfolio Parameters have been established to ensure that the liquid assets held in the EFA meet the primary objectives of maintaining liquidity and preserving capital. The parameters define eligible investments for the EFA and specify limits to protect the liquidity and capital value of EFA investments.
Liquidity Risk Tolerances
Liquidity risk tolerances have been established to ensure that a suitable level of EFA investments that can be readily sold during volatile market conditions is available to the Government at all times in the event that regular channels of financing are temporarily unavailable.
1. Level of Liquid Foreign Reserves
Liquid foreign reserves are held to safeguard Canada’s ability to meet payment obligations in situations where normal access to funding markets may be disrupted or delayed and to support investor confidence in securities issued by the Government of Canada.
- The level for the total market value of all foreign currency-denominated investments must be maintained at or above 3 per cent of Canada's annual nominal gross domestic product.
- The composition of liquid assets shall adhere to the requirements detailed in the Government's Prudential Liquidity Plan and foreign exchange intervention framework.
2. US-Dollar Holdings
Currency interventions to support orderly conditions for the Canadian dollar in the foreign exchange markets are likely to involve sales of US dollars to purchase Canadian dollars, highlighting the importance of owning the most liquid US-dollar-denominated assets. Thus, at least 50 per cent of liquid foreign reserves,1 measured on a market-value basis, must be denominated in US dollars.
As a contingency against a short-term interruption of domestic funding markets, at least 6 per cent of liquid foreign reserves on a market-value basis shall comprise US Treasury bills and US dollar cash.
3. Eligible Assets
Liquid foreign reserves shall be readily available to be sold or otherwise deployed with limited price impact to meet the Government’s foreign currency requirements.
- Eligible assets include fixed-income securities issued by sovereigns (including central banks and government-related entities), sovereign-supported issuers, sub-sovereign entities, 2 and supranational institutions.
- Eligible assets also include deposits with commercial banks, central banks and the Bank for International Settlements, repurchase agreements, commercial paper and certificates of deposit issued by private sector entities, gold and International Monetary Fund (IMF) special drawing rights. Bonds with embedded options and holdings of securities issued by and deposits with Canadian-domiciled entities (or entities that derive a majority of their revenues from their Canadian operations) are not permitted.
- All other classes of assets not listed in this appendix are prohibited.
4. Exposure to Issuers
Three categories of asset issuers have been defined for the EFA:
- Reference Issuers: These are government issuers of securities that are deemed by Canada to have reserve currency status and are actively traded, including cash.
- The minimum exposure to this category is 35 per cent of liquid foreign reserves on a market-value basis.
- High Credit Quality Issuers: These issuers are deemed by Canada to be of very high credit quality.
- Other Issuers: These issuers are high credit quality sovereigns and other entities that meet Canada’s liquidity and capital preservation requirements.
Capital Preservation Risk Tolerances
Capital preservation risk tolerances have been established to ensure that the market value of EFA assets will be relatively well preserved during times of market stress.
1. Maximum Term to Maturity
The term to maturity of individual assets is an important consideration since the value of longer-term fixed-income securities is generally more sensitive than the value of shorter-term fixed-income securities to movements in interest rates. In addition, in many instances longer-term securities are less liquid than shorter-term securities of the same issuer denominated in the same currency. Limiting the maximum term to maturity of assets aids in preserving the liquidity and capital value of assets that can be sold or otherwise deployed.
- The maximum term to maturity of individual assets held in the EFA is 10.5 years.
2. Other Eligible Currencies
To meet liquidity requirements and mitigate currency concentration risk, assets held as part of the liquid foreign reserves can be denominated in currencies other than US dollars, whose reference issuers satisfy the established liquidity and capital preservation constraints.
- Other eligible currencies include euros, British pounds and Japanese yen. In order to meet the Government’s international commitments, assets can also be denominated in IMF special drawing rights.
3. Minimum Credit Rating for Issuers of Eligible Assets and Counterparties
In order to mitigate the negative impact of potential credit events on the Government’s financial risk exposure related to the EFA, issuers of eligible assets and counterparties must be of acceptable credit quality, a determination that is informed by external credit ratings and internal credit analysis.
- Issuers must be deemed by Canada to have a credit rating of “A-” or higher.
- Counterparties for deposits, certificates of deposit, commercial paper and repurchase agreements must be deemed by Canada to have a credit rating of “A-” or higher.
- Counterparties for swaps and delivery-versus-payment transactions must be deemed by Canada to have a credit rating of “BBB” or higher.
- Reference issuers of securities that are deemed to have reserve currency status and are actively traded are exempt from the minimum credit rating requirement, since they are deemed to be the primary issuer of eligible securities in their local currency.
- The only allowable unrated investments are the following:
- securities issued by, and deposits with, central banks where the sovereign's credit quality is acceptable; and
- special drawing rights created by the International Monetary Fund.
4. Credit and Market Risk
The market value of liquid foreign reserve assets can be preserved by managing credit and market risks. An asset-liability matching framework, whereby the market value of assets and liabilities are matched by currency, term, and/or duration, is used to manage adverse impacts of changes in interest and foreign exchange rates on the Government's fiscal balance. Metrics such as Value at Risk, which measure the maximum potential loss the portfolio could suffer over a given period at a given confidence level, shall be monitored by senior officials to ensure the potential negative impacts of credit and market risk are managed within acceptable levels.
1 Liquid foreign reserves comprise foreign currency securities, and deposits. Special drawing rights, which are international reserve assets created by the International Monetary Fund, are excluded in the definition of liquid foreign reserves, although they form part of the EFA.
2 Sub-sovereigns are defined as levels of government within a sovereign territory, and hierarchically below the sovereign. For example, this could include, but is not limited to, states, provinces or municipalities within a sovereign.