Report on the Management of Canada's Official International Reserves April 1, 2019 - March 31, 2020

Purpose of the Report

This edition of the Report on the Management of Canada's Official International Reserves provides details on official international reserves operations from April 1, 2019 to March 31, 2020 (the 2019–20 fiscal year).

As required under the Currency Act, the report provides a comprehensive account of the framework within which the Exchange Fund Account (EFA) is managed, the composition and changes in the EFA during the year, a statement of whether the strategic objectives established for the EFA have been met, and information on agents appointed to perform services concerning the EFA.

The unaudited financial statements that appear at the end of this report are in Canadian dollars, as reported in the Public Accounts of Canada.

Exchange Fund Account

The EFA, which is held in the name of the Minister of Finance, represents the largest component of Canada's official international reserves. It is a portfolio that is primarily made up of liquid foreign currency securities, deposits and special drawing rights (SDRs). SDRs are international reserve assets created by the International Monetary Fund (IMF) whose value is based on a basket of international currencies. 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. Under the Currency Act, the Minister of Finance has the authority to acquire, borrow, sell or lend assets held in the EFA in accordance with the Statement of Investment Policy for the Government of Canada (see Annex 1).

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

A detailed description of the EFA's management framework is provided in Annex 2. The framework includes the objectives, principles and governance structure of the EFA. Annex 2 also describes the policies that pertain to investments, risk management, performance measurement and foreign currency funding activities.

Executive Summary

The Currency Act stipulates that this report provide a statement of whether the strategic objectives established for the EFA have been met during the review period. These objectives—to maintain an adequate level of liquidity, to preserve capital value, and, subject to these two primary objectives, to optimize returns—were achieved during 2019–20.

Level of the official international reserves: The market value of Canada's official international reserves increased to US$86.1 billion as at March 31, 2020, from US$83.4 billion as at March 31, 2019. The change reflects increases in the IMF reserve position and EFA assets of US$427 million and US$2,272 million, respectively. EFA assets, which totaled US$83.0 billion as at March 31, 2020, were at a level that is consistent with the Government's commitment to maintain holdings of liquid foreign exchange reserves at or above 3 per cent of nominal gross domestic product. Liquid reserve assets are composed primarily of debt securities of highly rated sovereigns, sub-sovereigns, agencies and supranational organizations that borrow on public markets.

Table 1
The EFA and Official International Reserves
market value in millions of US dollars, settled basis
March 31, 2020 March 31, 2019 Change
Securities 69,862 68,141 1,7212
Deposits1 4,748 4,398 350
Total securities and deposits (liquid reserves) 74,610 72,539 2,071
SDRs 8,410 8,209 201
Total EFA 83,020 80,748 2,272
IMF reserve position 3,080 2,653 427
Total official international reserves 86,100 83,401 2,699
Note: Numbers may not add due to rounding.
1 Cash deposits with central banks and the Bank for International Settlements.

Portfolio performance and return: In 2019–20, the EFA earned an average positive spread (or net “coupon return”) of 17 basis points, up from 16 basis points the previous year. This spread represents the difference between the yield to maturity on foreign currency fixed-income assets held in the EFA and the yield to maturity of foreign currency liabilities used to fund the assets at the time of calculation. The spread measures the remaining underlying net return of the portfolio on the assumption that the assets and liabilities are held to maturity and the coupons are reinvested at their respective yield to maturity.

Taking into account cash flows and unrealized changes in the market value of assets and liabilities due to changes in interest rates and credit spreads, the EFA reported a total return of 31 basis points in 2019–20. This is equivalent to a mark-to-market gain of US$231 million. This compares to a total return of 45 basis points (a gain of US$326 million) in 2018–19.

EFA composition: As at March 31, 2020, the US-dollar share of EFA liquid investments was US$51.9 billion or 69.5 per cent, the euro share was equivalent to US$12.9 billion or 17.3 per cent, the British pound sterling share was equivalent to US$6.1 billion or 8.2 per cent, and the yen share was equivalent to US$3.7 billion or 5.0 per cent.

Investments in fixed-income securities issued by sovereigns, sub-sovereigns and government agencies made up 75.9 per cent of EFA liquid investments, 17.7 per cent was invested in securities issued by supranational organizations and 6.4 per cent was held in cash.

Based on the second highest rating among those provided by Moody's Investors Service, Standard & Poor's, Fitch Ratings and Dominion Bond Rating Service, as of March 31, 2020, 74.3 per cent of EFA liquid reserve investments were rated AAA and 78.4 per cent were rated AA+ or better.

EFA funding sources: The foreign currency reserve assets held in the EFA are funded in a cost-effective manner through a funding framework that mitigates the impacts of movements in interest rates and foreign exchange rates on the Government's fiscal position by matching the funding with the currency, term and/or duration of the reserve assets.

During 2019–20, EFA operations were financed through cross-currency swapsFootnote 1 of domestic obligations and direct foreign currency issuance. Total cross-currency swap funding and maturities during the reporting period were US$6.8 billion and US$5.7 billion respectively. The swaps were transacted in US dollars, euros and yen, at various terms, and at a weighted cost equivalent to 3-month US$ LIBOR (London Interbank Offered Rate) less 30.7 basis points. This compared to an average rate of 3-month US$ LIBOR less 35.9 basis points for 2018–19. The primary driver for the change in funding costs from the prior year was a decrease in Canadian swap spreads.Footnote 2 For example, the 10-year swap spread fell from an average of around 43 basis points in fiscal year 2018–19 to an average of about 41.5 basis points in fiscal year 2019–20. A fall in Canadian swap spreads increases the cost of funding the EFA with cross-currency swaps, all else being equal.

In January 2020, the Government of Canada issued a US$3 billion global bond with a 5-year maturity priced at a spread of 6 basis points over the comparable US Treasury security. This is the tightest global bond pricing achieved for Canada in modern times, which reflects the country's outstanding credit quality and strong demand for sovereign fixed-income securities in general.

The level of outstanding short-term US-dollar commercial paper issued under the Canada bills program was US$1.5 billion at year-end, lower than the US$2.0 billion in the previous year. The decrease was primarily due to lower funding needs in March due to an increase in market value of the liquid reserves portfolio. The average commercial paper cost was US$ LIBOR less 18 basis points, compared to the 3-year average of US$ LIBOR less 25 basis points.

Report on Operations in 2019–20

The following sections describe the impact of market developments on the EFA, policy and program initiatives undertaken during the reporting period, and portfolio performance.

