Re por t o n Re s e r ve s Ma na ge m e nt

Contents

Message from the Governor ..........................................................................................................................1

1.0 Introduction.......................................................................................................................................................3

2.0 Governance Structure ....................................................................................................................................3

3.0 Operational Aspects of Reserves Management .........................................................................................5

4.0 Performance.....................................................................................................................................................6

4.1 Foreign Reserves Position...............................................................................................................................6

4.2 Sources of Foreign Reserves ...........................................................................................................................8

4.3 Currency Composition of Reserves.................................................................................................................9

4.4 Income Generated ....................................................................................................................................... 11

5.0 Developments ............................................................................................................................................... 12

5.1 External Reserves Management .................................................................................................................. 12

5.2 Training and Capacity Building .................................................................................................................... 13

6.0 Challenges Encountered ............................................................................................................................. 15

7.0 Way Forward ................................................................................................................................................. 15

List of Charts and Tables

Figure 1: Governance Structure for Reserves Management 5

Chart 1: Gross and Net International Reserves; 2011 – 2015 7

Chart 2: Import Cover; 2011 – 2015 7

Chart 3: Actual Net International Reserves against Target; 2011 – 2015 8

Chart 4: Sources of External Reserves; 2015 9

Chart 5: Currency Composition of Reserves; December 2015 10

Chart 6: Interest Return Generated from Foreign Reserves; 2011 - 2015 12

Table 1: Benchmark for Currency Composition 9

Acronyms

ARC Audit and Risk Committee

BSD Banking Services Division

CAIM Crown Agents Investment Management

CBS Central Bank of Seychelles

FEA Foreign Exchange Auction

FMD Financial Markets Division

FRN Floating Rate Note

FSSD Financial Services Supervision Division

GFR Gross Foreign Reserves

IAD Internal Audit Division

IC Investment Committee

IFRS International Financial Reporting Standards

IMA Investment Management Agreement

IMF International Monetary Fund

ISA International Standard on Auditing

LIBOR London Interbank Offered Rate

NIR Net International Reserves

PAT Portfolio Analytics Tool

PSD Payment Systems Division

RAMP Reserves Advisory and Management Program

RMU Risk Management Unit

RSD Research and Statistics Division

SWIFT Society for Worldwide Interbank Financial Telecommunication

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Message from the Governor

It is my pleasure to present this Reserves Management Report which aims at extending

transparency and accountability to the public on the activities of the Central Bank of Seychelles

(CBS) in its mandate as the manager of the official foreign exchange reserves of the country.

Over the years, reserves management activities were included in the CBS’ Annual Report and

for the last two years the amount of details provided have increased. Going forward, the CBS

will issue a stand-alone report on a yearly basis, which is in line with best international practices.

As a small open economy with heavy reliance on imports, building an adequate level of reserves

is essential for Seychelles. The holding of reserves asset has been on an upward trend since

the start of the country’s comprehensive macroeconomic reform program in 2008. In December

of the same year, total imports coverage of Gross Foreign Reserves (GFR) stood at 0.8 months.

Over the subsequent years, the figure has grown substantially to attain its highest levels of 4.9

months at the end of 2015. Having sufficient reserves allows for meeting payment obligations

for debt and international trades, wealth accumulation, boosting the country’s credit rating,

providing a cushion when the economic performance is not as expected or when faced with an

unforeseen calamity e.g. a natural disaster. The stance taken by the CBS is consistent with

the trend observed globally in that worldwide, official reserves have increased significantly over

recent years, as a consequence of countries converging as one global marketplace, allowing

trades and borrowings to take place with greater ease.

Being public funds, the CBS considers it an obligation to ensure that the reserves are prudently

managed such that they can meet their expected uses. Central Banks have traditionally

maintained a fairly conservative risk tolerance when it comes to investing foreign reserves.

Nonetheless, as seen in recent years following the 2008 global financial crisis, some Central

Banks have become more proactive in improving their external reserves positions. The income

generated on the reserves have provided support to their balance sheet, hence allowing for

operational independence and efficiency in the implementation of sustainable monetary

policies. At present, given the relatively low interest rate environment globally, there is an

increasing tendency for Central Banks to assume more risks for improved return generation.

