As part of its policy, the Swiss National Bank has accumulated foreign assets in the amount of one trillion Swiss francs. It would make sense for these assets to be managed by a new Swiss Sovereign Wealth Fund.
The Swiss National Bank holds a trillion francs of foreign assets. Does it manage them well? Over the years, many commentators have argued that these funds should be converted into a Sovereign Wealth Fund (SWF). Today, the SNB Observatory releases a report in which we analyse the case for a Swiss SWF.
We believe that a Swiss SWF offers advantages for Switzerland and for the SNB, but also that there are obvious challenges. These have often been glossed over in earlier debates.
The ballooning balance sheet of the SNB reflects massive safe-haven inflows. A first question to ask is whether these funds are here to stay. If not, an SWF – which invests to gain long-term returns at the risk of potential short-term losses if markets turn bearish – would not be viable.
The SNB would only reduce its foreign reserve holdings if it decided to buy Swiss francs to prevent it from depreciating. Most commentators agree that this is an unlikely scenario. Thus, the funds are here for the long haul and must therefore be managed accordingly.
What are the problems with the SNB investment management? The SNB manages its portfolio in a traditional central bank fashion since by law its monetary policy objective is of primary importance. It prioritises holding liquid, low-risk assets, which earn low returns. The exception is that it holds roughly 20% of its assets in higher earning, but also riskier, equities.
This strategy is not appropriate for a central bank that has large reserves and does not need to intervene in support of its own currency. For Switzerland it leads to too low investment returns. How much returns could be increased is difficult to assess but a back-of-the-envelope calculation suggests that the gain would not be negligible.
For instance, the Sovereign Wealth Fund of Norway, whose balance sheet is about the same size as the SNB’s, invest 70% of its assets in equities. Suppose that the SNB raised its portfolio allocation to equities to 70% and suppose equities earn on average 5% higher returns than bonds. If so, returns would increase by 2.5% or 25 bn Swiss francs per year, a truly staggering amount. Even an increase in returns of 1%, or 10 bn francs, would lead to very large gains. In brief, the SNB’s current central bank-style approach to investment management is costly to Swiss taxpayers.
Another problem with the current situation is that the SNB’s large balance sheet and its annual profits makes it fiscally relevant, which unavoidably attracts political attention. With a trillion francs in assets, the SNB naturally worries about making losses since they could jeopardize its independence. The excessive proximity to politics distracts the SNB’s attention from monetary policy.
Indeed, managing monetary policy is a full-time job. So is managing one trillion francs in assets. And some would argue that leaving two such important tasks in the hands of one institution not only leads to managerial overload but also represents an excessive concentration of power.
For these reasons, it makes sense to restart the discussion about separating monetary policy and the management of the SNB’s assets.
However, it is not always understood that a newly created SWF could not convert the assets to Swiss francs and invest the funds domestically since that would put upward pressure on the exchange rate. Indeed, an SWF would have to be legally barred from holding Swiss franc assets in order not to conflict with the SNB’s foreign exchange policy.
Some commentators even worry that repatriating the foreign currency profits would appreciate the Swiss franc and be problematic. However, the SNB already now repatriates its foreign currency profits, and the same approach could be taken by an SWF. And the experiences of the Norwegian SWF, which has found that announcing to market participants in advance when currency conversions will be undertaken and thereby limiting the effect on the exchange rate, suggest that these concerns may be exaggerated.
Furthermore, it is not always recognised that the SNB cannot simply give away its foreign assets since that would make it insolvent. It would be natural though for the SWF to swap a part of the SNB’s foreign exchange reserves for newly issued bonds denominated in Swiss francs. The drawback would be an apparent surge in Swiss gross public debt which might worry foreign investors. And questions about the coupon payments on the bonds between the SWF and the SNB as well as the question whether the bonds would be marketable have to be settled.
The legal basis of the SWF would also have to be determined. It would presumably be a public institution with a transparent mandate determined by parliament and enjoying the same independence as the SNB. The mandate would presumably contain restrictions on the investment universe that need to be settled.
It is time for a public, open-minded discussion. If the difficulties setting up an SWF can be overcome, this may be a good way forward.
This article is co-authored by Stefan Gerlach (Chef Economist at EFG Bank), Yvan Lengwiler (Professor of Economics at the University of Basel) and Charles Wyplosz (Professor Emeritus of Economics at The Graduate Institute, Geneva). They are the founders of the SNB Observatory.