Market Developments

The defining event of 2019–20 was the start of the COVID-19 pandemic.Footnote 3 The global economy experienced significant disruption and financial markets traded with heightened volatility for the majority of March. Central banks and fiscal authorities around the globe responded with unprecedented amounts of monetary easing and fiscal stimulus. Market volatility fell in response to the various policy responses and began to retrace a portion of the losses before March 31, 2020.

The EFA performed as expected during March, appreciating in value given the portfolio's well-diversified composition of high-quality assets.

Interest Rates

Overall, changes in interest rates in 2019–20 resulted in an increase of US$3,538 million in the market value of the liquid foreign reserves.

In the United States, the Federal Reserve cut its benchmark overnight lending rate by 225 basis points during 2019–20, which included 150 basis points of easing in March 2020. In response to the global COVID-19 pandemic, the Federal Reserve announced multiple purchase programs, which led to a significant expansion of its balance sheet. The yield on US 3-month securities fell 232 basis points compared to a decline of 183 basis points on 10-year US Treasury notes.

In Europe, the European Central Bank (ECB) announced an additional asset purchase program and a third series of targeted longer-term refinancing operations (TLTRO III). The deposit facility rate was also decreased by 10 basis points in fiscal year 2019–20.

Rates on German benchmark securities fell, leading to a modest flattening of the yield curve. Of note, the entire German benchmark yield curve was is negative territory multiple times in fiscal year 2019–20.

Credit Spreads

Credit spreads on fixed-income securities issued by supranational institutions, sovereigns and agencies in US dollars tightened and remained stable until a sharp widening in March in light of an expected worsening in economic conditions due to the spread of COVID-19 and containment efforts. The Federal Reserve announced multiple asset purchase programs to enhance liquidity, which led to a modest narrowing by the end of 2019–20.

Credit spreads on euro-denominated securities tightened relative to German government bonds for the majority of 2019–20 but widened in March before partially retracing after the European Central Bank announced an additional asset purchase program.

Overall, there was an approximately US$99 million decrease in the market value of reserves due to changes in credit spreads as of March 31, 2020.

Exchange Rates

In 2019–20, exchange rate movements resulted in a decrease of US$643 million in the market value of the liquid foreign reserve assets. However, the foreign reserves are managed under an asset-liability matching framework, and as such, exchange rate movements had a relatively minor impact on the Government's financial position since the decrease in the market value of assets is offset by a similar decrease in the value of associated liabilities.

The EFA is denominated in US dollars; therefore the value of the portfolio will fluctuate based on foreign currency prices relative to the US dollar. During 2019–20, the euro fell 1.6 per cent and the British pound sterling (GBP) fell 5.2 per cent against the US dollar. Since 17.3 per cent of the liquid reserves were held in euro-denominated securities and 8.2 per cent were held in GBP-denominated assets (on March 31, 2019), changes in the value of the euro and GBP against the US dollar had a negative impact on the market value of the reserves.

During 2019–20, the yen rose 3.4 per cent against the US dollar. Since about 5 per cent of the reserves were held in yen-denominated securities, the change had a positive but minor impact on the market value of reserves. 

For financial reporting purposes, the performance of the EFA is presented in Canadian-dollar terms. In comparison to the previous year, the Canadian dollar fell 5.7 per cent against the US dollar. Therefore, based on the prevailing Canadian dollar exchange rate on March 31, 2020, the EFA's liquid reserves appreciated in value from C$97,344 million to C$105,830 million.

Initiatives in 2019–20

In 2019–20, a LIBOR transition program was developed for the EFA. The EFA is exposed to LIBOR risk through its funding portfolio (e.g., floating rate cross-currency swaps and medium-term notes) and investment portfolio (e.g., floating rate notes).

Phase 1 of the program focused on reducing existing cross-currency swap exposures to LIBOR and refraining from taking on new swap, medium-term note and asset exposures linked to LIBOR. This phase was completed in 2019–20.

Phase 2 of the program involves a range of issues including systems work, legal documentation, and further policy work. Phase 2 is continuing with the objective of being able to implement the transition program before December 2021, in line with G20 and Financial Stability Board's guidance on benchmark reform.

Performance Versus Strategic Objectives

The Currency Act stipulates that this report provide a statement of whether the strategic objectives established for the EFA have been met during the review period. These objectives—to maintain an adequate level of liquidity, to preserve capital value, and, subject to these two primary objectives, to optimize returns—were achieved during 2019–20. The planned level of liquidity was maintained for the reserves portfolio throughout the reporting period, and the portfolio's exposure to market and credit risks was managed within approved limits. In addition, the net underlying return (coupon return) was positive.

EFA Returns

The EFA is a financial asset portfolio within the Public Accounts of Canada. For risk management purposes and to provide transparency on the net economic return or cost to the Government of maintaining the EFA, several performance indicators are measured and tracked on a regular basis and reported to senior management at the Department of Finance Canada and the Bank of Canada. Of these performance indicators, total return and coupon return are reported at market value. In addition, the net revenue of the EFA and corresponding cost of advances to the EFA are reported at book value. A brief overview of the portfolio's performance is provided below (a more detailed description is provided in Annex 4).

EFA Performance

Given the movements in interest rates and foreign exchange rates globally, the assets held in the EFA generated higher net revenues in 2019–20 than in 2018–19 (C$2.3 billion versus C$1.5 billion). The cost of advances to the EFA, which represents the estimated economic cost to the Government of financing the EFA, decreased compared to the previous fiscal year (C$1.8 billion versus C$1.9 billion).

Table 2
Summary of Main Performance Indicators
  April 1, 2019 to
March 31, 2020
April 1, 2018 to
March 31, 2019
1) Net revenue of the Exchange Fund Account (C$ millions) 2,283 1,482
2) Cost of advances to the EFA (C$ millions) 1,847 1,946
3) Measures of the net return on assets and liabilities    
Coupon return (basis points/US$ millions)
17/120 16/116
Total return (basis points/US$ millions)
31/225 45/326
  As at March 31,2020 As at March 31, 2019
4) Risk measures    
Total market risk (99% 10-day VaR, US$ millions)
1,260 547
Notes: Net revenue and cost of advances are based on actual and forecasted cash payments and receipts. The numbers are presented in Canadian dollars to be consistent with the financial statements. The measures of net return are market-based estimates and are presented in US dollars to be consistent with performance reporting for the EFA. See Annex 4 for further information on performance indicators.

In 2019–20, the net coupon return for the EFA, the difference between the yield to maturity of reserve assets and liabilities issued to fund the assets, was 17 basis points. The total returnFootnote 4 of the EFA decreased to 31 basis points from 45 basis points the previous year. The decrease was due primarily to a decrease in the market value of euro-denominated assets caused by changes in credit spreads.

