The Investment guidelines of Foreign Exchange Reserves of the National Bank Republic of Kazakhstan

The Investment guidelines

of Foreign Exchange Reserves

of the National Bank Republic of Kazakhstan

Chapter 1. General provisions

1. The present Investment guidelines (further Guidelines) is developed in accordance with the Law of the Republic of Kazakhstan “On the National bank of Republic of Kazakhstan”, by the Resolution of the Board of the National Bank Republic of Kazakhstan of May 29, 2003 № 000, the Rules " On the basic principles of the management of foreign exchange reserves of the National Bank of the Republic of Kazakhstan ".

2. The present Guidelines is intended to regulate and control operational activity related to the management of gold and foreign exchange reserves of the National Bank of the Republic of Kazakhstan (further National Bank). The provisions of Guidelines must be discussed by the Board of the National Bank not less than once a year.

3. The purpose of the management of foreign exchange reserves is maintenance of liquidity and safety of assets, preservations of purchasing force, and to maximize returns under restrictions of the present Guidelines.

Chapter 2. Basic terms

4. Basic currency is a currency used for purposes of valuation of the return of the Fund’s assets.

5. The duration of the fixed income security (portfolio) is the average term before maturity of the security. The parameter indicating how the market value of the security (portfolio) will approximately decrease/increase in case of an increase/decrease of yield to maturity of the security (portfolio).

6. Tracking error is defined as the annualized standard deviation of the difference in returns between the Portfolio and its target Index.

7. The Composite Index is an index of indices of fixed income securities of developed countries of the world consisting of high-liquid securities.

8. Credit rating is a parameter of a level of the credit risk on financial instruments given to issuers of fixed income securities by credit rating agencies Standard & Poor’s и Moody’s.

9. Cash currency - the monetary rests on the current accounts and on the specialized accounts of custodians (Accountovernight).

10. The portfolio is a set of financial instruments including cash.

11. Derivatives - forwards, SWAPs, a percentage SWAPs, the agreement on forward interest rate (FRA), options, futures and other operations representing a combination of the given transactions.

12. Excess return is the difference between actual portfolio return and benchmark return.

13. The structural product is a combination of assets and liabilities, which is composed on the different financial instruments.

14. Alternative instruments are assets and strategies to increase return (equities and debt of Emerging Markets, High Yield Bonds, Absolute Return, Hedge Funds, Private Equity, Distressed Securities and Real Estate).

15. Hedging risks - process of construction of a portfolio by purchase or sales of the certain financial instruments with the object of decrease the financial risks and possible losses. In National Bank hedging of risks is carried out by full or partial return to the benchmark distribution established by the present Guidelines. All derivative financial tools can be used with the object of hedging, except for options sale (call, put).

16. Asset-backed securities (ABS) are debt instruments on the security of loans for purchasing assets, excluding the real estate, guaranteed by an issuer.

17. Mortgage-backed securities (MBS) are debt instruments on the security of loans for purchasing the real estate guaranteed by an issuer.

18. Benchmark portfolio is a set of securities, the composition of which is defined by the interests of an investor. Benchmark portfolio’s return serves as a measure under evaluation of the return of assets’ management. Indices constructed and maintained by leading world financial companies are applied as benchmark portfolio.

19. The portfolio of transferring assets - the temporary portfolio formed according to required parameters of a portfolio in which transfer is planned.

Chapter 3. General Strategy of Foreign Exchange Reserves Management

20. Foreign Exchange Reserves consist of a liquidity portfolio, an investment portfolio, an absolute return portfolio and a portfolio of gold.

21. An efficiency measure of foreign exchange reserves management is the excess return of investment portfolio of foreign exchange reserves and absolute return portfolio of foreign exchange reserves over a period of one calendar year and the compliance with the restrictions of the present Guidelines.

Excess return is defined as the difference between actual portfolio return and benchmark return.

The holding period return of single financial instrument is not an indicator of management efficiency.

