Reserves Management

Legal Framework

            The executive committee set guidelines for foreign reserves management under the following legal stature:

            1. Bank of Thailand ACT (1943)

                        Section 12 allows these transactions

-         Buying and Selling foreign currencies, gold and silver

-         Deposits at Central banks and Foreign commercial banks

-         Buying and selling foreign assets according to section 4 of the Currency Act( 1958)

                                                                                   i.     Foreign government securities or international financial agency papers in which Thailand is a member.

                                                                                 ii.     Foreign government securities or securities issued by international agency in which Thailand is a member with explicit guarantees

                                                                                iii.     Papers, issued by institution in which Thailand is a member, for international loans among the member countries

2. Currency Act (1958)

Section 30 define the following as eligible assets in the foreign exchange reserves

-         Gold

-         Foreign Currencies

-         Foreign assets such as

                                                                                   i.     Foreign government securities or international financial agency papers in which Thailand is a member.

                                                                                 ii.     Foreign government securities or securities issued by international agency in which Thailand is a member with explicit guarantees

                                                                                iii.     Papers, issued by institution in which Thailand is a member, for international loans among the member countries

-         Gold, Foreign securities and special drawing rights from the International Monetary Fund (IMF)

-         Special Drawing rights

-         Thai government Bonds issued in foreign currencies

Investment Guidelines

            The Bank of Thailand allocates the foreign reserves into 3 portfolios

LIQUIDITY PORTFOLIO- for the purpose of liquidity to meet short term needs of monetary and exchange rate policies requirement of the Bank of Thailand. The asset class will have to be highly liquid such as deposits and short-term securities and all in USD.

INVESTMENT PORFOLIO- is a fund for the purpose of capital preservation and for investment returns from both interest payments and capital gains. Investment in the fund will emphasize the need for diversification in bonds, country of issuance and currency.

LIABILITY PORTFOLIO- a fund for the purpose of meeting the foreign liability needs with emphasis on Asset-Liability matching to minimize the risks of capital loss and inability to match the liability. Investment is made in the same currency as the foreign liability.

The Bank of Thailand requires a benchmark index for monitoring risks and returns for all the aforementioned portfolios. In practice, investment managers may choose to deviate their allocations away from the benchmark index within limits set by the Bank of Thailand. Presently a small fund is also managed by external fund managers for the purpose of diversification and to learn some new strategies and methods from the managers.

 Frameworks for Risk Management

            1. Market Risk- the most important tool to reduce market risks is the benchmark defined as the asset allocation for both bonds and currencies. This benchmark is obtained via maximization process under some given assumptions. Optimization results depend on the investment horizon with Value-at risk which is considered low compared with other long-term investments such as pension funds.

              In practice, investment managers will allocate assets differently from the benchmark. Actual returns and benchmark returns will not differ too much as the bank of Thailand limits deviations from benchmark in terms of Tracking error limits. (TE limits are the expected returns from deviating from benchmarks).  Levels of TE limits depend on past investment records and volatility of returns. Both benchmark and TE have to be approved by the executive committee and reviewed annually.

             2. Credit Risk – All assets are subject to credit risk exposure and the bank of Thailand has a guideline for minimum acceptable credit rating to be investment grade and limit the maximum amount for each credit risk levels. The higher the credit risks, the lower the amount allowed for investment. In addition, there is also a guideline for concentration risks to avoid having too much credit risk exposure in any one country.

          The Bank of Thailand has a strict guideline for credit risk exposures with commercial banks such as high minimum credit rating for safety and limits the amount of transactions the Bank of Thailand has with each counterparty. Similar to government bonds the Bank of Thailand diversifies across various counterparties to reduce the concentration of credit risks.

            Each credit risk limit must be reviewed and approved by the executive committee and updated periodically depending on the changing financial environments.

3. Liquidity Risk- The Bank of Thailand deals with liquidity risks by allocating a separate fund for the Liquidity Portfolio and has limited the holdings of illiquid assets such as bank deposits to a level such that it will not incur large losses when wanting to liquidate those assets. As of now, Repurchase Agreements and Interest rate futures are included in the asset universe.

4. Performance and Risk Measurement

            The bank of Thailand values the official reserves daily using the marked-to market method.  The department responsible for evaluating, marking-to-market daily portfolio values and risk management is completely independent from the office of reserves management. Furthermore the bank of Thailand issues a monthly return and risk attribution report for use in risk budgeting analysis. This report will be presented to the investment committee, executive committee and other highly qualified outsiders such as examination committee and the Bank of Thailand committee.

 Structure of the Reserves Management

            The executive committee approves the frameworks and regulations for reserve management whereby the investment committee selects and presents the frameworks and regulation for approval. The investment committee then ascertains that the management follows the above-mentioned frameworks and regulations.

            There are 3 separate departments for the management of reserves. The Front office is responsible for investment strategies and implementations. The middle office looks after the frameworks and risk management. Finally, the back office takes care of the deliverance, the payments and the accounts. The reason for the clear separation is for better internal control.

             However, the front office and the risk management team will work closely with each other for better coordination in the reserve management at the bank of Thailand