Investment risk profile
The risk profile of assets is determined by the currency reserves. The main risk to the currency reserves is market risk, in particular risks related to exchange rates, the gold price, share prices and interest rates. In addition, there is liquidity risk as well as credit and country risks, although these are smaller than market risk. The contribution of Swiss franc bonds to total risk is negligible.
Market risk of currency reserves
Exchange rates are the most important risk factor for the currency reserves. As currency risk is not hedged against Swiss francs, even minor changes in the Swiss franc exchange rates lead to substantial fluctuations in investment income, and thus in the SNB’s capital. In addition to currency risk, fluctuations in the gold price and stock prices as well as interest rate risk are relevant as well. Currency risk, share price risk and interest rate risk are limited through the specification of benchmarks and management guidelines. Various means, including the use of derivative financial instruments such as interest rate swaps, stock index futures and interest rate futures, are used to control these risks. To manage currency exposure within foreign currency investments, foreign exchange derivatives can also be used.
As a matter of principle, the SNB does not hedge currency risk against the Swiss franc, as hedging would have an undesirable impact on monetary policy. Hedging operations, for example selling foreign exchange forwards against Swiss francs, would create additional demand and increase upward pressure on the Swiss franc. Therefore, hedging would de facto have the same effect as a foreign exchange market intervention to strengthen the Swiss franc. For these reasons, currency risk must be accepted as an inherent component of currency reserves.
Credit risk of currency reserves
Credit risk stems from the possibility that counterparties or issuers of securities do not meet their obligations. Such risks are present in the case of bonds issued by all borrower categories. The SNB holds bonds issued by public and supranational borrowers, covered bonds and similar instruments as well as corporate bonds as part of its currency reserves. For issuers of bonds, the SNB requires a minimum rating of investment grade. Exposure to individual issuers is limited by means of concentration limits. Credit risk arising from non-tradable instruments with respect to banks was very low. Replacement values of derivatives were collateralised, in accordance with the ISDA (International Swaps and Derivatives Association) agreements with counterparties. Since May 2014, the SNB has been executing most of its interest rate swaps via a central counterparty. On the one hand, this facilitates netting of offsetting positions. On the other, efficiency gains are made in the daily management of collateral.
Most of the bonds held were government bonds, which, in turn, mainly comprised highly liquid bonds issued by European countries and by the US. In all, over 85% of bonds were rated AA or higher.
Liquidity risk of currency reserves
The SNB’s liquidity risk arises from the possibility that, should investments in foreign currencies need to be sold, such sales could be effected only partially or after considerable price concessions, or may not be possible at all. The SNB ensures a high level of liquidity in its foreign currency reserves by holding a large number of the most liquid government bonds in the major currencies, namely euros and US dollars. Liquidity risk is reassessed periodically.
Country risk of currency reserves
Country risk arises from the possibility that a country may hinder payments by borrowers domiciled in its sovereign territory or block the right to dispose of assets held there. In order to avoid entering into any unbalanced country risk, the SNB endeavours to distribute assets among a number of different depositories and countries. Gold holdings are stored according to this principle as well. In choosing a location, attention is paid to both appropriate regional diversification and easy market access. Of the 1,040 tonnes of gold, approximately 70% is held in Switzerland, some 20% at the Bank of England, and roughly 10% at the Bank of Canada. Decentralised storage of gold holdings in Switzerland and abroad ensures that the SNB has access to its gold reserves even in the event of a crisis.