As a result, there is a greater need to strengthen the risk management and governance

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structures arising from investment activities. Reserves management adopted by the CBS is

based on a sound governance framework which constitutes the hierarchy defined among the

decision levels, supported by an integrated risk management framework and monitoring

system. These aim to improve the reserves management framework of the CBS and preserve

the macroeconomic resilience of the country.

Capacity building of staff in the area of reserves management has also been one of the priorities

of the CBS. The prevailing growth trend in GFR since 2008 has made it imperative to obtain

in-house expertise to ensure that they are managed in the most efficient manner. In January

2014, the CBS negotiated to include an aspect of transfer of knowledge for staff, as part of the

engagement with its first external fund manager, the Crown Agents Investment Management

(CAIM). The effort has also been extended with the CBS’ Board of Directors approving the

commencement of a core technical advisory mandate under the World Bank’s Reserves

Advisory and Management Program (RAMP) in November 2014.

C. Abel (Ms)

Governor

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1.0 Introduction

This report outlines the activities undertaken by the CBS in the management of Seychelles’

external reserves during the year 2015; referring to the year-to-year performance in comparison

to the previous five years and the developments that have taken place over the period.

It begins by providing an overview of the governance structure and operational setup for

reserves management. This is followed by a description of the changes in reserves positions,

currency exposures and returns. In the latter part, the developments and major challenges

faced during the year are highlighted, concluding with the outlook for 2016.

2.0 Governance Structure

As stipulated under Part VI of the CBS Act 2004 as amended (Act), the CBS has the mandate

to hold and manage the official reserves of the Seychelles. As the reserves manager of the

country, the CBS has to ensure adequate level of reserves so as to meet all the rationales for

holding them. These rationales are derived from macroeconomic perspectives, explicitly set

out in the Investment Policy (Policy) approved by the Board. These are to repay public debt in

foreign currencies, provide protection in the event of balance of payment shocks or national

disasters, support the domestic macroeconomic policies and maintain confidence in the

exchange rate regime.

In view of the range of rationales for holding reserves, the Board also guides the investment of

the foreign reserves by setting out the investment objectives in the Policy. This is necessary to

ensure alignment of investment strategies adopted with the rationales for holding reserves. The

investment objectives are set out in the following order of priority, starting with the most

important; capital preservation, liquidity and return generation.

Through the Policy, the Board has delegated operational oversight of reserves management

activities to the Investment Committee (IC) which is chaired by the Governor. The composition

of the IC includes the two Deputy Governors as well as the heads of five key divisions namely

Financial Markets (FMD), Research and Statistics (RSD), Banking Services (BSD), Financial

Services Supervision (FSSD) and Payment Systems (PSD). The auditors from the Internal

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Audit Division (IAD) and officers from the Risk Management Unit (RMU) also partake as

observers during the meetings of the Committee. The IC meets once every month to review

performance and approve investment strategies, as well as when there are significant changes

in market conditions.

One of the key responsibilities of the IC is to translate the qualitative terms of the Policy into

measureable Investment Guidelines for application in the operational areas. The operations of

reserves management are undertaken by various divisions within the Bank, as detailed in

section 3. This is to ensure the duties are well segregated, which is a highly recommended

practice internationally in order to safeguard ethical business operations and mitigate

operational risks.

Internal reporting is another important aspect of good governance in reserves management.

This takes form of periodic and timely reports to the IC and the Board on the various operational

and monitoring areas. FMD prepares a review of investment activities and performance against

allocated budgets and benchmarks on monthly and quarterly bases to the IC and Board,

respectively. Similarly, the RMU reports on operational risks and compliance issues. In regards

to financial reporting, this is undertaken by the BSD, whereby relevant members of the

Management team are informed of the financial performance on a daily basis, through the

statement of income and expenditure. Additionally, in compliance with the Act and in

agreement with the International Monetary Fund (IMF) under the reform program, the IAD

conducts an audit of the Net International Reserves (NIR) statement on a semi-annual basis in

accordance with the International Standards on Auditing (ISAs) and ensures conformity of the

calculation methods with the IMF standards. Both the IAD and the RMU report their findings to

the Audit and Risk Committee (ARC) which is a sub-committee of the Board. These are mainly

the outcome of audit review and strategic risk identified, respectively. Figure 1 provides an

illustration of the governance structure for reserves management at the CBS.