Total Market Value at Risk (Total Market VaR)—which measures the potential loss on a net basis arising from interest rate, foreign exchange rate, credit and funding spread changes that will not be exceeded 99 per cent of the time if the EFA is held over a 10-holding-day period—stood at US$1,260 million.

Liquidity and Preservation of Capital

In practice, the EFA's liquid reserves (which exclude SDR holdings and the IMF reserve position) are mainly invested in the debt of sovereigns and their agencies (75.9 per cent as at March 31, 2020), as these securities both enhance the liquidity and preserve the capital value of the EFA (Table 3). A more detailed description of the changes in the level of the official international reserves is provided in Annex 3. 

Table 3
Composition of EFA Liquid Reserves
market value in millions of US dollars, settled basis
March 31, 2020 March 31, 2019 Change
Sovereigns and agencies 56,687 58,122 -1,435
Supranationals 13,178 10,019 3,159
Cash 4,748 4,398 350
Notes: Liquid reserves exclude SDR holdings. Numbers may not add due to rounding.

The largest portion of EFA liquid reserves is in US dollars because potential foreign currency needs are mostly in US dollars and, historically, foreign exchange market intervention has mainly consisted of transactions involving the US dollar. As at March 31, 2020, the US-dollar share of EFA liquid investments was US$51.9 billion or 69.5 per cent, the euro share was equivalent to US$12.9 billion or 17.3 per cent, the GBP share was equivalent to US$6.1 billion or 8.2 per cent, and the yen portion was equivalent to US$3.7 billion or 5.0 per cent (Table 4). By comparison, as at March 31, 2019, the US-dollar share was 66.5 per cent, the euro share was 18.7 per cent, the GBP share was 10.9 per cent and the yen share was 3.8 per cent.

Table 4
Currency Composition of EFA Liquid Reserves
market value in millions of US dollars, settled basis
March 31, 2020 March 31, 2019 Change
US dollars 51,887 48,271 3,613
Euros 12,891 13,562 -671
GBP 6,089 7,940 -1,851
Yen 3,746 2,766 980
Notes: Liquid reserves exclude SDR holdings. Numbers may not add due to rounding.

As specified in the Statement of Investment Policy for the Government of Canada, to help achieve the objective of preserving capital value, an issuing entity must be deemed by Canada to have a credit rating of A- or higher to be eligible for investment in the EFA. Compliance with issuer credit limits is monitored on a real-time basis.

The Government of Canada has committed to reducing mechanistic reliance on external credit ratings, consistent with Financial Stability Board principles and G20 commitments. Hence, Canada performs an internal assessment to support external credit risk assessments. As of March 31, 2020, the majority of EFA investments are given a rating of AA+ or higher by external credit rating agencies, as indicated in Table 5. The external rating is based on the second highest rating among those provided by Moody's Investors Service, Standard & Poor's, Fitch Ratings and Dominion Bond Rating Service.

Table 5
Credit Composition of EFA Liquid Reserves
market value in millions of US dollars, settled basis
  March 31, 2020 March 31, 2019 Change
AAA 55,425 54,143 1,282
AA+ 3,066 4,804 -1,738
AA 7,635 10,826 -3,191
AA-
A+ 3,736 2,767 969
A
A-
Below A-
Notes: Liquid reserves exclude SDR holdings. Numbers may not add due to rounding.

Exchange Fund Account Financing

EFA assets are funded by borrowings from a variety of sources (Table 6). Funding requirements are partially met through an ongoing program of cross-currency swaps of domestic obligations. Total cross-currency swap funding and maturities during the reporting period were US$6.8 billion and US$5.7 billion respectively.

During 2019–20, foreign currency was raised through cross-currency swaps at an average cost equivalent to 3-month US$ LIBOR less 30.7 basis points. This funding cost was higher than rates obtained during the previous fiscal year, which averaged 3-month US$ LIBOR less 35.9 basis points. As at March 31, 2020, Government of Canada cross-currency swaps outstanding stood at US$62.8 billion (par value). Swaps of US dollars, euros, GBP and yen made up 65.5 per cent, 19.7 per cent, 8.9 per cent and 6.0 per cent of the swap portfolio respectively.

The EFA can also be funded through direct foreign currency issuance using three programs: a short-term US-dollar paper program (Canada billsFootnote 5); a medium-term note program (Canada notesFootnote 6 and euro medium-term notesFootnote 7); and a global bondFootnote 8 program. The medium-term note program provides the Government with additional funding flexibility for issuance in a number of currencies, including the US dollar, euro and GBP. There were no medium-term notes issued in 2019–20. In January 2020, Canada successfully issued a 5-year US$3 billion global bond at a cost of 6 basis points over a 5-year US Treasury bond.

Table 6
Outstanding Foreign Currency Issues
par value in millions of US dollars
March 31, 2020 March 31, 2019 Change
Swapped domestic issues 62,806 59,275 3,531
Global bonds 9,000 8,244 756
Canada bills 1,534 2,020 -486
Medium-term notes      
Euro medium-term notes
165 568 -403
Canada notes
625 1,150 -525
Total 74,130 71,257 2,873
Note: Liabilities are stated at the exchange rates prevailing on March 31, 2020.

The mix of funding sources used to finance the reserves depends on a number of considerations, including relative cost, market conditions and the objective of maintaining a prudent foreign-currency-denominated debt maturity structure.

International Monetary Fund Programs

The Government of Canada participates in two lending arrangements with the International Monetary Fund (IMF) outside of the quota system that affect Canada's official international reserves: the multilateral New Arrangements to Borrow (NAB) and the temporary bilateral borrowing agreements (BBAs). These serve as second and third lines of defence, respectively, to supplement the IMF's loanable resources in the instance of severe global economic crises.

Canada's current participation in the NAB is governed by the November 2012 NAB Decision, which incorporated technical amendments made as a result of the IMF's 14th General Review of Quotas. In November 2016, Canada's participation in the NAB was renewed through November 2022. As of March 31, 2020, SDR 192 million or US$262 million (SDR 294 million or US$408 million in 2019) in lending has been provided by Canada to the IMF under the NAB.

Canada's participation in the BBAs is governed by the 2016 Note Purchase Agreement, which expires on December 31, 2020. The BBAs have never been activated by the IMF's Board of Directors, and no draws have been made on Canada's commitment. Amounts advanced under these arrangements are considered part of the official international reserves of Canada.

Collectively, Canada's outstanding loans under multilateral and bilateral arrangements with the IMF cannot exceed SDR 12,074 million at any given time. This reflects the maximum commitment under the NAB (SDR 3,874 million) and the temporary bilateral credit line to the IMF (SDR 8,200 million). At March 31, 2020, Canada's SDR holdings totaled SDR 6 billion, or US$8.4 billion.

