Fritz Zurbrügg: The Swiss National Bank's investment policy - some
topical issues
Speech by Mr Fritz Zurbrügg, Member of the Governing Board of the Swiss National Bank, at
the Money Market Event, Geneva, 20 November 2014.
* * *
Accompanying slides can be found at the end of the speech.
Ladies and gentlemen
Welcome to the Money Market Event of the Swiss National Bank (SNB) in Geneva. I am
delighted to be able to speak to you today about some of the topical issues facing the SNB's
financial markets department. As usual, I shall share the floor with the head of the Money
Market unit, Sébastien Kraenzlin. I shall focus my remarks on some of the investment policy
challenges currently confronting the SNB. Related issues - specifically the steep rise in our
currency reserves following our decision to purchase foreign exchange to enforce the
minimum exchange rate of CHF 1.20 against the euro - were the focus of attention some two
years ago at this same event. Since then, our currency reserves, which are primarily made
up of foreign exchange reserves and gold, have stabilised (slide 1). However, the question of
how to manage these investments as advantageously as possible is still a major concern for
us. In this context, I shall speak about two issues this evening: first, the importance of the
Asia-Pacific markets for the SNB; and second, the role of gold in our currency reserves. In
doing so, I shall reference the popular initiative "Save our Swiss gold" (also known as the
"gold initiative"), on which the Swiss electorate will be voting on 30 November. After I have
spoken to you, Sébastien Kraenzlin will outline some of the latest money market
developments.
The SNB's currency reserves - an overview
The SNB's currency reserves currently stand at more than CHF 500 billion - 80% of gross
domestic product (Switzerland's annual economic output). With a share of some
CHF 460 billion, foreign exchange makes up around 90% of our currency reserves. Since
autumn 2012, the size of the SNB's currency reserves has principally been determined by
financial market valuations and by interest and dividend income. Given how large our
portfolio of currency reserves is, fluctuations in value have a much greater impact today than
they did in the past, as has once again become clear this year. The SNB reported a profit of
CHF 28.5 billion for the first three quarters of this year.
I should emphasise at this stage that our investment policy is always subordinated to
monetary policy; it can only be understood in this context. Since September 2011, our
monetary policy has been dominated by the minimum exchange rate of CHF 1.20 against the
euro. With interest rates close to zero, the minimum exchange rate is the key instrument we
are deploying to avoid an undesirable tightening of monetary conditions. The SNB will
continue to enforce the minimum exchange rate with the utmost determination. To this end, it
is prepared to purchase foreign exchange in unlimited quantities and to take further
measures immediately if required.
Once monetary policy requirements have been met, our foreign exchange investments are
guided by three criteria: security, liquidity and return. In order to ensure that we meet the first
two criteria - security and liquidity - we hold a substantial portion of our foreign exchange
reserves in liquid government bonds, in the most important global currencies; almost
threequarters of our foreign exchange reserves are currently invested in such instruments. When
it comes to our third criterion - return - equities play an important role as they generally have
a higher return potential than the government bonds of the major advanced economies.
Currently, 16% of our foreign exchange reserves are invested in equities.
Given how substantial our foreign exchange reserves are, doing justice to all three of these
criteria simultaneously is no simple matter. On the one hand, the considerable growth of our
foreign exchange reserves has increased the concentration risk associated with conventional
government bonds; on the other hand, there is the risk that we may overuse certain markets,
thereby potentially triggering undesired price fluctuations. We therefore evaluate investment
possibilities on a continual basis. As part of our search for diversification, Asia-Pacific
markets in particular have become increasingly important for the SNB's investment policy in
recent years.
Growing importance of Asia for the SNB's investment policy
In recent decades, the focus of global economic activity has increasingly been shifting
towards Asia. The region now accounts for more than a third of global economic output. Asia
has contributed more than 50% to global growth over the last decade, with China and India
together generating over 40% (left-hand side of slide 2). For Switzerland - a country that is
highly export-oriented - Asia has become increasingly significant, too. Swiss companies
exported almost CHF 30 billion of goods to the region last year, almost three times more than
in 2000, bringing its share to 14% of the country's total exports (right-hand side of slide 2).
