Core Focus: The determinants of the currency composition of reserve portfolios, including trade patterns, external debt structure, and intervention needs, and the dominance of the US dollar and euro.

In-Depth Notes:
The currency composition of a reserve portfolio is a critical component of the strategic asset allocation. It determines the portfolio’s exposure to exchange rate risk, its ability to support intervention operations, and its alignment with the country’s external liabilities and trade flows.

Determinants of Currency Composition:
The currency composition of reserves is influenced by several factors. The first is trade and invoicing patterns—countries tend to hold reserves in currencies that are used for trade invoicing and settlement. The second is external debt denomination—countries may hold reserves in currencies that match their external debt liabilities to reduce currency mismatch risk. The third is intervention needs—reserve managers may hold additional liquidity in the main intervention currency . The fourth is the structure of the global financial system—the dominant role of the dollar in global finance reinforces its role as the primary reserve currency.

The US Dollar Dominance:
Global foreign currency reserves are concentrated in a small number of major currencies. The US dollar is the leading reserve currency, followed by the euro as a distant second. The SOMA and ESF foreign currency reserves are currently held in euros and Japanese yen . A significant portion of the U.S. monetary authorities’ foreign currency reserves is invested on an outright basis in government-backed securities. Foreign currency reserves may also be held on deposit at the Bank for International Settlements and at foreign central banks .

The Eurosystem’s Currency Composition:
The ECB’s foreign reserve assets are held in US dollars, Japanese yen, Chinese renminbi, gold, and Special Drawing Rights. The US dollar is the dominant reserve currency, followed by the Japanese yen. The inclusion of CNY reflects the growing importance of the Chinese currency in global trade and finance.

Currency Specialisation Models:
The Eurosystem adopted a currency specialisation model in 2006 . Prior to that, each NCB managed both a USD and a JPY portfolio. After the change, each NCB normally manages a single portfolio (either USD or JPY). This specialisation allows NCBs to focus their expertise and achieve greater efficiency. The number of portfolios has been reduced over time: initially 12 USD and 12 JPY portfolios; after 2006, 8 USD and 6 JPY portfolios; and since 2012, 11 USD and 4 JPY portfolios, plus one CNY portfolio since 2017 .

The Eurosystem’s Allocation by Capital Key:
Each NCB’s contribution to the ECB reserves was in proportion to its shareholding in the ECB, which, in turn, is a function of each Member State’s shares of the euro-area’s GDP and population . Under the EU Treaty, the ECB may make further calls of foreign currency assets from NCBs’ foreign exchange reserves.