Sale of assets with a negative holding period return is allowed with a purpose of risk reduction and improvement of the expected excess return.

22. The following financial instruments and transactions with them are permitted for investment of foreign exchange reserves:

1) Cash currency;

2) Government (sovereign), agency, supranational, corporate debt obligations with maturity less than one year, depositary certificates (CD), commercial papers (CP) with short-term credit ratings are not lower, than А1 – Standard and Poor's or P1 - Moody's;

3) Government (sovereign), agency, supranational, corporate, mortgage backed (MBS) and asset backed (ABS) debt obligations with credit ratings BBB - Standard &Poor's or Baa2 - Moody's and higher;

4) Deposits at banks in cash and in gold with counterparties whose long-term credit rating is not lower than A/A1 - Standard & Poor's or Moody's accordingly, or whose short term rating is not lower than A2/P1 – Standard &Poor's or Moody's accordingly; investment of cash remaining on current accounts into money market funds with credit rating AAAm –Standard &Poor's or Aaa - Moody's or in money market funds which meet all the requirements made to the funds with credit rating AAAm –Standard & Poor's or Aaa - Moody's;

5) Financial and commodity derivatives traded on exchanges of the following countries: USA, European Union, Japan, Australia;

6) The stocks which are included in the following indexes: S&P500 (SPX), DJ STOXX 50 € (SX5E), Nikkei 225 (NKY), FTSE 100 (UKX), S&P/ASX (AS51);

7) Structural products;

8) Alternative instruments;

9) Repo and reverse repo transactions with counter-parties, whose long-term credit rating is not lower than A - - Standard & Poor's or А3 - Moody's, using as a collateral permitted securities with market value not lower than 100 % of the trade amount on the trade date;

10) Purchase and sale of gold and foreign exchange transactions;

11) Purchase and sale of derivatives with counter-parties, whose long-term credit rating is not lower than A - - Standard & Poor's or А3 - Moody's. Additionally time limitation is applied for the following derivatives: forwards – 1 year, options and swaps – 15 years, futures without limits;

12) Transactions according to the principle “delivery versus payment” (DVP) may be carried out under a simultaneous delivery of assets between counter-partners (or custodians) without limitation on their credit rating;

23. All receipts and transfer of assets from accounts of the National Bank, connected with increase or reduction of foreign exchange reserves, are carried out through the liquidity portfolio. Transfer of assets between foreign exchange portfolios, types and volume, are carried out upon the recommendation of the Department of Monetary Operation of National Bank (further - division of monetary operations) with the approval of the authorized Deputy Governor or Governor of National Bank. For the given purposes building the temporary transferring assets portfolio, for no more than one month to which does not distributed restrictions of a portfolio from which transfer is planned.

24. Excluded

25. Derivatives can be used as for hedging risk of potential losses, by approach of the benchmark distribution, and for opening active positions within the framework of the restrictions established by the present Guidelines.

26. By the separate decision of Board of National Bank hedging of risks of a portfolio (a part of a portfolio) with possible infringement of limits and the restrictions established by the present Guidelines can be carried out.

27. The maximum term of Repo or Reverse Repo should not exceed 3 (three) months. The maximum term of accommodation of the deposit in currency should not exceed 3 (three) months.

Chapter 4. Parameters of liquidity portfolio.

28. The liquidity portfolio is intended for carrying out of operations with the object of realization of a monetary and foreign-exchange policy, maintenance of a high level of liquidity, satisfaction of short-term demand for currency and to service of an external public debt. Return is not the purpose of liquidity portfolio.

29. Excluded

30. Basic currency of liquidity portfolio is the US dollar.

31. The volume of liquidity portfolio should meet the following parameters:

1) To be not less than 1 billion US dollars;

2) To be not less than volume of payments on service of an external public debt for forthcoming 6 months. The given restriction is checked 1 time in calendar quarter (on the 10th working day of each quarter).