Asian countries have made substantial progress in developing their financial markets since
the Asian crisis at the end of the 1990s. Most financial markets in the region have become
significantly more liquid and diversified than they were 15 years ago thanks to gradual
liberalisation of capital flows, better financial market infrastructure and an expanding
domestic investor base. Hong Kong and Singapore now rank among the world's most
important financial centres. Between 2003 and 2013, Asian stock markets' contribution to
global market capitalisation increased from approximately 20% to over 30%.1 Bond issues
denominated in local currencies have also gained steadily in importance. This market
quadrupled in size between 2005 and 2014 and now totals some USD 8,000 billion.2 Equally,
Asian financial centres have made substantial inroads into global foreign exchange markets
in recent years (left-hand side of slide 3). In 2013, almost one-fifth of global foreign exchange
transactions took place in Singapore, Japan, Hong Kong and Australia. While these centres
have not yet reached the UK level, they are now almost on a par with the US. Singapore last
year supplanted Japan as the world's third-largest foreign exchange trading centre
(righthand side of slide 3).3
Against this backdrop, these markets have understandably gained in significance for the
SNB, too, which explains why we decided to open a branch office with eight staff in
Singapore in mid-2013. This office is primarily significant from the point of view of investment
policy, and to date our expectations on this score have been met in full. Our presence on the
ground in Singapore enables us to manage our Asia-Pacific portfolio much more effectively.
The importance of being able to operate on the Asian bond and stock markets during local
trading hours, for instance, has been confirmed. Our office there also allows us to manage a
host of on-site relationships, which deepens our understanding of Asian financial markets -
and economies in general. Moreover, having a local presence makes it easier for us to
monitor and enforce the minimum exchange rate round the clock, thereby contributing to the
implementation of monetary policy.
The growing importance of Asia is also reflected in our foreign exchange reserves. As I
mentioned earlier, given the enormous increase in our foreign exchange reserves, the
broadest possible diversification of our investments is extremely important. Consequently, we
have increased our exposure in this region over the last few years, in particular to Japan,
Australia, Singapore and Korea. Since 2010, the share of Asian currencies in our foreign
exchange reserves has almost doubled, from just under 6% to almost 12%. Prior to the
financial crisis, the SNB had less than CHF 5 billion invested in Asian assets - and these
investments were denominated exclusively in yen. Since 2010, we have been investing in the
Australian and Singapore dollars, and since 2012, in the Korean won as well. At the end of
2013, we had over CHF 50 billion invested in Asia, and of this, CHF 15 billion was invested in
these three new currencies (left-hand side of slide 4).4 Today, 3.5% of the SNB's total foreign
exchange reserves are allocated to these currencies (right-hand side of slide 4). We see
further potential in Asia as we move forward and it will not surprise you to hear that we see
China playing an increasingly important role here.
Investment quota for Chinese government bonds
Why does China interest us? The size of the Chinese market is undoubtedly a key factor:
central government has outstanding bonds worth approximately USD 1,000 billion.5 This
makes the onshore Chinese government bond market the fifth-largest in the world after the
US, the euro area, Japan and the UK (left-hand side of slide 5). Over and above the
consideration of market size, investments in China are also attractive from the point of view
of our security criterion, as they offer additional diversification of market, credit and
concentration risks.
As regards the diversification of foreign exchange risks, however, China offers only very
limited potential for us, as the renminbi is pegged to the US dollar. Nonetheless, the renminbi
has been allowed to appreciate relatively constantly against the US dollar since 2005 and
this incremental appreciation has had a positive effect on onshore Chinese bond yields in
francs. In Swiss franc terms, investments in three to five-year Chinese government bonds
have, on average, yielded more than 5% per year since 2005; this is substantially higher than
the yield available on other major government bond markets (right-hand side of slide 5).
In addition to these financial market advantages, China has strong economic fundamentals.
At 40%, China's government debt ratio is much lower than that of many advanced
economies.6 Furthermore, the credit quality of Chinese central government bonds is high
compared to that of other emerging economies, as is reflected in the ratings.