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Figure 1: Governance Structure for Reserves Management

Source: Central Bank of Seychelles

3.0 Operational Aspects of Reserves Management

The operations pertaining to reserves management are divided into three main areas namely

the front, middle and back offices, with the mandate of each office outlined in the Investment

Policy and Guidelines. The front office within the FMD is responsible for the daily portfolio

management and has the mandate to trade on the international money and foreign exchange

markets within approved guidelines. Setting of benchmarks and guidelines for operations falls

under the responsibility of the middle office, which becomes binding once approved by IC. The

middle office duties, which also entail compliance and control functions, are to an extent the

shared responsibility of the RMU and the Market Analysis Section of the FMD. All settlements

and maintenance of foreign exchange accounts based on the activities of the CBS are done by

the back office, which is a role being conducted by the BSD. In addition to the three main

offices, the IAD is responsible for the semi-annual audit of the reserves positions and activities.

This is in addition to the audits that they may perform from time to time. These activities are

further examined by the CBS’ external auditor on an annual basis.

Board of Directors

Investment Committee

Financial Markets Division

Banking Services Division

Audit and Risk Committee

Risk Management Unit

Internal Audit Division

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As mentioned in section 2, the objective for holding reserves in order of priority are for capital

preservation, liquidity and return generation. In view of these differing and at times diverging

investment objectives, total reserves are separated into three corresponding sub-portfolios

called tranches. The operational tranche is managed with a maximum of three months

investment horizon, in order to meet short term payment obligations and potential needs for

foreign currency interventions in the local market. The liquidity tranche has a maximum maturity

of twelve months as it aims to reflect balance of payments drawdowns for the twelve months

ahead. This tranche is the buffer in the event of external shocks and its optimum position

should reflect three months’ worth of imports coverage. Any excess over and above the

operational and liquidity requirements makes up the investment tranche. This tranche is geared

towards return generation and is managed with an average duration of approximately 1.5 years.

4.0 Performance

4.1 Foreign Reserves Position

The GFR position improved significantly over the last five years, as illustrated on Chart 1. By

the end of 2015 the position settled at US$536 million; an annual growth of 16 per cent from

the level of US$464 million in the preceding year. The performance was fundamentally a result

of continued active reserves accumulation in the local foreign exchange market throughout the

year. This was done through the Foreign Exchange Auctions (FEAs) whereby the CBS

purchased US$86 million from the market. Over the course of 2015 nonetheless, the GFR was

exposed to external pressures that originated from developments in the international markets.

With the continued strengthening of the US dollar due to the expected rate hike in December,

along with relentless loosening of monetary policy in the Eurozone and slower global growth,

most currencies lost momentum against the US dollar. Given that the US dollar is the reporting

currency for the Seychelles’ portfolio of reserves, this meant less value for non-US dollar

currencies.

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Chart 1: Gross and Net International Reserves; 2011 – 2015

Note: end of year figures Source: Central Bank of Seychelles

Consistent with the growth in GFR, an improvement was posted in the reserves adequacy level.

This is an approximation expressing the country’s overall reserves in terms of months of imports

cover, displayed on Chart 2. By the end of 2015, the reserves levelled at 4.9 months of imports

compared to 4.0 months by end 2014. This remained above the broad rule of thumb of 3.0

months being the minimum import coverage established by the IMF.

Chart 2: Import Cover; 2011 – 2015

Note: end of year figures Source: Central Bank of Seychelles

0%

20%

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100%

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2011 2012 2013 2014 2015

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Gross Net % change in GFR

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2011 2012 2013 2014 2015

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With regards to the NIR, by the end of the year it had grown by 17 per cent from US$363 million

in 2014. The NIR represents the quantitative performance criteria in reserves management

within the Seychelles’ macroeconomic reform program supported by the IMF. As per the

previous years, the actual NIR surpassed the target at the year end. The position on 31st

December 2015 was US$423 million; US$14 million above the target of US$409 million as

illustrated on Chart 3 below.