If market cost of a portfolio of liquidity does not meet the given parameters, within five working days from the date of an establishment of such discrepancy the increasing the liquidity portfolio is made due to transfer of a part of assets from an investment portfolio.

32. Assets of liquidity portfolio can be invested in financial instruments provided by the Section 22 of the Guidelines.

Chapter 5. Parameters of an investment portfolio

33. The objective of an investment portfolio is the increase returns of assets in long-term prospect.

34. Basic currency of an investment portfolio is the basket of currencies specified in table 1 of the appendix of 1 to Guidelines.

The basket of currencies is determined quarterly based on exchange rates on the last business day of each quarter.

The Maximum deviations in currency are specified in table 2 of the appendix 1.

35. The following composite index is a benchmark of the investment portfolio:

45 % ML US Treasuries (Bloom. ticker: G1O2)1-3 years

30 % ML EMU Direct Governments (Bloom. ticker: EG0V)1-5 years

10 % ML UK Gilts (Bloom. ticker: GVL0)1-5 years

10 % ML Japanese Governments (Bloom. ticker: GVY0) 1-5 years

5 % ML Australian Governments (Bloom. ticker: GVT0) 1-5 years

Country rebalancing of the benchmark portfolio is made according to the basket of currencies on the last business day of each quarter.

36. The duration of an investment portfolio should be within the limits of +30%/-40 % from duration of the benchmark.

37. Expected tracking error of the investment portfolio, including derivatives should not exceed 2 % per annum on the last business day of each month. If this limit is exceeded, the division of monetary operations will take steps necessary to bring it bellow 2% per annum during 5 business days.

38. Maximum deviations of various classes of instruments in investment portfolio in each currency are determined in table 1 of the appendix 2 of the Guidelines.

At the same time, maximum deviations for types of operations with derivatives are defined in table 2 of the appendix 2 of the Guidelines:

39. Repo and reverse repo transactions may be done in any volumes.

40. Maximum deviations in the investment portfolio in each currency for Corporates rated AA-(S&P)/Aa3(Moody's) and below are defined in table 1 of the appendix of 3 Guidelines.

Holding more than 5 % from volume of one issue of the corporate bond is forbidden. The given restriction is not distributed to structural products.

41. Maximum deviations in the long term portfolio in each currency for governments rated AA-(S&P)/Aa3(Moody's) and below are defined in table 2 of the appendix of 3 Guidelines.

42. Credit Risk limits are defined in Chapter 9 of this Guidelines.

Chapter 6. Parameters of a portfolio of absolute return

43. The objective of the given portfolio is maintenance of absolute return of assets in long-term prospect.

44. Excess return is calculated against USD Libor 3M - the three-monthly London interbank rate. Excess return is defined as a difference between the achieved return of portfolio for a calendar year and actual return USD Libor 3M for the similar period.

45. Basic currency of a portfolio of absolute return is the US dollar.

46. The VAR of portfolio for one month with confidence interval 95% has to be less than 5% from the volume portfolio. If this limit is exceeded, the Department of Monetary Operations will take steps necessary to bring VAR bellow 5% from the volume of portfolio during 30 business days.

47. Assets of a portfolio of absolute return can be invested in the following instruments:

1. The instruments allowed for the Investment portfolio.

2. Alternative instruments.

3. Structural products.

4. The stocks which are included in the following indexes:

S&P500 (SPX)

DJ STOXX 50 € (SX5E)

Nikkei 225 (NKY)

FTSE 100 (UKX)

S&P/ASX (AS51).

48. The long-term credit rating of a structural product should be not lower A - (S&P) or А2 (Moody's), and short-term - is not lower A-2 (S&P) or P-1 (Moody's).

48.1 In the case of the structural product is know-how of the counter-partner, the National Bank does not request price on the given structural product from other counter-partners.