Foreign investors still enjoy only very limited access to the onshore Chinese bond market,
however, as the renminbi is not freely convertible and capital flows are still subject to
controls. Notwithstanding this, the Chinese government has been working towards a gradual
opening-up of its domestic capital market for several years now. As part of this, China's
central bank, the People's Bank of China (PBC), launched a so-called Interbank Market
Programme in 2010, enabling central banks, sovereign wealth funds and insurance
companies to request an investment quota for the onshore Chinese interbank bond market
from the PBC. Provided they do not exceed this quota, these entities may invest freely in the
(onshore) Chinese government bond market.
More than 20 central banks - including those of France, Austria, Japan, Australia and
Singapore - have now received a renminbi investment quota. In July this year, the SNB
signed a renminbi investment quota agreement with the PBC. The SNB's investment quota
amounts to CNY 15 billion (in excess of CHF 2 billion). While this quota represents a very
small proportion of our foreign exchange reserves, it allows the SNB to gather some
experience of this market.
We intend to make use of this quota in the foreseeable future. According to the agreement,
the SNB is authorised to exchange currency at the PBC for renminbi up to a maximum
amount defined in the quota (slide 6). As in all global capital markets, bonds are traded
overthe-counter (OTC), in other words they are traded off-market via local investment banks or
the PCB's bureau in Shanghai. Approximately 90% of all bonds are traded on the interbank
bond market, and the remaining 10% are traded on the exchange. The interbank market is
regulated by the PBC. Bonds issued by the central government, local governments and
quasi-government banks dominate the interbank market, while corporate bonds play a
subordinate role. The SNB will only be investing in central government bonds - these make
up around one-third of the interbank market - with maturities of up to 50 years.
The role of gold in our foreign exchange reserves
Let me now turn to an older - but no less topical - component of our currency reserves: gold.
Since the foundation of the SNB over 100 years ago, gold has been an important part of our
currency reserves, however its function has changed significantly over time. Until 1973,
Switzerland was part of the Bretton Woods system of fixed exchange rates and the value of
the Swiss franc was defined in grams of gold. Under this system, currency reserves - and
thus also gold holdings - played an important role in monetary policy. The bulk of the SNB's
gold reserves were formed at this time.
The move away from the system of fixed exchange rates enabled the SNB to structure its
currency reserves more and more independently of monetary policy requirements. In the
1990s, the composition, management and optimal level of currency reserves were the
subject of intense and protracted discussions among politicians and academics. The SNB
was criticised for holding gold reserves that were in excess of what it needed for monetary
policy and for the fact that they generated too little return. This debate finally resulted in a
broad consensus, whereupon the SNB reduced its gold reserves and investment policy
considerations became increasingly important in decisions relating to the remaining gold
holdings.
This brings me back to the SNB's investment criteria mentioned at the outset: security,
liquidity and return. Gold typically performs poorly when it comes to liquidity and return, and
on the security front, gold should be viewed critically in the context of investment policy.
Although a certain diversification effect can come into play between gold and equities, I am
sure you are also aware that the gold price is even slightly more volatile than equity prices
(slide 7). Just last year, this volatility made itself felt on our balance sheet. The collapse of
the gold price in the spring of 2013 was responsible for a valuation loss of approximately
CHF 15 billion.
The SNB has held 1,040 tonnes in gold reserves since 2008, putting Switzerland in seventh
place internationally. At 125 grams per capita, Switzerland has the largest gold reserves per
head of population of any country - triple those of Germany and quintuple those of the US
(left-hand side of slide 8). The SNB's gold reserves have remained constant in recent years
and it has no plans to sell its holdings. The value of our gold reserves has thus moved in line
with the gold price in recent years (right-hand side of slide 8). However, given the substantial
increase in the SNB's foreign exchange reserves since 2009, the share of gold as a
percentage of total currency reserves has indeed changed, recently falling to just below 8%.
