Core Focus: The two-layer benchmark framework: the strategic benchmark for long-term risk/return preferences, the tactical benchmark for medium-term adjustments, and the roles of the Governing Council and Executive Board.

In-Depth Notes:
The benchmarking framework for the ECB’s foreign reserves is set at both strategic and tactical levels . This two-layer framework is a cornerstone of the ECB’s investment policy, providing a clear structure for decision-making while allowing flexibility to respond to changing market conditions.

The Strategic Benchmark:
The Governing Council first establishes a strategic benchmark for each currency, which constitutes the main guideline for the ECB’s investment policy . The strategic benchmark reflects the long-term policy requirements and risk and return preferences of the ECB . The investment objective is to maximize expected portfolio return under the constraint that there are no losses at a 99% confidence level in each individual year over the five-year investment horizon . The strategic benchmark is reviewed annually and rebalanced monthly . The strategic benchmark consists of specific allocations to various asset classes and the allocation across currencies. The specific currencies are predetermined and typically include the US dollar and Japanese yen .

The Tactical Benchmark:
The Executive Board determines a tactical benchmark . The tactical benchmark, which must be kept within pre-set bands around the strategic benchmark, reflects the short to medium-term risk and return preferences of the ECB, in the context of the prevailing market conditions . The objective of the tactical benchmark is to outperform the respective strategic benchmark within an investment horizon of three months . It is reviewed monthly and rebalanced monthly . The risk budget allocated to the tactical benchmark usually exceeds the budget of the NCBs’ portfolios by a factor of 2, allowing the tactical level to make larger adjustments .

The Three-Layer Approach:
The investment framework is organized around three layers: the strategic benchmark, the tactical benchmark, and the actual portfolios managed by NCBs . Information regarding all four characteristics is communicated to the NCBs, which implement the investment framework of the ECB . Through a portfolio management system which uses a special IT network built for the ESCB, the ECB receives online information on the deals carried out by all NCBs on its behalf . Concerning the daily management of foreign reserves, the NCBs have a margin of discretion within the deviation bands and limits defined by the ECB, aiming to maximise the efficiency of the management of the ECB’s foreign reserves . The investment framework has been periodically adjusted as a result of the inclusion of new members in the Eurosystem and has also contributed to enhancing the absolute return on the ECB’s foreign reserves .