48.2 In the case of the structural product is created by inquiry of National Bank (on a basis request for proposal), National Bank requests quotations on a structural product not less, than of two counter-partners. In this case the National Bank carries out the transaction on the best conditions.

48.3 Purchase of a structural product is allowed only in case the emitter of a structural product incurs the obligation to give an estimation of market cost (price Bid) last working day of each month.

48.4 The maturity of structural product of should not be longer than 15 years.

48.5 The restrictions applied to structural products, are not distributed on MBS, ABS and the structural notes emitted by agencies, the international financial organizations and banks with long-term credit rating ААА.

49. Market value of a portfolio of absolute return should not exceed 5 % from market value of the Investment portfolio on the date of purchase / transfer of assets in a portfolio of absolute return.

50. The maximal market value of a portfolio of absolute return should not exceed 10 % from market value of the Investment portfolio.

51. The maximal deviations by types of instruments on the date of purchase / transfer in a portfolio of absolute return are defined in the appendix 4.

Chapter 7. Parameters of gold portfolio

52. The gold portfolio consists of internal (located at the Gold Depository - the branch of the National Bank of Kazakhstan) and external gold (placed outside Republic of Kazakhstan).

53. The objective of Gold portfolio is safe keeping and protection from probable decreasing of attractiveness of currency assets in the world financial markets. The outperformance is not an objective of Gold portfolio.

54. The volume of external Gold portfolio should be around 1,500,000 OZS. The deviation +/-10% of the volume of external Gold portfolio (including derivatives) is permitted

55. Maximum duration of gold deposit should not be longer than 1 (one) year. Maximum duration of gold asset guaranteed deposit should not be longer than 5 (five) years, only the instruments allowed for investing under this Guidelines can be used as a guarantee.

56. Operations with physical delivery of gold from the Republic of Kazakhstan (the change in proportion of internal and external gold) should be done in accordance with the relevant resolution of the Governor of the National Bank.

57. In case of purchase of gold in the internal market with crediting it to the Gold Depository, the gold is related to the positions of the internal gold of the National Bank, in case of credit of gold to the accounts opened abroad, then it should be related to the positions of external gold of the National Bank.

58. Up to 25% of external gold volume could be invested in securities denominated in gold with long-term credit rating not lower than AAA and maturity not longer than 10 (ten) years.

Chapter 8. A limit on external management

59. The assets given for the external asset management should be included in one of the portfolios of gold and foreign exchange reserves. Transfer of the assets for external asset management should be done in compliance with the terms of the legal regulatory acts of the National Bank of Kazakhstan, which regulate procedure and terms of transfer of the gold and foreign exchange assets of the National Bank of the Republic of Kazakhstan for the external asset management (Asset Management).

Chapter 9. Credit risk limits

60. The National Bank carries out operations with counter-partners list of which is defined by National Bank. Maximum amounts of limit for non-collateralized obligations and limit on the volume of particular type of operation carried out with the counterparty must be set in accordance with the Instruction the normative legal act regulating the order of management by credit risk on operations with counter-partners and custodians of National Bank.

61. The National Bank should bring limits on counterparties to conformity with restrictions set in accordance with the Instruction within two business days or on the next business day after the close of the term deals, except of the cases connected to delays in finalizing of settlements with regard to the existing deals, which caused by the guilt of the counterparties. In case of decrease of long-term credit rating assigned to government and corporate securities, and credit rating of counterparties with regard to the existing deals with derivative instruments lower then level, defined in paragraph 6 of this Guidelines, then within 6 (six) months from the date of such rating decrease the National Bank should take actions in order to bring such positions and deals to conformity with requirements of this Guidelines.