Now let us turn to the gold initiative, which goes to the vote in just a few days. The
supporters of this initiative are demanding that the SNB hold at least 20% of its assets in gold
and at the same time requiring a ban on ever selling gold again. Moreover, the initiative
demands that the gold must be stored exclusively in Switzerland. In order to achieve the
share of 20%, the SNB would have to almost triple its gold holdings within five years. In
practice, given today's balance sheet total and gold price, the SNB would have to purchase
around CHF 70 billion worth of gold - around two-thirds of the world's total annual gold
production.
The SNB considers the initiative to be unnecessary and harmful. Its legal mandate is to
ensure price stability. In a system of flexible exchange rates, gold is no longer required for it
to perform this function and the gold initiative is therefore unnecessary. Price stability and the
stability of the Swiss franc are not determined by the share of gold in the SNB's balance
sheet, but by its monetary policy. It has achieved these goals more effectively than virtually
any other central bank: average inflation has remained below 1% for the last 20 years, and
never in the history of the SNB has there been such a sustained period of low and stable
inflation.
Prescriptions on the share of gold in the balance sheet, coupled with a sales ban, would
make it considerably more difficult for the SNB to fulfil its mandate in future. For this reason,
the gold initiative is harmful. In order to pursue a stability-oriented monetary policy, the SNB
needs to be able to supply the Swiss economy with Swiss franc liquidity quickly in periods of
crisis. The SNB's balance sheet expands when liquidity is increased. In the aftermath of a
crisis, it is critical that this newly injected liquidity be reduced again, in order to prevent an
undesirable rise in inflation. Scaling back liquidity, on the other hand, reduces the balance
sheet total. Given that the initiative is calling for gold to make up at least 20% of the SNB's
assets, a temporary liquidity increase would require gold holdings to be increased, too. In a
post-crisis scenario, the excess gold would have to be retained on the balance sheet for ever
due to the sales ban, and the SNB would have to sell some of its foreign exchange reserves
in order to effect a liquidity reduction. Consequently, this prescription regarding the
percentage of gold to be held, as well as the ban on sales, could ultimately lead to a situation
in which the SNB's assets consist almost entirely of gold, but in which it is unable to perform
balance sheet reductions required for monetary policy. In the long term, the passing of the
gold initiative could therefore threaten price stability in Switzerland.
Even with regard to security, the demands made by the backers of the initiative are
misguided. Insisting that the SNB hold a higher proportion of gold on its balance sheet even
though this gold cannot be deployed in an emergency is counterintuitive. In such
circumstances, the SNB's gold would lose its significance as a currency reserve; the notion
that gold should be held even though it cannot be utilised quickly and freely runs counter to
the very raison d'être of currency reserves. We may even go so far as to say that gold which
cannot be sold in a crisis no longer meets the definition of a reserve and thus offers no
security at all.
While the gold initiative's third demand - that all of the SNB's gold holdings should be stored
in Switzerland - may be unproblematic in monetary policy terms, this too runs counter to the
notion of security. Gold is stored in multiple locations for reasons of risk diversification, in
other words to improve security. The lion's share of the SNB's gold reserves (approximately
70%) is already stored in Switzerland and an appropriate regional diversification serves to
enhance the SNB's market access.
Concluding remarks
Please allow me to make a few closing remarks. Managing Switzerland's substantial foreign
exchange reserves in the country's best interest remains our key investment policy
challenge. New markets are playing an important role here. I have discussed the growing
significance of Asia and explained the process by which we plan to be able to invest a small
fraction of our foreign exchange reserves in China in the near future. Thanks to our branch
office in Singapore, we are optimally positioned to monitor developments and manage our
investments in the Asia-Pacific region efficiently.
Within the scope of its mandate, the SNB needs a certain amount of latitude in order to
continue fulfilling its monetary and investment policy objectives, especially given that the
Swiss monetary policy landscape is set to remain challenging in the foreseeable future. A
"yes" vote for the gold initiative would severely restrict our scope for action. It would therefore
make it considerably more difficult for the SNB to conduct successful monetary policy
operations in future.
Ladies and gentlemen, thank you for the trust you have placed in the SNB in the past. We
look forward to your continued support in the future.
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