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).

3. Governance

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.

9. Review

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,Footnote 9 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,Footnote 10 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:
    1. securities issued by, and deposits with, central banks where the sovereign's credit quality is acceptable; and
    2. 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.

Annex 2: Overview of the Exchange Fund Account Management Framework

Objectives

The objectives of foreign reserves management are to provide foreign currency liquidity to the Government, support intervention to aid in the control and protection of the external value of the Canadian dollar and promote orderly conditions for the dollar in the foreign exchange markets, if required. The liquid foreign currency assets held in the Exchange Fund Account (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, which represents the largest component of the foreign reserves, is an actively managed portfolio of liquid foreign currency securities and deposits. The key strategic objectives of the EFA are to maintain a high standard of liquidity, preserve capital value and optimize return subject to the liquidity and capital preservation objectives.

Principles

In pursuit of these objectives, the Government of Canada manages its foreign exchange reserves according to the following principles:

  • Effectiveness and efficiency: Policy development and operations shall take into account, to the extent possible, leading practices of other comparable sovereigns. Regular evaluations shall be conducted to ensure the effectiveness and efficiency of the governance framework and borrowing and investing programs.
  • Transparency and accountability: Information on investment and funding plans, activities and outcomes shall be made publicly available in a timely manner. Borrowing costs, investment performance and material exposures to financial risk shall be measured, monitored, controlled and regularly reported, as applicable.
  • Risk management: Risk monitoring and oversight shall be independent of financial asset and liability management operations.
  • 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 funded in a cost effective manner through a funding framework that mitigates the potentially negative impacts of movements in interest rates and foreign exchange rates on the Government's fiscal position by matching the funding with the currency, term and/or duration of the reserve assets. Credit risks associated with assets and liabilities are not offset under this framework and shall be addressed by other means.
  • Financial stability: The EFA is an account that supports Canada's preparedness for financial contingencies. As a result, the management of the EFA shall take into account Canada's international commitments and global regulatory initiatives to support financial stability.
For a complete description of the governance framework for managing the Government of Canada's financial assets and liabilities, see Funds Management Governance Framework.

Annex 3: Changes in the Level of the Official International Reserves

The level of the official international liquid reserves changes over time due to a variety of factors. As shown in Table A3.1, over the 12-month reporting period the level of reserves increased by US$2,699 million. The increase was due to return on investments (US$4,722 million) and reserves management operations (US$329 million), which was offset by foreign currency debt charges (-US$1,379 million), revaluation effects (-US$643 million) and net government operations (-US$330 million).

Table A3.1
Sources of Change in Canada's Official International Reserves
Between March 31, 2019 and March 31, 2020

market value in millions of US dollars
Change
Official intervention
Net government operations -330
Reserves management operations 329
Return on investments 4,722
Foreign currency debt charges -1,379
Revaluation effects -643
Total change 2,699

Official Intervention

Official intervention involves buying or selling foreign currencies in exchange for Canadian dollars, and would therefore affect the level of the official international reserves. Intervention in the foreign exchange markets for the Canadian dollar might be considered if there were signs of a serious near-term market breakdown (e.g., extreme price volatility with buyers and/or sellers increasingly unwilling to transact), indicating a severe lack of liquidity in the Canadian-dollar market. It might also be considered if extreme currency movements seriously threatened the conditions that support sustainable long-term growth of the Canadian economy. The goal would be to help stabilize the currency and to signal a commitment to back up the intervention with further policy actions, as necessary.

Since September 1998, the Bank of Canada has not undertaken any foreign exchange market intervention in the form of either purchases or sales of US dollars versus the Canadian dollar.Footnote 11 Footnote 12

Net Government Operations

During 2019–20, the Government sold liquid reserve assets with a market value of US$330 million to address a mismatch in the market value of the asset and liability portfolios. These sales are in accordance with the principles of managing the liquid foreign reserves portfolio under an asset-liability matching framework. 

Reserves Management Operations

The purchase and sale of foreign currency assets along with the issuance and maturity of debt used to fund those assets totaled US$329 million. Over the reporting period, funds raised through the issuance of bonds, foreign exchange (FX) swaps, cross-currency swaps, medium-term notes and Canada bills, totaling US$20.2 billion, were greater than debt maturities totaling US$19.9 billion (including Canada bill maturities of US$11.1 billion, cross-currency swap maturities of US$6.8 billion, medium-term note maturities of US$0.7 billion and bond maturities of US$2.3 billion).

Return on Investments

Return on investments comprises interest earned on investments (US$1,184 million) and an increase in the market value of securities resulting from changes in interest rates (US$3,538 million). The overall effect on the official international reserves was a net increase of US$4,722 million.

Revaluation Effects

Revaluation effects resulting from movements in exchange rates reflect changes in the market value of the official international reserves. Revaluation effects led to a decrease in the market value of the official international reserves of US$643 million, primarily due to the depreciation of the euro and GBP relative to the US dollar during the reporting period.

International Monetary Fund Reserve Position

Each member country of the International Monetary Fund (IMF) is assigned a quota that represents the maximum amount of resources that it is obliged to provide to the IMF, upon request. As well, the IMF typically has on deposit with each government holdings in the form of non-interest-bearing notes and non-interest-bearing accounts. Canada's reserve position at the IMF represents the difference between Canada's quota and the IMF's holdings of Canadian dollars, which is equivalent to the cumulative amount of all the money that Canada has advanced to the IMF over the years.

Canada's reserve position at the IMF is an asset that is included as a component of the official international reserves but is not held in the EFA. As such, changes in Canada's reserve position that may result from advances, repayments or revaluations directly impact the Government of Canada's consolidated financial statements. During 2019–20 the reserve position increased over the previous fiscal year.

More detailed information on monthly levels and changes in Canada's official international reserves is provided in Table A3.2.