Chapter 10. Reports

62. Department of Monetary Operation should provide the following reports on the gold and foreign exchange reserve’s management:

1) To the interested divisions of National Bank:

Market value of the gold and foreign exchange reserves with regard to the each portfolio by currencies with indication of duration and yields of portfolios;

Indicators of variability for yield’s volatility (tracking errors), duration, position on the yield curve, sector allocation and allocation by currencies of the long-term portfolio in comparison to the benchmark;

2) on a quarterly base until 30th day of the month which follows after reporting month – to the top management of the National Bank and, if necessary, to the relevant divisions of the National Bank:

Report on conformity of parameters of gold and foreign exchange reserves’ portfolios to the restrictions of this Guidelines and breach during reporting month;

Indicators of duration, placement of yield curve, sector allocation and allocation by currencies of the long-term portfolio including internal and external gold and foreign exchange reserves management in comparison to the benchmark;

Yields of the investment portfolio, benchmark portfolio and extra yields for the reported month;

Report on situation on the financial markets and its influence on gold and foreign exchange reserves portfolios, economical review;

Investment tactic review and explanation of the most important changes in the structure of gold and foreign exchange reserves portfolio.

Appendix 1

to the Investment Guidelines

of Management of Foreign Exchange Reserves

of the National Bank of the Republic of Kazakhstan

Table 1

Basket of currencies

Type of assets	Share in basket
USD	45%
EUR	30%
GBP	10%
JPY	10%
AUD	5%

Table 2.

Maximum deviations in currency

Type of assets	deviation
USD	+/- 10 %
EUR	+/- 10 %
GBP	+/- 5 %
JPY	+/- 5 %
AUD	+/- 5 %

Appendix 2

to the Investment Guidelines

of Management of Foreign Exchange Reserves

of the National Bank of the Republic of Kazakhstan

Table 1

Sector distribution of an investment portfolio

Type of assets	Market value (for derivatives, market value of underlying assets)
Минимум	Максимум
Governments (sovereigns) and agencies of countries included in the Benchmark, supranational, cash	70%	100%
Governments (sovereigns) of countries not included in the Benchmark, Corporates, commercial papers (CP).	0%	30%
Deposits, including assets from REPO operations invested in deposits	0%	30%
Derivatives (limited by Tracking Error)	0%	50%
MBS and ABS	0%	30%

Table 2

Allowable volumes by types of derivative instruments in

Investment portfolio

Type of derivatives	Market value (for derivatives, market value of underlying instruments)
Минимум	Максимум
Forwards	0%	100%
Purchase/Sale of Futures	0%	100%
FRA	0%	100%
SWAPs	0%	50%
Option Purchase	0%	50%
Option Sale	0%	20%
Other Derivatives	0%	20%

Appendix 3

to the Investment Guidelines

of Management of Foreign Exchange Reserves

of the National Bank of the Republic of Kazakhstan

Table 1

Maximum deviations in the investment portfolio in each currency for Corporates rated AA-(S&P)/Aa3 (Moody's) and below.

Type of assets	Market value
Minimum	Maximum
Corporates rated from ВВВ/Baa to BBB+/Baa1 (including)	0%	2%
Corporates rated from А-/А3 to А/А2 (including)	0%	4%
Corporates rated from А+/А1 to АА-/Аа3 (including)	0%	6%

Table 2

Maximum deviations in the investment portfolio in each currency for governments rated AA-(S&P)/Aa3 (Moody's) and below

Type of assets	Market value
Minimum	Maximum
Governments rated from ВВВ/Baa to BBB+/Baa1 (including)	0%	3%
Governments rated from А-/А3 to А/А2 (including)	0%	6%
Governments rated from А+/А1 to АА-/Аа3 (including)	0%	9%

Appendix 4

to the Investment Guidelines

of Management of Foreign Exchange Reserves

of the National Bank of the Republic of Kazakhstan

The maximal deviations by types of instruments on the date of purchase / transfer in a portfolio of absolute return.

Type of instruments	Market value
Minimum	Maximum
Instruments allowed for the Investment portfolio	0%	100%
Fund of Hedge Funds.	0%	100%
Structural products.	0%	100%
Stocks	0%	100%
Other types of alternative instruments	0%	40%