3 Risk developments

For a detailed overview of FMO’s risk governance and risk management approach please refer to the section "Risk Management" in FMO’s consolidated annual accounts as of 31 December 2020. The risk developments in the first half year of 2021 are disclosed below.

The ongoing COVID – 19 pandemic continued to affect FMO’s markets and clients in 2021, with signs of economic recovery appearing in some markets. FMO continued to monitor the impact on its portfolio and other risk types, which remains limited.

3.1 Capital adequacy

FMO complies with the CRR/CRD requirements and reports its capital ratios to the Dutch Central Bank on a quarterly basis. FMO calculates the capital requirement for its entire portfolio based on the standardized approach. At the end of June 2021, the Total Capital ratio amounted to 25.0%.

The increase of the total capital ratio is mainly a result of a decrease in risk weighted assets, caused by repayments of loans and lower market values for the derivatives.

FMO’s capital ratio remains above the combined ratio of the SREP minimum and FMO’s internal requirements.

• 1 _{Following specific provisions in the CRR, FMO is required to deduct from its regulatory capital significant and insignificant stakes for subordinated loans and (in)direct holdings of financial sector entities above certain thresholds. These thresholds correspond to approximately 10% of regulatory capital. Exposures below the 10% thresholds are risk- weighted accordingly.}

3.2 Credit risk

While the COVID – 19 pandemic had a severe impact on economic activities 2020, there are signs of economic recovery in 2021. In the April 2021 report, the IMF estimates the global contraction of the economy to be 3.3% in 2020. For 2021, it expects an economic growth of 6%, although uncertainties and regional differences are expected to remain.

During the first half of 2021, FMO's NPL ratio increased from 9.1% to 9.8%. The increase is caused largely due to NPL's in Myanmar and South Africa. The impact of the COVID – 19 pandemic on FMO's NPL levels remains relatively limited.

In March 2020, in response to the emerging COVID – 19 pandemic, FMO implemented a country crisis override (considered a management overlay) in the rating methodology, to be applied to the entire loan portfolio. Country ratings were considered the best proxy to estimate the increased risk of the individual clients. Risk ratings of a large number of clients were downgraded as FMO temporarily implemented more stringent country caps with respect to client sectors.

During second half of 2020, the overrides were reassessed on basis of most recent information available about individual clients. FMO observed that the initial override was too conservative. Therefore FMO decided to release a part of the management overlay in Q4 2020. Please refer to the Annual Report 2020 for more details. In first half of 2021, recent information for most individual customers was available for FMO. As recent information reflects the effects of the COVID – 19 pandemic in comparison with information available in 2020, FMO decided to remove the country crises override. This resulted in a release of ECL stage 1 and stage 2 allowances of about approximately €11 million. In addition, a significant amount of ECL stage 1 and stage 2 amounts was released arising from large number of prepayments during first half of 2021. 

Past due information related to FMO’s portfolio loans and receivables are presented in the table below. This categorization does not apply to financial assets other than loans, including interest- bearing securities and short-term deposits.

All Interest Bearing Securities (credit quality of AA or higher) and Banks (credit quality of BBB- or higher) are classified as Stage 1. An amount of €42 thousand is calculated for the ECL of both asset classes as per June 30, 2021.

The following table shows the credit quality and the exposure to credit risk of the loans to the private sector at amortized cost and fair value at June 30, 2021.

The following table shows the credit quality and the exposure to credit risk of the financial guarantees on June 30, 2021.

The following table shows the credit quality and the exposure to credit risk of the loan commitments to private sector on June 30, 2021. These represent contracts signed but not disbursed yet. A similar trend is visible for these exposures as loans to the private sector due to phase out of management overlay.

• 1 _{Total financial guarantees represent €123,216 classified as contingent liabilities and €101,963 classified as irrevocable facilities, as per Section 6 Commitments and Contingent Liabilities.}
• 2 _{Loan commitments for which no ECL is calculated (Fair Value loans or expired availability date).}

The following tables shows the changes in loans for the period June 30, 2021. 

• 1 _{Total financial guarantees represent €123,216 classified as contingent liabilities and €101,963 classified as irrevocable facilities, as per Section 6 Commitments and Contingent Liabilities.}

The modelling methodologies, assumptions and inputs applied in determining ECL in the current period are consistent with those applied in the financial year ending December 31, 2020, except for further release of the country caps.

The macroeconomic scenarios’ model was updated following the publication of the new macroeconomic outlook data by the International Monetary Fund (IMF) in April 2021. The updates of the model based on more optimistic GDP forecast, caused new point-in-time adjustments to probability of defaults in the impairment model, leading to a release of €21.28 million in combined stage-1 and stage-2 impairment charge.

• 1 _{Loans to private sector in this table include amounts related to ECL allowances for off balance loan commitments (refer to note 6).}

• 1 _{Loans to private sector in this table include amounts related to ECL allowances for off balance loan commitments (refer to note 6).}

FMO continues to support clients by undertaking several restructuring measures (See table below for forborn exposures). These include granting payment holidays (temporarily forbearing repayment of notional) to clients with short term liquidity needs. Since the start of COVID – 19, existing clients can also apply for loans providing additional liquidity. 

