strengthened financial risk framework also reflects an important consequence of taking on responsibility for the micro - prudential regulation of banks, which is that we should be willing to do unto ourselves as we would do unto others : a golden rule for central bankers. and it reflects a strong desire to investigate new ways of driving innovative analysis and lean against the risks of groupthink. strengthening the bank of england ’ s financial risk framework the bank has had strong first - and third - line financial risk functions for some time. an expert first - line team assesses, prices and haircuts the wide range of collateral pre - positioned with us, monitors the specific risks taken in live operations on a day - to - day basis, and evaluates the financial condition of our counterparties, liaising with our supervisory colleagues in the bank ’ s prudential regulation authority arm. and internal and external auditors regularly assess the effectiveness of the bank ’ s financial controls. until recently, however, the bank has not had a dedicated second - line financial risk function, reflecting a perception that central banking operations did not give rise to tensions of the sort seen between profit making and risk control in private firms. the amount of residual risk to which the bank was actually exposed, after taking account of large collateral haircuts and government indemnities, was also felt to be relatively small. as the scale of the bank ’ s balance sheet persisted however, it became increasingly clear that we needed to do more to bring our risk framework up to best practice. that was for three main reasons, each linked to the drivers i listed a moment ago. first, the increasing complexity of the bank ’ s operations meant that we needed more effective ways to measure the risks we were taking, add them up across the different specific operations, and evaluate them against an explicit statement of the bank ’ s risk tolerance. second, the increasingly contingent nature of our risks meant we needed much better forward - looking tools for evaluating how those risks might crystallise in different scenarios, and ensuring we had sufficient resources to respond. and, third, the need to hold ourselves accountable, identify potential blindspots and safeguard against groupthink in our internal work, required more effective internal challenge and reporting mechanisms. in the summer of 2015, we therefore set up a brand new second line financial risk challenge function, staffed using some of our risk experts who previously helped the pra to challenge commercial banks : bringing the ‘ golden rule ’ to life. we developed a

liquid or less costly than the market for the underlying asset, or if derivatives enable us to better manage risk. finally, here we can see the returns achieved on our portfolio since 1999 ; these figures are also published on our website ( cf. slide 5 ). as you can see from the last column, the annual return on investment in local currency terms has always been positive. if returns in swiss francs are sometimes negative, this is solely due to changes in the exchange rate of the local currencies against the swiss franc, as shown in the two preceding columns. exchange rate risk is thus the main determinant of total return on investment. the chart we are looking at now provides a further illustration of the dominant role played by exchange rates in our portfolio ( cf. slide 6 ). it shows the factors driving changes in our foreign exchange reserves. as you can see, exchange rate movements are the main cause of changes in our foreign exchange reserves. returns in local currency play only a secondary role. as i pointed out earlier, diversification is the only way for the snb to mitigate the impact of foreign exchange fluctuations. hedging would mean diluting the effectiveness of monetary policy, because purchasing protection against exchange rate movements would effectively cancel out the impact of monetary policy on the swiss franc exchange rate. the challenges ahead to finish, i would now like talk about some of the challenges the snb is always faced with in the management of foreign exchange reserves. first challenge : ensuring that our resources, methods and structures guarantee the effective management of our portfolio. i have already emphasised that the complexity and risk associated with the management of our investments have recently increased significantly. this has required a corresponding increase in our management team headcount. i am confident that we now have enough staff for both the asset management and the risk management units to meet the challenge. we are also prepared to continue developing our structures should the need arise. as regards governance, we have ensured a strict separation between asset management and risk management, by transferring the risk management unit to another department of the snb. our asset managers ’ performance is constantly benchmarked against the relevant markets. for some portfolios, performance is also benchmarked against that of our external asset managers. second challenge : achieving optimal portfolio diversification. the snb has to manage a large volume of foreign exchange reserves. so it needs to find fairly large markets to absorb these volumes, while retaining a high level of liquidity, which narrows