Risk Management

Organization of risk management

For FMO, acting in its role as Fund Manager (hereafter ‘FMO’) to be able to carry out the Fund’s strategy, it is essential to have an adequate risk management system in place to identify, measure, monitor and mitigate financial and non-financial risks. IDF (hereafter ‘the Fund’) has a pre-defined risk appetite translated into limits for group, client, country, region and currencies exposures. Limit usages are monitored on a monthly basis and for each proposed transaction.

The Fund Manager reviews each transaction and provides consent to eligible proposals. The Investment Committee, comprising of senior representatives of several departments, reviews financing proposals for new transactions. Each financing proposal is assessed in terms of specific counterparty, product risk as well as country risk. All financing proposals are accompanied by the advice of the Credit department. This department is responsible for credit risk assessment of both new transactions and the existing portfolio. For small exposures, Credit department has the authority to review new transactions.

In addition, financial exposures in emerging markets are subject to a periodic review, which are in general executed annually. Exposures that require specific attention are reviewed by the Investment Review Committee. The larger and higher risk exposures are accompanied by the advice of the Credit department. If the Investment Review Committee concludes that a client has difficulty in meeting its payment obligations, the client is transferred to the Special Operations department – responsible for the management of distressed assets – where it is intensely monitored.

Risk Taxonomy Framework FMO

Risk profile & appetite

The Fund actively seeks to take risk stemming from debt and equity investments in private institutions in developing countries. This risk profile is supported by maintaining prudent levels of capital and liquidity and strong diversification of the portfolio across regions and sectors.

Capital management

The Fund aims to optimize development impact. This can only be achieved with a sound financial framework in place, combining a healthy long-term revolvability of ≥100% and sound capital adequacy. Therefore, FMO seeks to maintain a strong capital position for the Fund. The Fund’s structure is based on a 100% contribution from the Dutch government. Total contribution from the Dutch government is € 354.5 mln at 31 December 2018 (31 December 2017: € 354.5 mln). Total fund capital – which is the sum of the contribution by the government, undistributed results from previous years, results from the current year, grant and evaluation costs – increased to € 332 mln in 2018 (2017: € 326.5 mln).

Reputational risk

The Fund’s investments in developing and emerging markets are exposed to reputational risks such as environmental and social risks and various types of legal risks. The Fund has a limited appetite for reputational risk when such risks would prompt key stakeholders to intervene in the decision making or running of our daily business. Outside of this, the Fund has a moderate appetite for reputational risk, accepting that reputational impacts of activities may incidentally lead to negative press coverage, NGO attention, client feedback, or isolated cases of financial losses, as long as these activities at the outset have a clear expected contribution to FMO’s goal to achieve development impact with the Fund. FMO cannot fully avoid such risks due to the nature of its operations, but chooses to mitigate them as much as possible through strict policies, upfront assessment and, when necessary, through agreements with the Fund’s clients. FMO manages issues from the perspective of learning lessons and prevention. Through transparency and a willingness to respond to challenges made, we aim to remain accountable and reduce our reputational risk.

Financial risk

Investment risk

Credit risk

Credit risk is defined as the risk that the Fund will suffer economic loss because a counterparty cannot fulfill its financial or other contractual obligations arising from a financial contract. Credit risk is the main risk within the Fund and occurs in two areas of its operations: (i) credit risk in investments in emerging markets and off-balance instruments such as loan commitments and guarantees; and (ii) credit risk in the treasury portfolio, only consisting of bank accounts and money market instruments.

Management of credit risk is FMO’s core business, both in the context of project selection and project monitoring of Fund's investments. In this process, a set of investment criteria per sector is used that reflects benchmarks for the required financial strength of the Fund’s clients. This is further supported by internal scorecards that are used for risk classification and the determination of capital use per transaction. As to project monitoring, the Fund’s clients are subject to periodic reviews. Credit policies and guidelines have been formulated covering treasury operations; these are reviewed regularly and approved by the ALCO.