3.3 Equity investment risk

The global effects following the COVID – 19 pandemic in 2020 resulted in a substantial depreciation of FMO's private equity portfolio. At the end of June 2021, this picture has improved significantly as global equity prices partially recovered across sectors and geographies. Moreover, the USD appreciation during the first half of 2021 also had an upward effect on the financial performance of these assets. These two factors have resulted in a profit for these investments. Results from valuations amounted to a gain of €52.8 million (H1 2020: loss of €166.3 million) and FX effect amounted to a gain of 45.4 million (H1 2020: loss of 19.2 million). Moreover, sales and distributions amount to a gain of €4.6 million (H1 2020: loss of €4.0 million). However the gain from valuations has increased during 2021, FMO has received less dividends as financial institutions around the globe are still restricted to payout dividends. 

3.4 Concentration risk

Concentration risk is the risk that FMO’s exposures are too concentrated within or across different risk categories. Strong diversification within FMO’s emerging market portfolio is ensured through stringent limits on individual counterparties, sectors, countries and regions. To ensure diversification within FMO’s emerging market portfolio across regions, a country limit framework is in place to mitigate concentration risk from the perspective of the portfolio as a whole. Country limits range from 8% to 22% of FMO’s shareholders’ equity, depending on the country rating, where FMO sets higher limits in less risky countries. Sector limits are in place, with a limit equal to 50% of the country limit for each sector in any given country.

During the first half of 2021, country risk in FMO’s markets has generally stabilized compared to 2020, with few rating changes. The most noteworthy downgrades during this period were in Ethiopia, Kenya and Tunisia. Due to the downgrades of these African countries also the regional rating for Africa was reduced by one notch. In general, the economic outlooks for FMO’s markets are positive compared to the strong observed contraction in 2020. Economic recovery is projected in 2021 for nearly all important markets. In this regard the outlook for Myanmar forms an exception, whereby the military coup has prompted a mass civil disobedience movement. The unstable situation in the country leads to an expected contraction of -8.9% of the economy (IMF WEO April 2021) and the situation is closely monitored by FMO.

3.5 Market risk - Currency Risk

FMO continued the limited appetite for currency risk in 2021. Exposures are hedged through matching currency characteristics of assets with liabilities, or through derivative transactions such as cross-currency swaps and FX forwards conducted with either commercial parties or with The Currency Exchange Fund (TCX Fund N.V.). Most currency exposures are hedged to US dollars on a micro-hedge basis, whereby the US dollar position is managed on a portfolio basis accordingly. FMO does not take any active positions in any currency for purpose of making a profit. Each individual currency is managed within a strict position limit and an overall appetite level is set at 1% of shareholder’s equity for the total open position across all currencies. Individual exposures and total open currency positions were within risk appetite in 2021. FMO maintains a deliberately unhedged foreign currency position which stems from the private equity investments and which serves the purpose of a structural hedge for our capital ratio.

3.6 Compliance risk

Following a DNB onsite inspection in 2018, DNB identified several shortcomings in the way FMO conducts Customer Due Diligence/Know Your Customer. As FMO sees this as an area where the risk of non-compliance with Wwft and Sanctions Law is present, a FEC Enhancement program (FEC EP) was set up to demonstrate full compliance by the end of 2021. In 2019 FMO started with execution of the FEC EP which consisted of, amongst others, conducting the Systematic Integrity Risk Assessment (SIRA), the Risk Appetite Statement on Integrity, which was updated to include Tax Integrity Risk as well, and enhancing the CDD-AML Policy, CDD-AML Manual and a wide range of guidance notes. It became clear in September 2020 that the progress of the FEC Enhancement program was not fast enough. The updated FEC Framework has meanwhile been implemented. Part of the FEC EP consists of remediation of the customer KYC files and bringing them in line with the updated framework. The remediation of customer KYC files continues in 2021 and progress is closely monitored by the Management Board. As agreed with DNB, the project is to be finalized on December 31, 2021.

3.7 Regulatory risk

During the unprecedented COVID – 19 pandemic in 2020, regulators implemented a set of supervisory relief measures with the aim to alleviate the operational burden for banks and to support lending. Therefore supervisors have temporarily allowed banks to operate below certain capital buffers (CCB and P2G), which is a measure that was still in place when writing this report.

Despite the high priority level of the COVID – 19 pandemic, European supervisors and legislators remain committed to further advancing the management and disclosure of climate-related and environmental risks. On 27 November 2020 the ECB published a final Guide on climate-related and environmental risks, which lays down the supervisory expectation on how these risks should be managed and disclosed under prudential rules. The guide focuses on how climate change can translate into financial risks for the financial sector. In early 2021 a project was started with the aim to embed the management of climate-related risks within FMO’s risk management framework, disclosures and strategy over the coming 2-3 years.