ANNUAL REPORT 2008 - Polymer Bank Notes of the World

and SDR holdings increased by around 2.6%in 2008, despite the sale of 30 tonnes of goldduring the year. This increase was mostly dueto the appreciation of gold by around 9.4% in2008, as measured in euro terms. No losses inthe ECB’s foreign reserves were experienced asa result of defaulting investment counterparties.In 2008 the list of eligible instruments in whichthe ECB’s foreign reserves can be invested waskept unchanged. Interest rate swaps, which wereintroduced in late 2007, were used regularlyin 2008. The preparatory work to establish anautomatic securities lending programme forthe ECB’s US dollar-denominated assets wascompleted in 2008. It is envisaged that theprogramme will start in 2009, although this willdepend on prevailing market conditions.OWN FUNDS MANAGEMENTThe ECB’s own funds portfolio consists ofthe invested counterpart of the ECB’s paid-upcapital, as well as amounts held from time totime in its general reserve fund and its provisionagainst foreign exchange rate, interest rate andgold price risks. The purpose of this portfolio isto provide the ECB with income to help to coverits operating expenses. The objective of itsmanagement is to maximise expected returns,subject to a no-loss constraint at a certainconfidence level. The portfolio is invested ineuro-denominated fixed income assets.The value of the portfolio at current market pricesgrew from €9.3 billion at end-2007 to €10.2 billionat end-2008. The increase in market value wasdue to the investment in the own funds portfolioof the provision against foreign exchange rate,interest rate and gold price risks established by theECB in 2005, as well as to investment returns andthe contributions by the Central Bank of Cyprusand the Central Bank of Malta to the capital andreserves of the ECB following the adoption of theeuro by Cyprus and Malta.The list of eligible issuers of covered bonds andsenior uncovered bonds was extended slightlyin 2008. No losses were experienced as a resultof defaulting investment counterparties.RISK MANAGEMENT ISSUESThe financial risks to which the ECB isexposed in its investment activities are closelymonitored and measured in order to keepthem within the levels specified by the ECB’sdecision-making bodies. For this purpose, adetailed limit structure is in place and limits aremonitored daily. Regular reporting ensures thatall stakeholders are adequately informed of thelevel of such risks.In 2008 the ECB further enhanced the riskmanagement framework for its investmentoperations by upgrading IT systems and finetuningits credit risk methodology. The overallframework proved resilient in the wake of thefinancial crisis and no losses occurred as a resultof a counterparty or issuer default. Moreover,as part of its efforts to support the developmentof state-of-the-art strategic asset allocationmethodologies in central banks, the ECB, incooperation with the World Bank and the BIS,organised the first conference on strategic assetallocation for central banks and sovereign wealthmanagers in Frankfurt on 24 and 25 November2008.One of the indicators used to monitor marketrisk is Value-at-Risk (VaR), which definesthe loss for a portfolio of assets that will notbe exceeded at the end of a specified period oftime with a given probability. The value of thisindicator depends on a series of parameters usedfor the calculation, in particular the confidencelevel, the length of the time horizon and thesample used to estimate asset price volatility.As an illustration, computing this indicator forthe ECB’s investment portfolio on 31 December2008, using as parameters a 95% confidencelevel, a time horizon of one year and a sampleof one year for asset price volatility, would resultin a VaR of €9,185 million. Computing the sameindicator with a five-year instead of a one-yearsample would result in a VaR of €5,823 million.Most of this market risk is due to currency andgold price risk. The low levels of interest rate riskreflect the fact that the modified duration of theECB’s investment portfolios remained relativelylow in 2008.ECBAnnual Report2008111