This chapter provides an overview of FMO's risk governance and risk management approach. The sections describe the key risk domains that FMO faces in accordance with applicable disclosure requirements and developments throughout 2018. Together with the quantitative Pillar 3 disclosures - available on FMO's website - it constitutes FMO's Pillar 3 disclosure.
FMO has a comprehensive risk management framework in place reflecting its banking license, state guarantee and a mandate to do business in high-risk countries. The purpose of FMO’s risk management framework is to support the institution’s ambitions while safeguarding its long-term sustainability. Risk management practices are integrated across the institution, from day-to-day activities to strategic planning, to ensure both compliance with relevant regulations and adherence with internal risk appetite. A sound risk management framework is required to preserve the institution’s integrity, which is essential for delivering the mission. Hence, FMO aims to uphold its reputation and that of the banking sector. To accomplish this goal, employees are expected to fulfill their roles within the bank with integrity and care, and carefully consider the interests of all stakeholders.
The risk-based roles and responsibilities are organized in adherence to the “three lines of defense” principle, with the role of the first line of defense (e.g. Front Office) being balanced by the second line of defense (Risk Management), and the third line (Internal Audit) to perform independent assessments as to whether processes are sufficiently controlled. FMO has a two-tier board structure consisting of a Supervisory Board and a Management Board.
The Supervisory Board (SB) appoints the members of the Management Board and supervises its activities. The SB advises the Management Board and approves the annual budget, the strategic development and the risk appetite in which the Management Board operates. Each Supervisory Board member has specific expertise in FMO’s primary areas of operation. These members are appointed in the Annual Meeting of Shareholders.
The Management Board (MB) develops and implements FMO’s strategy and is responsible for the daily management of the bank. The MB is also responsible for ensuring compliance with relevant legislation and regulations. It comprises three statutory directors: the Chief Executive Officer (CEO), the Chief Investment Officer (CIO), and the Chief Risk and Finance Officer (CRFO).
The MB has established several committees that are responsible for decision-making on certain subjects and for advising the MB on risk related topics. The most relevant risk committees for 2018 are shown in the figure and described below.
The Asset and Liability Committee (ALCO). The ALCO assists the MB by evaluating, monitoring and steering the financial risk profile of FMO in accordance with the risk appetite as approved by the SB. The ALCO approves, monitors and evaluates policies, limits and procedures to manage the financial risk profile of FMO on a portfolio level, except for credit and equity risk related policies. The ALCO is responsible for overseeing FMO’s capital and liquidity positions and defining possible interventions. The CRFO (Chair), Director Risk, Director Treasury, Director Credit, Legal & Special Operations (CLS) and two Directors from Front Office are voting members of the ALCO.
The Financial Regulation Committee (FRC). The FRC ensures that FMO adheres to existing financial and prudential regulation and assesses the impact of financial and prudential regulations on FMO’s business strategy. The FRC for financial regulation is chaired by the Director Treasury, while the FRC for prudential regulation is chaired by the Director Risk. Members of the committees are senior representatives of Finance, Treasury and Risk & Compliance. In terms of governance, the FRC is a sub-committee of the ALCO.
The Operational Risk Committee (ORC). The ORC is mandated by the MB to evaluate, monitor and steer the operational risk profile of FMO in accordance with the risk appetite. The ORC approves policies and supporting standards and takes decisions in the context of the Product Approval and Review Process (PARP). The Committee is effective as of January 2018 and chaired by the CRFO.
The Investment Committee (IC). The IC is responsible for approving financing proposals and advising MB on transactions in terms of specific counterparty, product as well as country risk. The IC is chaired by the Director CLS and consists of senior representatives of Front Office and CRFO departments. 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. Credit has also the authority to approve new transactions with small exposures.
The Investment Review Committee (IRC). The IRC is responsible for monitoring the portfolio asset quality and for reviewing financial exposures, which require specific attention, and decide on the following actions. If the IRC concludes that a client has difficulties in complying with the contractual obligations, it is transferred to the Special Operations department, which is responsible for the management of distressed assets. The IRC also decides on specific loan impairments, approves credit risk and concentration risk policies and is responsible for internal credit rating models. It is chaired by the CRFO.
The Compliance Committee (CC). The CC is delegated by the MB to take decisions on compliance related matters and compliance issues based on proposed solutions. The CC is chaired by the CRFO and meets at least four times per year. If it is required, the CC can escalate decisions to the MB. CC topics include compliance developments, compliance related projects, laws and regulations, compliance policies and procedures.
