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Siem Reap, CAMBODIA, 6 December 2007 Presented to SEACEN- World Bank Treasury Workshop

ACTIVE RESERVE MANAGEMENT IN BANK INDONESIA By Koppa Kepler Senior Portfolio Manager Bank Indonesia. Siem Reap, CAMBODIA, 6 December 2007 Presented to SEACEN- World Bank Treasury Workshop. Agenda. Foreign Exchange Reserve Management Risk Management Function Challenges Ahead.

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Siem Reap, CAMBODIA, 6 December 2007 Presented to SEACEN- World Bank Treasury Workshop

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  1. ACTIVE RESERVE MANAGEMENTIN BANK INDONESIABy Koppa KeplerSenior Portfolio ManagerBank Indonesia Siem Reap, CAMBODIA, 6 December 2007Presented to SEACEN- World Bank Treasury Workshop

  2. Agenda • Foreign Exchange Reserve Management • Risk Management Function • Challenges Ahead

  3. A) FOREIGN EXCHANGE RESERVE MANAGEMENT

  4. Legal Base Central Bank Act Board of Governors Decree Investment Guideline Dealing Guideline Risk Management Guideline Settlement Guideline Treasury System Guideline

  5. Act No. 23 / 2004 concerning Bank Indonesia Article 7 paragraph 1: The objective of Bank Indonesia is to achieve and maintain the stability of the rupiah. Article 13: • Bank Indonesia shall manage the foreign exchange reserves • Bank Indonesia shall, in managing the foreign exchange reserves as referred to in paragraph (1), conduct various foreign exchange transactions • Bank Indonesia may, in managing the foreign exchange reserve as referred to in paragraph (1), receive foreign borrowing.

  6. The objectives are… The objectives of Bank Indonesia reserve managements are: • To preserve the value of the foreign exchange reserve • To ensure the adequacy of liquidity for payment of the government debt and smoothing the rupiah exchange rate • To earn return on the investment of the reserves

  7. The principles are.. The management and maintenance of foreign exchange reserves is based on 3 pillars: • Security • Liquidity • Profitability The purpose of managing and maintaining the foreign exchange reserves constitutes an integral part of the effort to maintain exchange rate stability

  8. Director Head of Bureau of Reserve and Exchange Rate Management Head of Bureau of Reserve and Exchange Rate Analysis Deputy Director Reserve Management Team • Domestic Market Analysis Exchange Rate Management Team Risk Management Team Settlement Division System and Administration Div. • International Market Analysis Derivatives & Liquidity Team Organizational Structure

  9. Dealing Room Front Office • Executing investment transactions • Trading • Managing liquidity Financial and Economic Analysis Risk Management Middle Office Middle Office • Monitoring risk • Analyzing risk • Compliance • Market analysis • Economic analysis • Product development Settlement Back Office • Settlement of payment • Internal accounting Grand Framework of Reserve Management Supporting unit Maintenance Treasury System And Administration • System maintenance • Administration

  10. BANK INDONESIA’s PORTFOLIO Total Return (Benchmark Based) Managed by Branch Office Internally Managed PMI (Market Index) BI’s PORTFOLIO ROIA Managed by HQ Externally Managed PNMI (Non Market Index) • EPM • TPSL • EMEAP Cooperation back

  11. The way Bank Indonesia manages reserves • Stipulating strategic benchmark: • As a yardstick for long term reserve management • To achieve optimal asset and currency allocation • Allow deviation from strategic benchmark for certain percentage level • Setting up investment and dealing guideline • As a operational guideline • To regulate investment and transaction limit • In manages reserve: • Conducting variety of transaction such as: money market, fixed income, derivatives, and foreign exchange trading • Utilizing representative office in some financial center as a reserve managers • Employing external managers and third party securities lending agents

  12. Objectives and Principles of Reserve Management Portfolio Related to Reserve Mgt. Risk Maintain Value & Preserve of Capital Payment System Risk IDR Stability Effectiveness in Monetary Policy

  13. Reserves Statistic Net inflows of reserves was obtained from oil & gas export receipt, loan disbursement, return on reserve management, and also international bonds issuance