Credit risk in the emerging markets loan portfolio

The Fund offers loans in emerging market countries. Strong diversification within the Fund’s emerging market portfolio is ensured through stringent limits on individual counterparties (single client limit of 10% of the Fund’s capital), countries and sectors (max. 40% of the annually available budget to be invested in one sector, fund or country).

Internal credit approval process

Credit risk from loans in emerging market countries arises from a combination of counterparty risk, country risk and product specific risks. These types of risk are assessed during the credit approval and credit review process and administrated via internal scorecards. The lending process is based on formalized and strict procedures. Decisions on authorizations depend on both the amount of economic capital and the risk profile of the financing instrument. For distressed assets, the Special Operations department applies an advanced workout and restructuring approach.

In measuring the credit risk of the emerging market portfolio at counterparty level, the main parameters are the credit quality of counterparties and the expected recovery ratio in case of defaults. Counterparty credit quality is measured by scoring counterparties on various dimensions of financial strength. Based on these scores, FMO assigns ratings to each counterparty on an internal scale from F1 (lowest risk) to F21 (highest risk), equivalent to a scale from AAA to CCC ratings.

Gross exposure IDF portfolio distributed by internal ratings1

Indicative counterparty credit rating 2018

Gross Exposure

IDF%

FMO-A%

F1 - F10 (BBB- and higher)

-

-

2.6

F11 - F13 (BB-, BB, BB+)

29,793

12.1

45.1

F14 - F16 (B-, B, B+)

83,171

33.7

42.2

F17 and lower (CCC+ and lower ratings)

133,795

54.2

10.1

Total

246,759

100.0

100.0

  • 1 Please note that this does not include the entire portfolio. Equity investments are not rated. In addition, there are some other cases in which it may not be possible to make a rating for a client.

Overall, the distribution of Gross exposure has remained very similar to last year, with only minor changes. Just like last year, IDF has no exposure in the category F1-F10. There has been a slight growth in the category F14-F16 category, whereas exposure in both F11-F13, and F17 and lower has slightly decreased.

Loans past due and value adjustments

At the end of 2018 the value adjustments on loans were € 74.6 mln (2017: € 69.4 mln).

Non-Performing Loans (NPL) are defined as loans with a counterparty-specific value adjustment and/or loans with interest and/or principal payments that are past due 90 days or more. The Fund’s NPL ratio increased from 32.7% (2017) to 37% (2018).

IFRS 9 loans past due and impairments 2018

 

Stage 1

Stage 2

Stage 3

Fair value

Total

Loans not past due

75,527

30,382

11,104

41,534

158,548

Loans past due:

    

-

-Past due up to 30 days

-

4,744

4,365

-

9,109

-Past due 30-60 days

-

-

-

-

-

-Past due 60-90 days

-

-

-

-

-

-Past due more than 90 days

-

-

77,214

5,841

83,054

Subtotal1

75,527

35,126

92,683

47,375

250,711

Less: amortizable fees

-702

-310

-34

-

-1,046

Less: ECL allowance

-2,762

-1,671

-74,551

-

-78,984

Plus FV adjustments

-

-

-

-210

-210

Carrying value

72,062

33,145

18,098

47,165

170,471

      

Non performing loans (loans past due > 90 days + Impaired loans)

92,683

    

NPL percentage

37.0%

    
  • 1 Gross outstanding + accrued interest.

When the terms and conditions of a loan have been modified significantly, the Fund considers these loans as restructured. Changes in terms and conditions usually include extending the maturity, changing the interest margin and changing the timing of interest payments. The loans are assessed to determine if they qualify for de-recognition and if that is the case, they are recognized as a new loan with valuation differences through profit and loss. Value adjustments related to restructured loans are being measured as indicated in the accounting policies under ‘Value adjustments on loans’.

In 2018, there was one write-off on a loan in IDF (Green Resources: € 10.1 mln). 2017: two on loans and one on equity.

