The Partnership Development Facility-PDF (the Fund) aims to optimize development impact by providing early stage capital for projects in the Agri- food, water and climate sectors in DGCF countries. FMO, acting as the Fund Manager, has a risk management system in place to identify, measure, monitor and mitigate financial and non- financial risks. The Fund provides financing in form of development contribution and its capital structure is based on cashflows from FMO-OS. As such, the Fund is not exposed to financial risk. In this respect, FMO’s processes for risk management are used as a starting point and adjusted where necessary.
Total contribution from FOM-OS is € 4,875 at 31 December 2019 (31 December 2018: € 2,575). For the year 2019, the contribution from FOM-OS was € 2,300 (2018: € 2,575). Total fund capital – which is the sum of the contribution by the government, less cumulative distributions, as well as net profits and losses from previous years and from the current year, – was € 833 in 2019 (2018: € 660).
The key aspect for successful operation of the Fund is selection of projects with the potential to be turned into financeable long-term solutions. When investigating investment opportunities, the Fund follows a structured approach consistent with its Investment Criteria. The Fund Manager, together with the Manager of the Project and Partnership Development team, reviews each transaction and provides an initial approval for an eligible project to be taken up on the pipeline and reviews whether the financial proposal is in line with the Fund’s Investment Criteria. The Engagement Committee, comprising of senior representatives of FMO NL Business, reviews and approves the financial proposals for every new transaction and asseses wether the proposal is in accordance with the Fund's investment criteria and startegic composition of the project portfoio. Each financial proposal is furthermore assessed in terms of specific counterparty risk, performance risk, reputational risk, environmental and social risk as well as country risk. All financial proposals are accompanied by the advice of the Fund Manager and the Environmental and Social Officer.
The Fund can co-finance up to 50% of the project costs needed to advance early stage projects. Funding can be used either for analyzing and identifying the needs and potential of a project, assessing the feasibility of a project, pilot testing or supporting the procurement process. Beneficiaries of the Fund can either be Dutch businesses or project sponsors (public or private) in emerging markets. Together with the project developer, FMO NL Business experts engage in different stages of a project, with a focus on the impact and financeability of the project in order to increase the probability of materialization of the project.
Counterparty credit risk
Counterparty credit risk in the treasury portfolio is the risk that the Fund will suffer economic losses because a counterparty fails to fulfill its financial or other contractual obligations from open positions in the portfolio. The Treasury department of FMO is responsible for day-to-day counterparty risk management. Risk is the ‘second line of defense' and responsible for assessing, quantifying, and monitoring counterparty risk daily. Limit excesses and material findings are reported to the ALCO on a monthly basis, together with recommended mitigations and/or actions. The Risk Department is also responsible for updating related policies and processes and for setting up limits, including minimum credit rating requirements, exposure limits, as well as transaction limits. The policies, processes, relevant parameters, and limits are reviewed and approved by the ALCO annually.
FMO mitigates its counterparty credit risk through various means. Minimum requirements of credit quality are set for counterparties of treasury activities. The choice of banks as FMO counterparties is based on the Treasury Counterparty Risk Policy, which requires banks to have a minimum rating of A- and money market funds rating AAA.
Main objective is to manage liquidity and expenditures of the Fund in a way that results in informed decision making about funding requests from the Ministry of Foreign Affairs or FOM-OS to the Fund, and accountability and transparency regarding the cost declared on the Fund.
The Fund is financed by the Returning cash flows of FOM-OS. The FOM-OS portfolio is currently managed and monitored by the FMO-OS Fund Management team. To avoid any conflict of interest, FOM-OS and PDF have separate fund management staff. The Manager Risk Portfolio & Fund Management within FMO NL Business is responsible for the operational process for fund management. The processing of liquidity transfers (applying for funds, repayments) by Accounting and Treasury follows existing FMO procedures, Actual staff costs up to a certain amount are eligible under the Fund. The Manager Risk Portfolio & Fund Mgt within NL Business is responsible for the allocation and justification of staff cost to the Fund. There is a monitoring system in place to warrant the correct staff cost allocation.
To ensure diversification within FMO’s emerging market portfolio across regions, a country limit framework is in place to minimize concentration risk from a total portfolio perspective. The Fund is only eligible to invest in DGGF (Het Dutch Good Growth Fund) countries determined by the Ministry of Foreign Affairs.
Reputation risk is inevitable given the nature of the Fund's operations in developing and emerging markets. FMO has a moderate appetite for reputation risk, accepting that reputational impact of activities may incidentally lead to negative press coverage, NGO attention or undesirable client feedback, as long as these activities clearly contribute to FMO’s mission. FMO actively mitigates the risk as much as possible through strict and clear policies, thorough upfront assessments, consultations with stakeholders, and when necessary, through legal agreements with clients. FMO has in place a Sustainability Policy, as well as statements on human rights, land rights, and gender positions.
Environmental, social and governance risk
Environmental & Social (E&S) risk refers to potential adverse impacts of the Fund’s investments on the environment, employees, communities, or other stakeholders. Corporate Governance (G) risks refers primarily to risk to client business. ESG risks can lead to non-compliance with applicable regulation, NGO and press attention or reputation damage. These risks stem from the nature of the Fund’s projects in difficult markets, where regulations on ESG are less institutionalized.