  14. Strategic Investment Policy Benchmark : Compositon & Return Target Overall Credit Line Tactical Investment Comitee (FPI) Operational Trading Activity (executing transactions) Yearly by Board of Governor Weekly Deviation from strategic Benchmark Review on Individual Credit Lines Daily Deviation from Committee Portfolio Credit lines usage Security Selection Decision making structure

  15. Investment Decision Making Process ITF Investment Technical Forum (weekly) BADNT : - International fundamental economy, - medium - long term view of interest rate, yield & exchange rate, BMDNT : - short term view of interest rate, yield & exchange rate based on technical aspect, market sentiment, liquidity portfolio TMRs : - risk monitoring & analysis, - compliance monitoring, - performance evaluation, investment recommendations IF Investment Forum (annually, semiannually, weekly, & incidentally) Investment decision Executed by BMDNT Monitored by TMRs

  16. Investment Guideline

  17. Dealing Guideline

  18. How does the investment policy work? • Portfolio Positioning (Duration Strategy) • FX Overlay Strategy • Credit Strategy (Spread Strategy) • Cross Market Strategy (US vs Europe) • Yield Curve Strategy

  19. B) RISK MANAGEMENT FUNCTION

  20. Organizational Structure of Risk Management Team In Directorate of Reserve Management Director Bureau of Reserve and Exchange Rate Analysis Bureau of Reserve and Exchange Rate Management Deputy Director Reserve Management Team • Domestic Market Analysis Eaxchange Rate Management Team Risk Management Team Settlement Division System and Administration Div. • International Market Analysis Derivatives & Liquidity Team Risk Analysis Performance Evaluation Development of Risk Measures & Investment Guidelines • Market Risk • Credit Risk • Compliance Monitoring • Internal • External (EPM, TPSL, ABF) • Risk Measures • Investment Guidelines

  21. Risk Management Function in Directorate of Reserve Management • 1. Risk Controlling : Measuring, Monitoring, Evaluation and Reporting. Focus on: Market Risk, Credit Risk, and Operational Risk on Transaction, including Limit Monitoring. • 2. Performance Evaluation : Financial Performance and Compliance to Investment Guideline, • 3. Development of Risk Measures and Investment Guideline,

  22. Main Products of Risk Management Team • Daily Risk Management Report (DRMR): • Risk Measurement, • Risk/Limit Monitoring (Compliance Monitoring), • Regular Performance Evaluation: • Internal: Non Market Index Portfolio, Market Index Portfolio, Representative Office Portfolio, Forex Trading (+Bonds Trading & Derivatives Trading) • External: External Portfolio Manager, Third Party Securities Lending Agent, Asian Bond Fund 1 & 2 • Risk/performance analysis for Investment Forum, • Regular counterparty (credit risk) evaluation, • Risk analysis for product development, • Daily Marking to Market(for accounting and risk management purposes)

  23. 1. Risk Controlling:Risk Measuring, Monitoring, Evaluation and Reporting • Market Risk • Value at Risk (VaR): • Variance-co-variance, 99%CL & 10d holding period • VaR limit • Marking to Market: closing bid price (Bloomberg) • Duration limit: • Relative to benchmark (Market Index Portfolio), • Absolute limit (Non Market Index Portfolio), • Currency Allocation (USD & Non USD): • Relative allocation limit to benchmark (Market Index Portfolio), • Absolute allocation limit (Non Market Index Portfolio), • Loss limit and open position limit (Forex Trading, Bonds Trading, Derivatives Trading), • Derivative transactionfor hedging (Fwd, Swap, IRS, FRA, FX Options) (+ Retrospective Hedging Effectiveness Test)

  24. 1. Risk Controlling:...cont’dRisk Measuring, Monitoring, Evaluation and Reporting • Credit Risk: • Counterparty Selection • General Requirements (MM, Forex, Derivatives & Securities): • Past performance compared to peers, • Trend of past profit/loss, • Experience in the market, • Special Requirements • MM: minimal credit rating of P-1 & A3 (Moody’s, or equivalent S&P/Fitch) • Forex: track record, and minimal credit rating of P-2 & Baa3 (Moody’s, or equivalent S&P/Fitch) • Derivatives: minimal credit rating of P-2 & A3 (Moody’s, or equivalent S&P/Fitch) • Securities: primary dealer, and/or minimal credit rating of Baa3 (Moody’s, or equivalent S&P/Fitch)