Chart 3: Actual Net International Reserves against Target; 2011 – 2015

Notes: End of year figures Source: Central Bank of Seychelles

4.2 Sources of Foreign Reserves

As per Chart 4, the main source of external reserves accumulation posted for 2015 was the

purchase of foreign exchange from the domestic market through the FEAs. This was almost

half the amount of reserves accumulated during the year being reviewed. Receipts by

government also continued to be an important resource for building up reserves, representing

26 per cent of total inflows. These came from different fees and charges collected by the

government, such as that for the use of the national airspace and the maritime zone. Moreover,

as is the case in many developing countries, additional reserves also came by way of

multilateral as well as bilateral loans and grants for national projects and budget support, which

in 2015 represented 14 per cent of reserves accumulated.

0.0

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2011 2012 2013 2014 2015

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NIR NIR Target

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Chart 4: Sources of External Reserves; 2015

Source: Central Bank of Seychelles

4.3 Currency Composition of Reserves

As approved by the IC, the external reserves are managed with a strategic currency

composition benchmark which indicates the long term currency exposure levels most desired

by the CBS. The benchmark during 2015 comprised of 70 per cent exposure to the US dollars,

20 per cent to euros, 9 per cent to UK pound sterling and a balance of 1 per cent to other

currencies which qualify as reserves by the IMF definition (see Table 1). The latter includes

Canadian dollar, Australian dollar, Swiss francs, Japanese yen and most recently the Chinese

Renminbi. The currency composition is reviewed periodically and in instances of significant

change in market fundamentals. To optimise reserves management, the IC may allow

deviations from the strategic composition benchmark.

Table 1: Benchmark for Currency Composition

Currency Minimum Benchmark Maximum

USD 30% 70% 75%

EUR 3% 20% 30%

GBP 5% 9% 30%

OTHERS 0.0001% 1% 15%

100%

49%

26%

14%

7%3% 1%1%

Foreign Exchange Auction Government Receipts

Loans and Grants Minimum Reserve Requirement

IMF Disbursement Others

Income on CBS Reserves

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For the year under review, the CBS maintained the country’s foreign currency reserves

principally in US dollars, UK pound sterling and euro. However, given the prevailing low interest

rates in Europe and the US, the CBS also engaged in trading and continued investment in

commodity currencies such as the Australian and Canadian dollars, in order to generate more

returns. Nevertheless, with the continuous downtrend in the price of oil throughout 2015

coupled with the volatility in the Asian equity markets, both Canada and Australia struggled to

escape the adverse effect, pulling the currencies to ultra-lows relative to the US dollar.

Simultaneously, 2015 saw the dramatic strengthening of the US dollar based on its own

fundamentals, which further added to the undesirable impact on other currencies’ value. This

ultimately led to the CBS gradually moving away from commodity currencies and towards the

US dollar near the end of the year, so as to reduce currency risk exposure.

As a result and similar to the preceding year, the composition of US dollars at the end of 2015

deviated from its prescribed benchmark level. The same was observed for the euro as

illustrated on Chart 5, in view that market conditions were not considered as “normal”. The

portion of GFR that was held in US dollar stood above the maximum limit whereas that for the

euro stood below the minimum. This accounts for the negative interest environment in the

Eurozone and thus the continuous reserves accumulation strategy in US dollars.

Chart 5: Currency Composition of Reserves; December 2015

Note: End of year figures

Source: Central Bank of Seychelles

USD70.00%

EUR20.00%

GBP9.00%

Other1.00%

Benchmark Composition

USD79.43%

EUR1.94%

GBP13.10%

Other5.53%

Actual Composition as at December 2015

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UK pound sterling and the ‘others’ category, which comprised of Australian and Canadian

dollars, remained above the ideal position as per the prescribed benchmark but below the

maximum limit at year end.