The Fund has an appetite for managed risk in portfolio, accepting ESG performance below standards when starting to work with a client, with the goal that performance is brought in line with our ESG risk mitigation requirements within a credible and reasonable period. ESG risks are mitigated through environmental and social action plans and monitoring. The risk appetite for deviations from the exclusion list and human rights violations is zero.
Compliance Risk is the risk of failure to comply with laws, regulations, rules, related self-regulatory organization, standards and codes of conduct applicable to FMO. Being a regulated bank, the most important applicable laws in relation to products and customers, are the Dutch Financial Supervision Law (WFT); AML (WWFT); Sanctions Law and General Data Protection Regulation.
Fund’s customers follow FMO’s procedures e.g. customer onboarding; assessment of compliance risks, periodic Know Your Customer (KYC) reviews as well Event Driven KYC Reviews. FMO’s standards and policies and good business practices foster acting with integrity. FMO is committed to its employees, clients and counterparties, adhering to high ethical standards. FMO has a Compliance framework which entails identifying risks, designing policies, monitoring, training and providing advices. FMO has policies on topics such as know your customer (KYC) & sanctions, anti-bribery and corruption, receiving and giving gifts-entertainment & hospitality, conflicts of interest, internal fraud, private investments, outside positions, 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 an FMO employee. Management is periodically informed via the Compliance Committee or when required on an ad-hoc basis, on integrity related matters at client or employee level. In 2019 no significant integrity incidents related to FMO employees have been reported and there were no incidents at existing clients’ outside FMO’s risk appetite.
KYC & Sanctions
FMO’s KYC procedure includes screening of clients on compliance with applicable anti-money laundering, terrorist financing and international sanctions laws and regulations. Due diligence is performed on clients, which includes checks such as verifying the ultimate beneficial owners of the client we finance, identifying politically exposed persons, and screening against mandatory international sanction lists. These checks are also performed regularly during the relationship with existing clients. Following the DNB onsite inspection in 2018, FMO set up a FEC Enhancement Plan (FEC EP) . In 2019 FMO started with execution of the FEC EP which consisted of a.o. conducting the Systematic Integrity Risk Assessment (SIRA) and enhancing the know your customer (KYC) policy and procedures. The updated KYC policy and procedures have been implemented. Part of the FEC EP consists of remediation of the customer KYC files and bringing them in line with the updated policy. FMO has not been able to achieve the interim target on number of remediated customer KYC files. However additional actions, based on lessons learnt, are undertaken to further improve the FEC EP. The progress of the FEC EP is closely monitored by the Management Board and reported to DNB.
It cannot always be prevented that a client is involved or alleged to be involved in illicit acts (e.g. corruption). If such an event occurs, FMO will initiate a dialogue with the client to understand the background in order to be able to assess the severity. When FMO is of the opinion that no improvement by the client will be achieved (e.g. awareness, implementing controls) or the risk to FMO’s reputation is unacceptably high, FMO can invoke legal clauses in the contract to terminate the client relationship.
Operational risk is the risk of loss resulting from inadequate or failed processes, people and systems or loss caused by external events. Operational risks are not actively sought and have no direct material upside in terms of return/income generation, yet operational risk events are inherent in operating a business. Operational risk events can result in non- compliance with applicable (internal and external) standards, financial losses or misstatements in the financial reports, and reputational damage.
FMO has in place an operational risk framework that governs the process of identifying, measuring, monitoring, reporting and mitigating operational risks, based on the ‘three lines of defense’ governance principle. Management of the first line is primarily responsible for managing (embedded) risks in the day-to-day business processes. The first line acts within the risk management framework and supporting guidelines defined by specialized risk departments and committees, the second line of defense. Internal Audit, as the third line, provides independent assurance on the effectiveness of the first and second lines.
In 2019 a Risk Control Self Assessement was initiated by the risk department for FMO NL Business. During this process management and co-workers at all levels assessed and evaluated operational risks areas and their main controls resulting in a risk treatment action plan for the coming year.
FMO is in the process of further strengthening its internal control framework for front-to-end processes. The Business Process Management function and an increase of the level of maturity of internal controls has been established in 2019. The implementation of the Control Testing process is on the agenda for 2020.
Legal risk is defined as the risk of a counterparty (client, supplier, stakeholder or otherwise) not being liable to meet its obligations under law or FMO being liable at law for obligations not intended or expected, caused by lack of awareness or misunderstanding of, ambiguity in, or indifference to the way law and regulation apply to business, relationships, processes, products and services, leading to financial or reputational loss.
Given the specific nature of legal risks that can occur, no risk appetite metrics are assigned to this risk type. Instead, the most relevant developments are included in the risk appetite report on a quarterly basis. FMO’s Legal team is responsible for the review of the legal aspects of Fund’s contracts with its clients and for mitigating legal risks arising from Fund’s businesses and operations. Where applicable, the team seeks external expertise.