  25. 1. Risk Controlling:...cont’dRisk Measuring, Monitoring, Evaluation and Reporting • Credit Risk (cont…) • MM, Forex & Derivatives: • Global Limit, based on a certain percentage of invested reserve projection for next year, • Counterparty limit based on: • Amount of Global limit, • Counterparty’s Tier-1 Capital, • Counterparty’s Credit Rating, • Securities: • Issuer limitation: Government/sovereign, Supranational, and Government Agency • Maximal allocation on each issuer, • Minimal credit rating: BBB for government, and AA for supranational and agency.

  26. 1. Risk Controlling:...cont’dRisk Measuring, Monitoring, Evaluation and Reporting • Credit Risk (cont…) - Counterparty Evaluation: • Monthly: credit rating • Semiannually: settlement, limit usage, financial condition, and institutional condition (merger, acquisition, liquidation, etc) • Incidental: special condition • Operational Risk on Transaction - Focus on operational limit monitoring: transaction limit, frequency limit

  27. 2.Performance Evaluation • Internal (Monthly Report) • Market Index Portfolio: Portfolio Total Return VS Benchmark, Tracking Error & Information Ratio • Non Market Index Portfolio: ROIA (Return on Invested Asset), Risk Adjusted Return • Rep. Office Portfolio: ROIA (Return on Invested Asset), Risk Adjusted Return • Forex Trading Performance • Compliance to guidelines • External (Monthly Report) • External Portfolio Managers: Portfolio Total Return VS Benchmark, Tracking Error & Information Ratio, compliance to guidelines, • Third Party Securities Lending: Reinvestment Spread VS benchmark, Utilization Ratio, compliance to guidelines. • Asian Bond Fund 1 & 2: Portfolio Total Return VS Benchmark, compliance to guidelines

  28. 3. Development of Risk Measures and Investment Guideline Based on: • Objectives and strategy of forex reserves management, • Forex reserves management development • Best practices, Recent Development Program: • Hedging Effectiveness Test, • New Credit Risk Measurement, • Benchmark and Investment Guideline Review related to Reorientation of Reserve Management, • Risk Management Guideline.

  29. C) CHALLENGES AHEAD

  30. Relevant Issues to be discussed Key trends In Reserves Mgt Major Central Bank Policy From Controlling Risk to Risk management The Role of Global Market Outlook Strategy Searching Best Alternative of Investment Policy The Effective Liquidity Management Reserve Managers/ Portfolio Managers Do we need a new paradigm in optimizing reserve management strategy ?

  31. Rise in fx reserves • The quest for higher yield • Credit Spread products • USD still dominant rules of BI reserve • Balancing assets allocation and currency allocation (currency overlay) • Use of Derivatives as a hedging tool • Use of Third Party Securities Lending. (offering additional opportunities) • Use of External manager (transfer knowledge and mitigate risks) Current Condition The reserves Diversification Instruments

  32. Key Trends in Reserve Management : Where are We now? ROIA vs Total Return Strategic Road Map Portfolio Benchmarking and its implications (Revisited) Reorientation= New Paradigm = New Guidelines? In Search of Excellence (HRD issues)

  33. Our next agendas are Things To do • Strategic Policy: • Resolve the benchmark selection is the first priority. • 1. Asset only approach with maximum duration of 5 years • 2. Trading activities are supplementary • Implementing integrative approach on total return and nominal return. • Sharpening the Fundamental analysis capability with portfolio model. • Empowering the risk monitoring report. • Sharpening the content of performance • evaluation • Hedging Strategy

  34. Our next agendas ..cont’d Things To do • Product Development: • Securities Lending enlargement • External Portfolio Manager selection • Further Derivatives Instruments for Bonds • Emerging Bond Market

  35. thank you…

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