4.4 Income Generated

Similar to the preceding years, the country’s external reserves were held predominantly in the

form of fixed term deposits. The annual return generated over the last five years is depicted in

Chart 6. The highs in performance recorded in 2011 and 2012 were due to placements in high-

yielding commodity currencies, specifically the Australian dollar. This was a strategic move to

increase the overall risk tolerance of the portfolio and hence return. However, this strategy was

recalibrated in late 2013 to focus more on limiting currency risk and lengthening the investment

horizon and as expected, the return dropped. Furthermore, the low interest rate environment

which persisted through 2014, carried forward throughout 2015, and was further impacted by

the tumbling price of oil and commodities.

Although the CBS maintained its investments in Australian and Canadian dollar, interest return

on the investments were lower than the preceding years. In addition, towards the end of 2015,

the US as expected hiked its interest rates, compelling the CBS to strategically shift most of its

exposure towards the US dollar in order to benefit from the improved yield and reduced

currency risk. Hence, the return generated for 2015 was similar to that of the preceding year,

with total interest earned on deposits levelling at US$1.4 million.

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Chart 6: Interest Return Generated from Foreign Reserves; 2011 - 2015

Source: Central Bank of Seychelles

5.0 Developments

5.1 External Reserves Management

The implementation of the three-year Investment Management Agreement (IMA) signed with

CAIM in January 2014 continued during 2015. This agreement allows CAIM on behalf of the

CBS to actively invest in fixed income securities including treasury bills as well as fixed rate,

floating rate, inflation indexed-link and zero-coupon bonds issued or guaranteed by G7

governments and supranationals. As it is usually the case with external management

arrangements, the CBS and CAIM have agreed on a benchmark on the basis of which to

monitor risk and performance. In 2014, the benchmark was selected to reflect the currency

composition of Seychelles’ foreign liabilities. It was a composite benchmark comprising of the

Bank of America Merrill Lynch US Treasury Bills and Bonds, UK Gilts and German Bunds

indices with maximum maturity of three years.

The objective of an active management mandate is to outperform an agreed benchmark over

an agreed investment horizon. CAIM managed to outperform the benchmark, however, returns

from both the benchmark and the fund were negative from inception to 31st December 2015 as

measured in the reporting currency, which is US dollar. This negative performance was largely

a result of the relentless strengthening of the US dollar over the year as well as the negative

yield in the Eurozone. In view of this situation, the CBS decided to completely remove

exposures to currency risk and minimise the probability of negative return by adopting a purely

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2011 2012 2013 2014 2015

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US dollar benchmark, hence dollarizing the external portfolio. The new benchmark was

approved in December 2015 and it is expected to come into place in the first quarter of 2016.

It will comprise only of the Bank of America Merrill Lynch US Treasury Bills and Bonds indices

extended to a maturity of five years.

5.2 Training and Capacity Building

As per the IMA signed with CAIM, staff involved in reserves management activities continued

a training program throughout the year, with one onsite attachment at the CAIM head office in

UK and ongoing web-based training. The program was designed in a segmented approach,

addressing potential instruments for investment by the CBS, one after another. In 2015,

trainees covered Floating Rate Notes (FRNs) – see Box 1 and foreign exchange spot and

forward products. The modules extended over the management processes throughout the full

cycle of investment and covered pre-investment analysis, decision making, custodian

relationships, settlement and position management, accounting and auditing as well as

performance evaluation.

In addition, the core technical assistance from World Bank’s RAMP continued during the year.

As part of this program, staff participated in various workshops to enhance capacity in

accounting and settlement, counterparty relationships, strategic asset allocation and good

governance in reserves management. The RAMP team also led an onsite mission to the CBS

in preparation for the inception of fixed income indexation as well as the implementation of the

Oracle based software to link the front, middle and back offices—the Portfolio Analytics Tool

(PAT2). The software aims to mitigate operational risks by providing an automated means to

keep track of portfolio holdings and monitor compliance to the Investment Guidelines. PAT2

also generates Society for Worldwide Interbank Financial Telecommunication (SWIFT)

messages for straight through processing of transactions from the front office along with

corresponding accounting entries compliant with the International Financial Reporting

Standards (IFRS). Moreover, it serves as data capture solution to facilitate periodical

management reporting in the areas of compliance and performance monitoring, as well as

credit and market risks management.