Table A3.2
Canada's Official International Reserves
Month-to-Month Changes

market value in millions of US dollars
Month-end Securities Deposits Special
drawing
rights1
Reserve
position
in the IMF2
Total Total
monthly
change
2019            
March 68,141 4,398 8,209 2,653 83,401 -1,019
2019–20            
April  68,355  5,047 8,464 2,966 84,832 1,431
May  69,394  5,009 8,353 2,948 85,704 872
June  69,874  5,053 8,454 2,919 86,300 596
July  68,963  4,805 8,344 3,148 85,260 -1,040
August  69,901  4,807 8,308 3,132 86,148 888
September  69,703  4,138 8,277 3,120 85,238 -910
October  69,876  4,107 8,375 3,157 85,515 277
November  67,854  5,567 8,498 3,094 85,013 -502
December  67,631  5,982 8,527 3,157 85,297 284
January  71,604  3,233 8,491 3,144 86,472 1,175
February  72,632  3,363 8,463 3,110 87,568 1,096
March  69,862  4,748 8,410 3,080 86,100 -1,468
Total n/a n/a n/a n/a n/a 2,699
Note: Numbers are from the Official International Reserves press release.
1 SDR-denominated assets are valued in US dollars at the SDR rate established by the IMF. A rise in the SDR in terms of the US dollar generates an increase in the US-dollar value of Canada's holdings of SDR-denominated assets.
2 The reserve position in the IMF represents the amount of foreign exchange that Canada is entitled to draw from the IMF on demand for balance of payments purposes. It equals the Canadian quota, less IMF holdings of Canadian dollars, plus loans to the IMF.

Annex 4: Detailed Portfolio Return and Performance

Unless otherwise noted, in this report, the official international reserves are reported in US dollars on a market-value settled basis. This annex provides detailed technical information on indicators used to measure the portfolio's performance in four areas: 1) revenues; 2) net return on assets; 3) cost of advances to the EFA; and 4) market and credit risk measures.

1) Revenues

Revenues include income from investments and foreign exchange gains. Data are reported in Canadian dollars, as EFA revenues are reported in Canadian dollars in the attached financial statements. In 2019–20, income totaled C$2,283 million compared to C$1,482 million in 2018–19. The main categories of income are summarized in Table A4.1.

Table A4.1
Revenues of the Exchange Fund Account
millions of Canadian dollars
April 1, 2019 to
March 31, 2020
April 1, 2018 to
March 31, 2019
Net revenue from investments    
Marketable securities 2,158 1,468
Cash and cash equivalents 99 84
Special drawing rights 96 106
Total net revenue from investments 2,353 1,658
Other income    
Net foreign exchange gain/loss -70 -176
Net revenue 2,283 1,482

2) Total Net Return on Assets

The net return on assets of the EFA is reported using a measure called "total return". It represents the net return generated by the EFA by including the changes in the market values of the assets and liabilities over the reporting period. By including the market or fair values of the EFA's assets and corresponding liabilities, the total return measure includes unrealized gains or losses, which is the difference between what an asset (or liability) is worth compared to what it cost.

Total Return on a Market-Value Basis

The total return measure is used in several different ways. It is used to compare the performance of the EFA's assets to its liabilities in order to depict the net return of the portfolio on a market-value basis. It is also used to decompose the EFA into the key sources of return. This is done by decomposing the total return measures for both the assets and liabilities through a technique called "performance attribution". Performance attribution allows management to discern what aspects of total return resulted from controllable influences as compared to those sources that are market-driven. As well, the attribution analysis provides an indication as to how well objectives of the asset-liability management framework of the EFA are being met.

Table A4.2 provides an estimate of the total return on a market-value basis for the EFA as a whole and its key portfolios compared to the corresponding liabilities. The total return of the asset benchmark is also included—5.84 per cent versus 5.75 per cent for the EFA asset portfolio. The total net return was 31 basis points, or a gain of US$231 million, in the fiscal year ending March 31, 2020, compared to a total net return 45 basis points, or a gain of US$326 million, in the fiscal year ending March 31, 2019. For 2019–20, the total net return reflects net returns in US‑dollar terms of 67 basis points for the US-dollar portfolio, -29 basis points for the euro portfolio, -58 basis points for the GBP portfolio and 5 basis points for the yen portfolio. The total net return was primarily driven by the difference in the credit spreads on the assets versus changes in funding spreads of the liabilities in the US-dollar, euro and GBP portfolios. In the yen portfolio the main driver of returns was the net coupon effect. The total return numbers include interest flows as well as all gains or losses earned over the period, regardless of whether they were realized or not.

Table A4.2
Total Return of the EFA Compared to Liability Benchmarks
April 1, 2019 to March 31, 2020 April 1, 2018 to
March 31, 2019
  US$
portfolio
Euro
portfolio
GBP
portfolio
Yen
portfolio
Total EFA Total
benchmark
Total EFA
EFA asset portfolio              
Return in original currency 8.90% 0.19% 3.50% 0.23% n/a n/a n/a
Return in US$ (A) 8.90% -9.44% -8.04% -1.12% 5.75% 5.84% 0.40%
Liability benchmarks              
Return in original currency 8.22% 0.51% 4.15% 0.18% n/a   n/a
Return in US$ (B) 8.22% -9.15% -7.47% -1.17% 5.44%   -0.05%
Return vs. liability benchmark
in basis points (A – B) in US$
67 -29 -58 5 31 40 45

Performance Attribution of Total Return

Table A4.3 summarizes the attribution results for the EFA's US-dollar and euro portfolios for the fiscal year ending March 31, 2020. Total return is decomposed into three underlying return factors: coupon and amortization, changes in credit spreads, and changes in interest rates.

For 2019–20, the attribution results indicate that the coupon effect contributed positively to returns whereas the yield curve and credit spread effects varied by portfolio. The positive return on the US-dollar portfolio outweighed the negative return on the euro portfolio, largely as a result of the larger relative size of the US-dollar portfolio.

The coupon return (the difference between the yield to maturity of reserve assets and liabilities issued to fund the assets) contributed positively to total return. The coupon return generally represents the underlying return of the portfolio if matched assets and liabilities are held to maturity.

The credit spread effect (the difference between the change in the market value of EFA assets and the foreign liabilities due to changes in the credit quality of EFA issuers and Canada) was the main driver of returns in the EFA's portfolio. In the US-dollar portfolio, the change in funding spreads reduced the value of the liabilities while the change in asset spreads increased the value of the assets, resulting in a positive return. In the euro portfolio, the credit spread effect decreased the value of the assets by a greater amount than it decreased the value of the liabilities, resulting in a negative return. The credit spread effect is transitory to the extent that assets are held to maturity.

The yield curve effect (the impact of changes in the general level of interest rates) demonstrates the extent to which the EFA's assets and liabilities are matched in terms of their sensitivity to changes in interest rates. The small difference for the US-dollar and euro portfolios demonstrates the benefit of the asset-liability management framework of the EFA over the reporting period.

Any difference between the actual return and the sum of the above effects is the residual return, which reflects the fact that performance attribution approximately explains total return.