The Project Portfolio Committee (PPC). The PPC approves new cross-departmental projects and prioritizes running cross-departmental projects. As of 2019, this committee will no longer be active. Monitoring of and decisions on major projects will be the direct responsibility of the MB.
The Issue Management Committee (IMC). The IMC was officially established in 2018. It convenes on a regular basis and takes decisions on FMO’s responses to issues and reputational risks. It is chaired by the CEO.
Our external auditor identified the below Key Audit Matters. These are addressed in the respective risk management paragraphs.
IFRS 9 adoption and impairments of loans to the private sector
Valuation of Equity investments
Reliability and continuity of the information technology and systems
Measurement of impact and footprint data, methodology and reporting
Risk appetite and taxonomy
The Risk Appetite Framework (RAF) sets out the overall approach, including policies, processes, controls, and systems through which risk appetite is established, communicated, and monitored. It includes a risk appetite statement, risk limits, and an outline of the roles and responsibilities of those overseeing the implementation and monitoring of the RAF. FMO’s risk appetite articulates the type and quantum of risk that the bank is able and willing to accept in pursuit of its strategy. FMO was established to take the risks that are required or necessary to make debt and equity investments in the private sector in emerging markets. Therefore, FMO needs a risk appetite that supports a stable organization that can continue realizing development impact in the long run.
The RAF is reviewed by the Management Board and approved by the Supervisory Board on an annual basis. If necessary, it can be revised on a semi-annual basis, particularly in case of material developments or a change in the strategic goals. The maintenance and update of this document is the responsibility of Risk Management.
The risk appetite is subsequently translated into different risk domains, setting out how much of that risk FMO is willing to take to maintain this risk appetite. The figure below shows the risk domains in line with FMO’s risk taxonomy.
The only risks that FMO actively pursues are credit risk and equity risk resulting from loans to and investments in private institutions in emerging markets. Other risks cannot always be avoided, but FMO mitigates these risks as much as possible. The risk appetite, governance, and monitoring metrics for each risk domain are described in more detail in the sections below.
In 2019, FMO will extend its risk taxonomy and RAF to accommodate new risk types identified such as model risk, business model risk and impact risk. Regarding impact risk, the section below introduces FMO's current approach and limitations in reporting impact results as per 2018. For more details on the impact model and related limitations, please refer to the chapter "FMO impact model" of the Annual Report.
FMO uses an impact model to measure its expected impact of investments in line with the SDGs. Under FMO’s Corporate Strategy towards 2025, these goals match FMO’s capabilities to foster economic growth, support decent jobs and combat climate change. They also align with FMO’s ability to stimulate gender equality and inclusive development, and to reduce inequalities between countries by working in the Least Developed Countries. FMO reports on three SDGs across all our focus sectors: Decent work and Economic growth (SDG 8), Reduced inequalities (SDG 10) and Climate action (SDG 13).
As for any other model, there are limitations in the current practice of monitoring and reporting impact. For instance, FMO currently reports on ex-ante estimates while realized impact (ex-post) on the ground can differ from ex-ante expectations. Furthermore, despite progresses have been made to date towards a more universally shared method of reporting on impact, no unique market methodology and taxonomy in this field is present yet. Misrepresenting impact results may affect FMO’s strategy, reputation, financial performance (such as the sustainable bond funding framework) and relations with relevant stakeholders.
In 2018, a dedicated department has been established to strengthen FMO’s monitoring and reporting on impact contribution.
Pillar 3 disclosure
FMO publishes the required Pillar 3 disclosures on an annual basis in conjunction with the publication of the Annual Report. Together, these documents fulfil the Pillar 3 disclosure requirements of the CRD IV regulation.
Market discipline and transparency in the publication of solvency risks are important elements of the Basel III rules for Pillar 3. Central to these publications is information on the solvency and the risk profile of a bank, providing disclosures on such matters as its capital structure, capital adequacy, risk management, and risk measurement, in line with the objective of IFRS 9. The objective of FMO’s disclosure policies is to ensure maximum transparency in a practical manner.
The consolidation scope for prudential reporting is equal to the accounting scope for FMO. As per 30 June 2016, FMO was granted the Solo Waiver for prudential reporting on the basis of Article 7 and therefore only reports figures related to CRR on a consolidated basis.