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Box 1: Instrument Highlight – Floating Rate Note

FRNs also knows as floaters, are short for medium term bonds that have variable rate coupons. Hence, they

are types of fixed income securities i.e. debt instruments usually issued by governments and corporations to

finance capital and current expenses and providing investors with return in the form of fixed periodic

payments and return the principal lent out at maturity. The coupon rates on the FRNs are based on a money

market benchmark for interest rates, such as the London Interbank Offered Rate (LIBOR), plus a fixed

margin. At the beginning of each coupon period, the coupon rate to be paid on the coupon date is calculated

by taking the reference rate of the day plus the fixed margin. For example, an FRN may have a coupon rate

of 6 months USD LIBOR + 1 per cent. The size of the margin also referred to as the spread depends on the

credit quality of the issuer and the maturity of the bond. As is the case with fixed rate bonds, interest rates

have an inverse relationship with price.

The interest rate on an FRN can change as frequently as the issuer chooses and this is called the “reset

period”, whose frequency for revision mitigate the sensitivity of the bonds to interest rate fluctuation. Hence

FRNs have considerably lower interest rate risks compared to fixed rate bonds of the same maturity. In view

of the embedded interest rate reset, FRNs have close to zero duration; the change in the price of the bond

due to interest rate fluctuation is minimal.

Usually FRNs have a cap and/or a floor and the investor will only know the maximum and/or minimum interest

rate the note might pay. The issuer may pay interest monthly, quarterly, semi-annually or annually. Given

the floating nature of FRNs, they may be issued with a call option, limiting investors’ downside exposure. A

call option on a bond implies that the issuer may decide to pay off the debt issued at some point through the

life of the investment if interest rates are not going in the favoured direction.

The CBS invests in FRNs through the IMA signed with its external manager, CAIM. The CBS gave CAIM the

mandate to actively buy and sell floaters with a minimum credit rating of AA. FRNs in the portfolio are issued

or guaranteed by approved G-10 governments and in the currencies set by the Investment Policy and

Guidelines.

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6.0 Challenges Encountered

The low interest rate environment internationally persisted throughout 2015, with a slight relief

in the last quarter on the US dollar front as the Federal Reserve actioned to normalise monetary

policy. In order to maintain the return levels to an acceptable level, the CBS maintained

investment in commodity currencies including the Australian and Canadian dollars despite the

higher levels of risks associated to these markets. When the Federal Reserve increased

interest rates in December, the appeal for the other currencies in the composition lessened,

particularly for GBP and the commodity block. In light of this, the CBS shifted most of its

exposure into USD so as to benefit from the improved yield and reduce the currency risk.

The year 2015 was also a preparation period for the forthcoming principal repayments on

negotiated debt which resumes in 2016. The foreign currency public debt outlay for 2016 is

expected to increase by two thirds from the level of 2015. Hence, the CBS intensified its effort

to accumulate US dollar in the domestic market and build up an adequate reserves buffer. The

task was to balance and ensure that actions to gather foreign currency reserves does not cause

major disruptions to the supply of foreign exchange in the market, hence impacting the foreign

exchange rate.

7.0 Way Forward

During the year 2016, the CBS will continue with the work already started to improve the

reserves management framework. This will include the final phases of preparation to install

PAT2 supported by the World Bank which will overcome the current shortcomings in IT

infrastructure. RAMP will continue to build the capacity of staff by providing various short and

medium term courses in the fields of risk and investment management as well as settlement

and accounting.

The CBS also intends to maintain its training agreement with CAIM and in the first half of the

year the program will extend to the management of money market instruments trading on the

major international markets. Moreover, the conversion of the CAIM managed funds from

composite currencies to purely US dollar denominated investment is expected to be completed

by the end of the first quarter of 2016.

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Also in 2016, the reserves management team intends to commence the implementation of a

fixed income securities indexation strategy. Initially, the front office will construct a theoretical

or ‘paper’ portfolio of fixed income securities based on a benchmark selected by the middle

office. Establishing a ‘paper’ portfolio will allow the team to simulate positions vis-a-vis a set

benchmark and optimise the benchmark and security selection, as well as other operational

processes in the investment cycle.