Stage 3 value adjustments on loans 2018

      

Customer

Gross

Charge off %

Charge off

Amortized Fees

Net Portfolio

Movement in 2018

Al Manara Water Company Limited

24,692

90%

-22,322

-15

2,355

-3,555

Societe Beninoise De Gaz

27,113

90%

-24,402

-3

2,709

-1,150

Societe Togolaise De Gaz

25,408

90%

-22,867

-16

2,525

-1,078

Green Resources As

-

0%

-

-

-

5,632

Africa Improved Foods (Holding) Bv

1,746

25%

-437

-10

1,331

-437

Africa Improved Foods Rwanda Limited

6,984

25%

-1,746

-39

5,324

-1,746

Rajasthan Sun Technique Energy

11,104

25%

-2,777

-

8,652

-2,777

Grand Total

97,048

77%

-74,551

-83

22,896

-5,110

Equity risk

Regarding equity risk that results from equity investments, a distinction can be made between:

  • Exit risk, the risk that FMO’s equity stake cannot be sold for a reasonable price and in a sufficiently liquid market;

  • Equity risk, the risk that the fair value of an equity investment decreases.

The Fund takes a long-term view of its equity portfolio, aiming to sell its equity stake within a period of five to ten years. The Fund can accommodate an increase in the average holding period of its equity investments and wait for markets to improve again to realize exits. We have no deadlines regarding the exit date of our equity investments. Equity investments are assessed by the Investment Committee in terms of specific obligor as well as country risk. The Investment Review Committee assesses the valuation of the majority of equity investments quarterly. The performance of the equity investments in the portfolio is periodically analyzed during the fair value process. Based on this performance and the market circumstances, exits are pursued in close cooperation with our co-investing partners. The total outstanding equity portfolio on December 31, 2018, amounts to €96.3 mln (2017: €93.2 mln) of which €47.7 mln (2017: €44.6 mln) is invested in investment funds.

Concentration risk

Country risk

Country risk arises from country-specific events that adversely impact the Fund’s exposure in a specific country. Within FMO, country risk is broadly defined. It includes all relevant factors that have a common impact on the Fund’s portfolio in a country such as economic, banking and currency crises, sovereign default and political risk events. The assessment of the country rating is based on a benchmark of external rating agencies and other external information.

In the fund risk appetite, the country risk exposure for IDF is set at a maximum of 40% of the total portfolio.

The level of the country limits depends on the sovereign rating. FMO recognizes that the impact of country risk differs across the financial products it offers. In 2018 the ratings of Benin (8% of the portfolio) is upgraded from F18 in 2017 to F14 in 2018.

Overview country ratings IDF Portfolio

  

Indicative external rating equivalent 2018

IDF (%)

FMO-A (%)

F9 and higher (BBB and higher ratings)

-

5.1

F10 (BBB-)

8.7

7.6

F11 (BB+)

-

-

F12 (BB)

-

3.5

F13 (BB-)

2.8

13.8

F14 (B+)

20.5

30.0

F15 (B)

17.3

14.9

F16 (B-)

14.0

17.1

F17 and lower (CCC+ and lower ratings)

36.7

8.0

Total

100.0

100.0

Single and group risk exposures

In the fund risk appetite the maximum customer exposure for IDF is set at 10% of the total portfolio.

Counterparty credit risk

Credit risk in the treasury portfolio stems from bank account holdings and placements in money market instruments to manage the liquidity in the Fund. The Risk Management department approves each obligor to which the Fund is exposed through its treasury activities and sets a maximum limit for the credit exposure of that obligor. Depending on the obligor’s short and long-term rating, limits are set for the total and long-term exposure. FMO pursues a conservative investment policy.

Liquidity risk

Liquidity risk is the risk that insufficient funds are available to meet financial commitments. The Fund has a conservative liquidity management ensuring sufficient liquidity is available. In case of a liquidity shortfall the Fund can make a funding request to FMO for up to a maximum of 10% of the Fund’s net portfolio.