Table A4.3
Performance Attribution for the US-Dollar and Euro Portfolios Compared to Liability Benchmarks
April 1, 2019 to March 31, 2020

per cent
US$ portfolio Euro portfolio
Assets Liabilities Difference Assets Liabilities Difference
Coupon return 1.88 1.72 0.17 -0.44 -0.66 0.22
Yield curve effect 6.74 6.86 -0.12 1.42 1.36 0.06
Credit spread effect 0.12 -0.41 0.53 -0.92 -0.31 -0.60
Residual return 0.16 0.06 0.09 0.13 0.12 0.00
Return in original currency 8.90 8.22 0.67 0.19 0.51 -0.32
Exchange rate effect       -9.64 -9.67 0.03
Total return in US$ 8.90 8.22 0.67 -9.44 -9.15 -0.29
Note: Numbers may not add due to rounding.

3) Notional Cost of Advances to the EFA

From the Consolidated Revenue Fund

The cost of advances represents an estimate of the cost of maintaining the EFA by adding the cost of foreign debt payments (including the interest on cross-currency swaps) to the notional amount of foreign interest that would be paid on non-interest-bearing items or items funded in Canadian dollars. For 2019–20, the cost of advances to the EFA was C$1,848 million. EFA advances represent funds (liabilities) from the Consolidated Revenue Fund (CRF) in support of maintaining the EFA. The EFA is a stand-alone account of assets while foreign liabilities are paid out of the CRF.

Actual foreign interest charges: The proceeds from foreign currency borrowings are remitted to the CRF and concurrently advanced to the EFA. Foreign debt interest and principal repayments are charged to the CRF but are paid using the foreign assets of the EFA, reducing the amount advanced to the EFA. Actual foreign interest paid is converted into Canadian currency for the purpose of determining this portion of the notional cost of advances; for 2019–20 this value was C$1,699 million.

Notional interest charged in Canadian dollars: Because domestically funded EFA assets, SDR advances and the portion of net revenues reinvested in the EFA (i.e., cumulative net revenues of the EFA less cumulative foreign debt interest payments) are not linked to foreign liabilities, an imputed interest cost is used to approximate the notional interest charge on the portion of advances from the CRF related to those assets. For 2019–20, a weighted cost of domestic and foreign funding (2.03 per cent) was used in calculating notional interest paid in Canadian dollars, resulting in a value of C$149 million.

4) Risk Measures

The risk management framework covers market, credit, liquidity, legal and operational risks related to the financing and investment of the foreign reserves. Risk measures are reported on a monthly basis to management at the Department of Finance Canada and the Bank of Canada.

Market Risk

Market risk stems from changes in interest rates, credit spreads and exchange rates. Several industry-standard measures of market risk exposure are employed: scenario analysis, stress testing and Value at Risk (VaR) (Table A4.4). Stress testing and scenario analysis are used to evaluate the portfolio's performance under extraordinary circumstances in the market. VaR is a statistical measure for estimating potential losses to the EFA portfolio arising from extreme but plausible market movements such as changes in interest and exchange rates.

Stress tests are regularly carried out to gauge the sensitivity of the EFA portfolio to large changes in exchange rates and interest rates, including the portfolio impact of a 1 per cent depreciation of the euro, GBP and yen vis-à-vis the US dollar and a 3 per cent increase in interest rates across the yield curve. In addition, a stress test of cross-currency basis rates is performed. The results showed that, during the reporting period, the EFA assets and the associated liabilities (on a net basis) had very minimal exposure to currency depreciations and upward shifts in the yield curve.

In addition, some hypothetical scenario analyses that mimic market conditions during four previous extraordinary market events were regularly conducted: the 2008 financial crisis, the 2010 European debt crisis, the 2011 Japan earthquake and Brexit in 2016. The scenario analyses showed that the EFA would generally perform well during such periods of market turbulence.

Total Market VaR is a statistical measure that estimates the possible loss in portfolio value within a specific time period during normal market conditions as a result of interest rate, foreign exchange rate and credit spread changes. This is regularly reported for the entire EFA portfolio and on the net position of assets and liabilities. As of March 31, 2020, the EFA had a 99-per-cent 10-day Total Market VaR of US$1,260 million, which implied that 99 per cent of the time, the value of the portfolio was not expected to decline by more than US$1,260 million, on a net basis, over a 10-trading-day period. The asset-only VaR measure estimates the possible loss in the value of EFA assets within a 10-day period during normal market conditions as a result of interest rate, exchange rate and credit spread changes. As of March 31, 2020, the Asset VaR was US$2,738 million.

Table A4.4
Market Risk Measures
millions of US dollars
March 31, 2020 March 31, 2019
Assets only Assets vs.
liabilities (net)
Assets only Assets vs.
liabilities (net)
Single factor stress tests        
1% depreciation of euro, GBP and yen  -227 -1 -243 -4
3% upward parallel shift in yield curve -8,270 20 * *
Cross-currency basis shock 0 -583 * *
Scenario analyses        
2008 financial crisis 2,170 2,607 884 2,566
2010 European debt crisis -3,761 49 -3,302 55
2011 Japan earthquake 114 -106 * *
2016 Brexit 161 -461 * *
99% 10-day Total Market VaR   1,260   547
99% 10-day Asset VaR 2,738   840  
* Data not available for fiscal year 2018–19 as stress test was adopted in fiscal year 2019–20.

Credit Risk

Credit risk includes the risk that a counterparty or issuer will be unable or unwilling to meet their obligations to pay as well as the risk that the value of an instrument will change as a result of actual or perceived changes in the credit quality of a counterparty or issuer.

A collateral management framework is used for managing the credit risk to financial institution counterparties arising from the cross-currency swaps used to fund the EFA. Under this framework, Initial Margin, composed of high quality collateral, is pledged by the swap counterparties for the EFA at the initiation of the swap. In addition, Variation Margin is received or paid based on whether the market value of the swaps with each counterparty is positive or negative to the Government of Canada. The Government relies on a collateral manager and the Bank of Canada for the daily management of Initial and Variation Margin.

The Credit VaR model was used to measure the EFA's exposure to credit risk during the reporting period (Table A4.5). However, the Credit VaR estimate does not capture the market risk effect of cross-currency funding and therefore does not reflect the total risk of the EFA.

Table A4.5
Credit Risk Measures
millions of US dollars
March 31, 2020
Credit VaR and expected shortfall  
99.9% 1-year Credit VaR 3,290
Expected shortfall 5,676

The Credit VaR model provides an estimate of the maximum potential loss in portfolio value within a year as a result of a credit event, such as the downgrade or default of counterparties or issuers, under normal market conditions. As of March 31, 2020, the EFA had a 99.9-per-cent 1-year Credit VaR of US$3,290 million, which implied that 99.9 per cent of the time, the value of the portfolio was not expected to decline by more than US$3.3 billion over a 1-year period due to credit events. An associated measure, expected shortfall, computes the expected average loss in portfolio value during a 1‑year period due to an extreme, unexpected credit event, whose possibility of happening (less than 0.1 per cent) was not captured by the Credit VaR statistic. The expected shortfall measure for the EFA was US$5.7 billion as of March 31, 2020.

