Standing Committee on Public Accounts (PACP) Department of Finance Appearance on the Public Accounts of Canada 2024

Exchange Fund Account

Issue

The Deputy Minister will be appearing before the Standing Committee on Public Accounts to discuss the recent tabling of the Public Accounts for 2023-24, which includes the Exchange Fund Account (details at Section 8 of Vol.1)

Key points

• The legislative purposes of the EFA – set out in the Currency Act – is to help support the Canadian dollar and provide a source of liquidity for the government, if required.
• The government has committed to maintain liquid reserves (a subset of the EFA comprising foreign currency securities and deposits) equal to or above 3 per cent of GDP.
  • As of March 31, 2024, liquid reserves were above this commitment, at about 4 per cent of GDP.
• Canada's reserves are positively viewed by rating agencies, with EFA assets largely composed of highly-liquid, safe investments.
• In 2023-24, the EFA reported a total return of US$188 million (23 basis points) – as reported in the Report on the Management of Canada's Official International Reserves for 2023-24. 

Anticipated Questions and Answers

In general, the Exchange Fund Account is not a major source of questions to the government, with the statutory release of the annual report not typically gathering public attention.

1. In the Public Accounts, foreign exchange accounts assets ($180.1 billion) vastly exceed foreign exchange liabilities ($44.1 billion) in 2023-24. Does this mean the government is running a very large net asset position with its international reserves?

   No. The EFA is managed under an Asset-Liability Matching framework to mitigate interest rate and currency risks.  This means that liabilities to fund the EFA broadly match its assets.

   However, given that the bulk of the funding of the EFA originates from the Consolidated Revenue Fund, the difference between foreign exchange accounts assets and liabilities is accounted as part of the total interest-bearing debt (general market debt).

2. Why are the cost of advances to the EFA higher than the net revenues of the EFA in 2023-24? Does this mean the EFA is losing money?

   No. The EFA portfolio is asset-liability matched (ALM) and as such its performance should be measured over the longer-term. 

   While the difference between net revenues of the EFA and the cost of advances to the EFA could be perceived as its "annual fiscal balance", the EFA total return measure - which showed a gain of US$188 million in 2023-24 - is its main performance metric.  It is published as part of the Report on the Management of Canada's Official International Reserves for 2023-24. 

   Investment and funding decisions in the EFA have multi-year horizons, which is taken into account in the total return measure.  Relying on a year-over-year measure to assess the EFA's performance would be misleading.

3. How come the EFA registered a loss on the sale of marketable securities in 2023-24?

   In the statement of operations (in section 8), the EFA registered a loss on the sale of marketable securities in 2023-24.

   Such loss mainly reflects the "switch" from lower coupon assets to higher-yielding assets. In cases where the market value of the asset being sold is lower than its book value, there could be an accounting loss incurred in the first year of the transaction but over time, it is more than offset by the annual revenues collected from higher coupons on the new asset.

   Part of the benefit of such transactions is apparent in the interest earned on marketable securities which increased from $1,643 million in 2022-23 to $2,743 million in 2023-24 (it was $851 million in 2021-22) and is expected to continue to grow in coming years.

4. How do you determine what kind of assets (e.g., which countries, currencies) are purchased in the EFA?

   The Statement of Investment Policy for the Government of Canada (SIP), established by the Minister under the Currency Act, sets out the policy governing the acquisition, management and divestiture of assets held in the EFA.

   The SIP stipulates that the EFA shall hold a diversified portfolio of fixed-income assets of high credit quality issued by sovereigns, sovereign-supported issuers, sub-sovereign entities, supranational institutions, as well as 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 IMF special drawing rights.

   EFA investments can be denominated in four currencies including US dollar, euros, Yen and British pound, as well as IMF's Special Drawing Rights (SDRs).

5. Why do Canada's reserves not include gold holdings unlike many other countries and central banks?

   Canada does not invest in gold.  In the early 1980s, the Government of Canada decided to convert the bulk of its gold holdings into high credit quality, marketable fixed income securities that earn interest income and are denominated in foreign currencies.

   Compared to gold, investments in liquid fixed-income securities are more clearly aligned with the purpose of the EFA.

   The vast majority of Canada's foreign exchange reserves is invested in high quality financial assets from G7 and other advanced economies. These financial assets are composed primarily of debt securities of highly rated sovereigns, sub-sovereigns, agencies and supranational organizations.

Background

The Exchange Fund Account (EFA), which is held in the name of the Minister of Finance, represents the largest component of Canada's official international reserves (OIR). It is a portfolio that is primarily made up of liquid foreign currency securities, deposits, and special drawing rights (SDRs).

In addition to the EFA, Canada's official international reserves include Canada's reserve position at the IMF. This position, which represents Canada's investment in the activities of the IMF, fluctuates according to drawdowns by and repayments from the IMF.

The legislative purposes of the EFA, as specified in the Currency Act, are to aid in the control and protection of the external value of the Canadian dollar and to provide a source of liquidity for the Government, if required.

The Department of Finance Canada and the Bank of Canada jointly develop and implement the funding and investment policy of the EFA. As fiscal agent of the Government, the Bank of Canada executes funding and investment transactions and manages EFA cash flows. 

The management of the EFA is also guided by key strategic objectives to help achieve its legislative purposes, including:

• Maintaining an adequate level of liquidity;
• Preserve capital value, and,
• subject to the achievement of the two primary objectives, optimize returns (i.e., maintaining the cost/benefit of the EFA at an acceptable level for the Government).

In the Government of Canada's Public Accounts, the "foreign exchange accounts" items (assets and liabilities) in the Consolidated Statement of Financial Position represent the financial assets and liabilities related to Canada's international official reserves (OIR).

The OIR comprises the Exchange Fund Account, of which the largest portion is liquid reserves (foreign currency securities and deposits), and IMF Special Drawing Rights holdings. The second part of the OIR includes the assets and liabilities related to Canada's membership in the IMF.