Market risk

Interest rate risk

Interest rate risk is the risk of potential loss due to adverse movements in interest rates. Changing interest rates mainly have an effect on the fair value of fixed interest balance sheet items. Given the balance sheet and capital structure of the Fund interest rate risks are considered limited.

Currency risk

Currency risk is defined as the risk that changes in foreign currency exchange rates have an adverse effect on the value of the Fund’s financial position and future cash flows. Limits have been set on currency positions and are monitored on a regular basis.

The Fund offers financing in emerging market currencies. We aim to match the currency needs of our clients, thereby reducing their currency risk. On December 31, 2018 36% (2017: 15%) of the committed portfolio was in emerging market currencies. Please note that, contrary to last year, all equity deals are considered local currency given the local exposure.

Non financial risk

Environmental, social and governance risk

The Fund faces environmental and social risks in its emerging market projects. These risks stem from the nature of our projects, which in some cases could carry negative environmental and/or social impacts. The Fund accepts that in the pursuit of development impact there is a risk of negative press and/or negative reactions from NGOs in the context of ESG performance and mitigates this risk through environmental and social action plans and monitoring. The risk appetite for deviations from the exclusion list and human rights violations by projects financed by FMO is zero. Internally, FMO strives to limit the footprint of its own workplace and strives to the highest standards in employee satisfaction. Ensuring a high diversity in staff is a leading Human Resources principle.

Compliance risk

Compliance & integrity means for FMO adhering to relevant integrity laws and regulations, FMO standards and policies and good business practices and acting with integrity. FMO Management is committed to its employees, clients and counterparties adhering to the highest ethical standards.

FMO has a Compliance framework which entails e.g. designing policies, identifying risks, monitoring, training and providing advice. FMO has policies on topics such as know your customer & sanctions, anti-bribery and corruption, conflicts of interest, internal fraud, private investments, privacy and speak up. FMO also regularly trains its employees in order to raise awareness by means of e.g. face-to-face trainings and mandatory compliance related e-learnings. Employees are also encouraged to speak up in case of suspected integrity violations conducted by a FMO employee. Management is periodically, and when required on ad hoc basis, informed on integrity related matters at client or employee level. In case of violations, management will take appropriate actions. In 2018 no significant integrity incidents related to FMO employees have been reported and there were no incidents at existing clients’ outside FMO’s risk appetite.

Operational risk

Operational risk is the risk of loss resulting from inadequate or failed processes, people and systems or loss caused by external events. FMO aims to manage operational risk for the Fund in a cost-effective way. Operational risks – including those related to information security and personal data breaches – are identified, measured and controls are implemented and their effectiveness is monitored. Operational risks are managed and monitored in accordance with a three line of defense governance principle. In the first line of defence business management executes and reviews processes, reports incidents and performs risk and control self- assessments. In the second line of defence monitoring is performed by specialized risk departments and committees. The third line of defence is performed by the Internal Audit function. Although controls are in place, incidents sometimes happen, and damage may occur.

FMO registers and analyses operational risk events and losses systematically. Analysis of these data triggers actions to improve controls.

Operational risks resulting from new products or activities are considered in FMO’s Product Approval and Review Process. FMO monitors the trends of operational risks, including information security risks and where deemed necessary anticipates on the unfavorable effects.

Other risk

Legal risk

Legal risk is defined as the risk that a (term in a) contract entered into by FMO (or an FMO partner) with a client, or a rule or statute in a relevant jurisdiction, relevant for the full implementation of such term or contract, is interpreted, by a court of law, arbiter or otherwise, in such a way as to adversely affect FMO’s position, for instance because a contract is not (fully) enforceable in accordance with its terms, or the structure of the transaction is deemed invalid or illegal.

FMO has a legal department charged with the review of contracts entered into by FMO. Legal risk is mitigated in various ways. Members of the team are qualified in a variety of jurisdictions. Where appropriate, the legal department draws on external expertise, in particular for the legal analysis in the emerging market jurisdictions in which FMO operates. In addition, the legal department manages a library of template documents, which are used to benchmark and standardize transaction documents to the extent possible.