Annex 5: List of Agents and Mandataries as Defined by the Currency Act

The Currency Actstipulates that this report include a list of the following agents and mandataries appointed by the Minister under subsection 17.2(3) of the Act to perform services concerning the EFA.

Bank of Canada

The Bank of Canada, as specified under the Bank of Canada Act, is the fiscal agent for the Government of Canada. As part of its fiscal agency responsibilities, the Bank manages the Government's foreign exchange reserves.

RBC Investor Services Trust and State Street Corporation

RBC Investor Services Trust and State Street Corporation manage the securities-lending program for the EFA. As the Government's agents and mandataries, they carry out securities lending on behalf of the Government. The program involves loaning a security from the Government to a counterparty, who must eventually return the same security, in order to earn additional return on the portfolio.

State Street Trust Company Canada, Together With State Street Bank and Trust Company

State Street Trust Company Canada, together with State Street Bank and Trust Company, is responsible for managing the collateral pledged in connection with foreign exchange swaps and cross-currency swaps.

Unaudited statement of financial position and statement of operations of the exchange fund account
Year ended March 31, 2020

Statement of Financial Position (unaudited)
as at 31 March

(in millions of Canadian dollars)
2020 2019
Financial assets    
Cash and cash equivalents (Notes 2, 3)
6,684 5,878
Investments (Notes 2, 3)
   
Marketable securities
93,485 90,333
Special Drawing Rights
11,848 10,989
Total investments
105,333 101,322
Total financial assets
112,017 107,200
Liabilities    
Due to the Consolidated Revenue Fund (Note 4)
112,017 107,200
The accompanying notes are an integral part of these financial statements.

Paul Rochon
Deputy Minister
Department of Finance

Darlene Bess, CPA, CA
Chief Financial Officer
Department of Finance

Statement of Operations (unaudited)
for the year ended 31 March

(in millions of Canadian dollars)
2020 2019
Net revenue from investments    
Marketable securities
   
Interest
1,458 1,492
Net gains (losses) on sale of marketable securities
702 (22)
Transaction costs and other
(2) (2)
Interest on cash and cash equivalents
99 84
Interest on special drawing rights
96 106
Total net revenue from investments
2,353 1,658
Other    
Net foreign exchange gain (loss)
(70) (176)
Net income for the year (note 2) 2,283 1,482
The accompanying notes are an integral part of these financial statements.

Notes to the Financial Statements
for the year ended 31 March 2019 (unaudited)

1. Authority and Objectives

The Exchange Fund Account (the Account) is governed by Part II of the Currency Act. The Account is in the name of the Minister of Finance and is administered by the Bank of Canada as fiscal agent. The Financial Administration Act does not apply to the Account.

The legislative objectives of the Account 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 Minister of Finance empowers the Account to acquire, borrow, sell or lend assets deemed appropriate for this purpose, in accordance with the Account's Statement of Investment Policy.

Assets held in the Account are managed to provide liquidity to the Government and to promote orderly conditions for the Canadian dollar in foreign exchange markets, if required. Canada's current policy is to intervene in foreign exchange markets on a discretionary, rather than a systematic basis and only in the most exceptional of circumstances. Since September 1998, no transactions have been aimed at moderating movements in the value of the Canadian dollar.

In accordance with the Currency Act, the net revenue for the year is paid to or charged to the Consolidated Revenue Fund (CRF) of the Government of Canada within three months after the end of the fiscal year. The Minister of Finance reports to Parliament on the operations of the Account within the first 60 days on which Parliament is sitting after the end of the fiscal year. These statements have been prepared by the Department of Finance.

2. Significant accounting policies

As stipulated in the Currency Act, the financial statements of the Account are prepared in a manner consistent with the accounting policies used by the Government of Canada to prepare its financial statements.

a) Revenue recognition

Revenue from investments is recognized on an accrual basis and includes interest earned (including the amortization of premiums and discounts), gains or losses on sales of securities, and revenues from securities-lending activities. Interest is accrued on short-term deposits, deposits held under repurchase agreements, marketable securities, and special drawing rights (SDRs).

b) Expense recognition

The Account's administrative, custodial, and fiscal agency services are provided and paid for by the Bank and the Department of Finance. These costs have not been recognized in the Statements.

In addition, the notional cost of the funding of the Account's assets and advances from the CRF is not recognized in the Statements.

c) Financial assets

Cash and cash equivalents

Cash and cash equivalents consists of cash on hand and short-term deposits. Short-term deposits are measured at cost and are generally held to maturity. The resulting revenue is included in Interest on cash and cash equivalents.

Deposits held under repurchase agreements

Deposits held under repurchase agreements are measured at cost. The resulting revenue is included in Net revenue from investments. As at March 31, 2020, the Account did not hold any deposits held under repurchase agreements ($nil at March 31, 2019).

Marketable securities

Purchases and sales of securities are recognized at the settlement dates. Marketable securities are measured at cost and are adjusted for amortization of purchase discounts and premiums on a straight-line basis over the term to maturity of the security. The carrying value of marketable securities includes accrued interest.

On derecognition of a security, the difference between the asset's carrying amount and the sum of the consideration received and receivable is recognized in Net revenue from investments.

Impairment

The Bank assesses at the end of each reporting period whether there has been a loss in the carrying value of short-term deposits, deposits held under repurchase agreements, and marketable securities. When conditions indicate that the decline in value is other-than temporary, these assets are re-measured at their recoverable amount with the amount of the impairment loss recognized in Net revenue from investments in the Statement of operations.

Securities-lending program

Under the securities-lending program, the Account has agency agreements with two major financial institutions. Loans of securities are effected on behalf of the Account by these agents, who guarantee the loans and obtain collateral of equal or greater value from approved counterparties. These transactions can range from 1 to 31 days in duration. The securities loaned continue to be accounted for as investment assets. Income on securities-lending transactions is included in Interest in the Statement of Operations.

Special drawing rights (SDRs)

The SDR serves as the unit of account for the International Monetary Fund (IMF) and its value is based on a "basket" of five major currencies: the Euro, the US dollar, the British pound sterling, the Japanese yen, and the Chinese renminbi.

SDRs are initially recognized at cost and are subsequently re-measured at each reporting date into Canadian dollars at market exchange rates.

