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MANAGING FOREIGN RESERVES
The primary goal of the foreign exchange reserve (FER) of Eesti Pank is to secure the stability of the
Estonian kroon. When investing in the foreign exchange reserve the bank follows the conservative risk limits established to
the assets backing the Estonian kroon, which prioritise maintaining the assets and their liquidity while earning
investment income.
The foreign exchange reserve is divided into two: the liquidity buffer and the investment portfolio.
The liquidity buffer accounts for the extremely liquid resources necessary for fulfilling the currency board function, which the
central bank can use at any time for Estonian kroon and foreign currency transactions with domestic credit institutions. Assets
of the other, larger component of the foreign exchange reserves are invested in international financial markets.
The breakdown of the foreign exchange reserve into two is necessary primarily because very short-term
investments do not yield greater income compared to the money market interest rates. However, if all funds are placed in long-term instruments, satisfying
the demand of the foreign exchange market may entail undesired additional costs. A liquid share has been separated from the
foreign exchange reserves, its volume covering the monthly foreign currency needs of the banking system with a 95% probability.
Generally all the assets of the liquidity buffer are invested in overnight repurchase agreements, secured by government
bonds.
How are investments made?
Investment activities in Eesti Pank are the responsibility of the Financial Markets Department where
all the related risks are measured and managed. The general principles of investing foreign exchange reserves and the
prescribed risk limits approved by a regulation of the Governor of Eesti Pank are strictly adhered to. An investment decision
means assuming an investment position deviant from the benchmark portfolio and choosing the specific instruments. The
decision-making process is divided into two: the strategical and the tactical part.
A strategical decision is reached on the basis of macroeconomic analyses and forecasts. A strategic
investment decision is made with a 3-6 month outlook and it is essentially a division of the investment portfolio among countries
and taking a greater or smaller risk compared to the benchmark portfolio.
A tactical investment decision is made with a shorter perspective, taking into account near-market
indicators, such as the current level of financial markets, the latest dynamics, the differences in countries' interest rates,
etc.
The compliance of the investment portfolio to the agreed limits is checked in real-time (i.e. constantly, at
the same moment). Regular reports on the positions, risks and results are forwarded to the bank's management as well as to the
Internal Audit Department.
Using external asset managers
Hiring external asset managers usually has several goals: to improve the results of reserve management,
decrease the fickleness of results, acquire additional know-how by using the services of the world's leading investment companies
and assess the efficiency of our own reserve managers compared to the world's best.
Taking into account all these considerations, during several years Eesti Pank has also entrusted the
management of some of its foreign reserves to external asset managers. The foreign asset managers as well as Eesti Pank's asset
managers have exactly the same restrictions and norms to follow in the placement of reserves. Thus, the results are fully
comparable and have depended only on investment decisions.
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