Translation of foreign currencies and SDRs

Assets denominated in foreign currencies and SDRs are translated into Canadian-dollar equivalents at the rates prevailing as of March 31, which were as follows:

Translation of foreign currencies and SDRs
2020 2019
US dollar 1.4076 1.3362
Euros 1.5522 1.4989
Japanese yen 0.0131 0.0121
British sterling 1.7485 1.7400
SDRs 1.9211 1.8550

Gains or losses resulting from the translation of assets and advances from the CRF denominated in foreign currencies and SDRs, as well as from transactions throughout the year, are recognized as Net foreign exchange gain (loss) and are included in the Statement of Operations.

Investment revenue in foreign currencies and SDRs is translated into Canadian-dollars at the foreign exchange rates prevailing on the date the revenue is earned.

d) Use of estimates and measurement uncertainty

The preparation of the Statements requires the Bank's management to make estimates and assumptions based on information available as of the date of the Statements. Significant judgements and estimates are primarily applied in the determination of whether an impairment exists and in the measurement of fair value where quoted prices do not exist (Note 3).

3. Financial instruments

Fair value of financial assets
(in millions of Canadian dollars)
  31 March 2020 31 March 2019
Carrying
Amount
Fair
Value
Carrying
Amount
Fair
Value
Cash and cash equivalents        
US dollar
6,014 6,014 4,904 4,904
Euro
488 488 250 250
Japanese Yen
14 14 6 6
British Sterling Pound
168 168 450 450
Short-term deposits - - 268 268
Total cash and cash equivalents 6,684 6,684 5,878 5,878
Investments        
Marketable securities
       
US dollar
62,636 67,021 59,234 59,328
Euro
17,538 17,655 17,646 17,872
Japanese Yen
5,266 5,259 3,678 3,692
British Sterling Pound
8,045 8,403 9,775 10,159
Total marketable securities
93,485 98,338 90,333 91,051
SDRs
11,848 11,848 10,989 10,989
Total investments 105,333 110,186 101,322 102,040
Total financial assets 112,017 116,870 107,200 107,918

The estimated fair value of Cash and cash equivalents approximates their carrying value, given their short term to maturity.

The estimated fair values of Marketable securities are based on quoted market prices and include accrued interest. If such prices are not available, the fair value is determined by discounting future cash flows using an appropriate yield curve.

Since SDRs are translated into Canadian-dollar equivalents at the rates prevailing at the Statements' date, the carrying value approximates fair value on the reporting date.

There were no impairments recognized in 2020 ($nil in 2019).

Credit risk

Credit risk is the risk that a counterparty to a financial contract will cause a loss to the Account by failing to discharge its obligations in accordance with agreed upon terms.

To ensure that the Account's asset portfolio is prudently diversified with respect to credit risk, the Statement of Investment Policy prescribed by the Minister of Finance specifies limits on holdings by class of issuer (sovereign, agency, supranational, corporation or commercial financial institution), by any one issuer or counterparty, and by type of instruments.

The Statement of Investment Policy also specifies the treatment of holdings that do not meet eligibility criteria or limits due to exceptional circumstances such as ratings downgrades.

With respect to the Statement of Investment Policy, the Account may hold fixed income securities of highly rated sovereigns, central banks, government-supported entities and supranational organizations. To be eligible for investment, an entity must have an acceptable credit rating informed by external credit ratings and internal credit analysis. The Account may also make deposits and execute other transactions, up to prescribed limits, with commercial financial institutions that meet the same rating criteria.

As stipulated in the Currency Act, the Minister of Finance may appoint agents to perform services concerning the Account. Through the securities-lending program, agents can lend securities only up to a prescribed maximum amount and only to a list of approved counterparties. Each borrower must enter into a Securities Loan Agreement with at least one of the agents. Borrowers are also required to provide collateral for securities borrowed, according to a specific list approved by the Government, with collateral limited to specific security types, terms to maturity, and credit ratings.

The agents also provide an indemnity in the event of default by the borrower. The Account enters into securities lending transactions in order to increase its return on investments.

Market risk

Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate due to changes in market prices. Market risk comprises three types of risk: interest rate risk, currency risk, and other price risk. Interest rate risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate due to changes in market interest rates. Currency risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in foreign exchange rates. Other price risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices, other than those arising from interest rate risk or currency risk. The Account is not exposed to significant other price risk.

Interest rate and currency risks are managed, with due consideration of the risk to the Government of Canada, through the asset-liability management policy. This policy utilizes a strategy of matching the duration structure and the currency of the Account's assets with the foreign currency borrowings of the Government of Canada that notionally finance the Account's assets. Other price risks are mitigated by holding high quality liquid assets.

Liquidity risk

Liquidity risk is the risk that an entity will encounter difficulty in meeting its obligations associated with financial liabilities. Liquidity risk is minimized by limiting the portion of the Government of Canada's foreign liabilities that needs to be renewed within a one-year period. In addition, liquidity risk is mitigated by holding short-term investments that are matched to the Government of Canada's maturing liabilities in foreign currencies.

Securities lending

As at March 31, 2020, there were no loaned securities in the EFA's investments ($nil at March 31, 2019).

4. Due to the Consolidated Revenue Fund (CRF)

The Account is funded by the Government of Canada through interest-free advances from the CRF. Advances to the Account from the CRF are authorized by the Minister of Finance under the terms and conditions prescribed by the Minister of Finance. Pursuant to Section 19 of the Currency Act, these advances are limited to US$150 billion by order of the Minister of Finance effective March 26, 2015.

The CRF advances the proceeds of the Government of Canada's borrowings in foreign currencies and allocations of SDRs by IMF to the Account. Subsequent repayments of foreign currency debt are made using the assets of the Account and result in reductions of foreign currency advances from the CRF.

The Account requires Canadian-dollar advances to settle its purchases of foreign currencies. Canadian dollars received from sales of foreign currencies are remitted to the CRF. This, together with foreign currency payments made on behalf of the Government of Canada, causes reductions in the level of outstanding Canadian-dollar advances and can result in overall net deposits of Canadian-dollars by the Account with the CRF.

At March 31, advances from the CRF were composed of the following currencies:

Currency composition of advances from the CRF
(in millions of Canadian dollars)
2020 2019
US dollars
74,116 68,165
Euros
17,666 17,288
British Pound Sterling
7,840 10,062
Japanese yen
5,266 3,640
SDRs
6,599 6,372
Subtotal - foreign currencies 111,487 105,527
Canadian dollars (1,753) 191
Net revenue 2,283 1,482
Total 112,017 107,200
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