Financial Risk

Investment risk

Investment risk is defined as the risk that actual investment returns will be lower than expected returns, and includes credit, equity, concentration and counterparty credit risks.

Credit risk

Definition

Credit risk is defined as the risk that the bank will suffer an economic loss because a customer fails to meet its obligations in accordance with agreed terms.

Risk appetite and governance

For FMO’s emerging market loan portfolio, adverse changes in credit quality can occur due to specific customer and product risk, or risks relating to the country in which the customer conducts its business. The main source of credit risk arises from investments in emerging markets and off-balance instruments such as loan commitments and guarantees.

Credit Risk management is very important at FMO, both in the context of project selection and project monitoring. In this process, a set of investment criteria per sector and product is used that reflects minimum standards for the required financial strength of FMO’s customers. This is further supported by credit risk models that are used for risk quantification, calculations of expected credit loss allowance, and the determination of economic capital use per transaction. Funding decisions depend on the risk profile of the customer and financing instrument. For credit monitoring, FMO’s customer are subject to annual reviews at a minimum. FMO also monitors customers that are identified due to financial difficulties through a quarterly Watch List process to proactively manage loans before they become non-performing. For distressed assets, the Special Operations department actively manages workout and restructuring.

FMO has set internal appetite levels for non-performing loans and specific impairments on loans. If any of the metrics exceed the appetite levels, Credit will assess the underlying movements and analyze trends per sector, geography and any other parameter. Credit will also consider market developments and peer group benchmarks. Based on the analysis, Credit will propose mitigating measures to the IRC. If any of the indicators deteriorate further, Risk Management will be involved to assess to what extent the trend is threatening FMO’s capital and liquidity ratios.

Developments

FMO has embarked on an overhaul of its credit risk policy and processes. The objective is to implement a more aligned and effective portfolio management framework across the organization. Implementation has started in 2021 via the Investment Risk Project, which will continue further in 2022. 

In the first half of 2020, a management overlay ('country crisis override') was introduced to reflect the impact of significant increases in credit risk on certain exposures of the loan portfolio, as a result of COVID-19. The overlay was derived by changing the country cap applied when assessing the customer's credit rating as a part of calculating the expected credit losses (‘ECL’). The overall impact of the country crisis overrides in the financial results for the year ending December 2020 was an increase in impairments of EUR 34 million. During 2021, FMO continued to substitute credit ratings previously overwritten as a part of the country crisis override as new relevant information became available. Updated information is available for most customers as of this reporting date, thereby negating the need for manually overwritten customer ratings. Therefore, the overlay has been removed in 2021.

Exposures and credit scoring

The following table shows FMO's total gross exposure to credit risk per year-end. The exposures, including derivatives, are shown gross, before impairments and the effect of mitigation using third-party guarantees, master netting, or collateral agreements. Regarding derivative financial instruments, only the ones with positive market values are presented. The maximum exposure to credit risk decreased during the year to €8.09 billion as of year-end 2021 (2020: €8.20 billion).
There was an increase in short term deposits at the Dutch Central Bank accompanied by a slight increase of 4 million in FMO’s credit exposure from loans to the private sector in emerging markets, which stayed at €5.09 billion.

• 1 The lower the credit rating, the higher the F-rating in FMO’s terminology and the worse the creditworthiness of the clients, and vice versa.
• 2 In this example, the final rating considering the country cap cannot be more than three notches better than the country rating.

In measuring the credit risk of the emerging market portfolio at customer level, the main parameters used are the credit quality of the counterparties and the expected recovery ratio in case of defaults. Credit quality is measured by scoring customers on various financial and key performance indicators. FMO has a Customer Risk Rating (CRR) methodology. The model follows the EBA guidelines regarding the appropriate treatment of a Low Default Portfolio and uses an alternative for statistical validation to perform the risk assessment of the models when there is limited or no default data.

The CRR models are based on quantitative and qualitative factors and are different for respective customer types. The models for Banks and Non-Banking Financial Institutions (NBFIs) use factors including the financial strength of the customer, franchise value, and the market and regulatory environment. The model for Corporates uses factors including financial ratios, governance, and strategy. The Project Finance model uses factors focusing on the transaction characteristics, market conditions, political and legal environment, and financial strength of the borrower.

Based on these scores, FMO assigns ratings to each customer on an internal scale from F1 (lowest risk) to F20 (default) representing the Probability of Default. This rating system is equivalent to the credit quality rating scale applied by Moody's and S&P. Likewise, the Loss Given Default is assigned by scoring various dimensions of the product specific risk and incorporating customer characteristics. The probability of default and loss given default scores are also used as parameters in the IFRS9 expected credit loss model. Please refer to the section 'Significant accounting policies', for further details on the Expected Credit Loss (ECL) calculation methodology.

The majority of our gross loan portfolio (77%) remains in the F11 to F16 ratings categories. 

Credit quality analysis

Apart from on-balance finance activities, FMO is also exposed to off-balance credit-related commitments. Guarantees, which represent contingent liabilities to make payments if a customer cannot meet its obligations to third parties, carry similar credit risks as loans. Most of the guarantees are quoted in US Dollars. Guarantees on export facilities are collateralized by the underlying letters of credit, and therefore carry less credit risk than direct uncollateralized borrowing. The following table shows the credit quality and the exposure to credit risk of the financial guarantees for the period.

• 1 Financial guarantees represent €69,341 classified as contingent liabilities and €136,450 classified as irrevocable facilities as per Note 'Irrevocable and contingent liabilities'

• 1 Financial guarantees represent €66,099 classified as contingent liabilities and €340,451 classified as irrevocable facilities as per Note 'Irrevocable and contingent liabilities'

Additionally, irrevocable facilities represent commitments to extend finance to customers and consist of contracts signed but not disbursed yet which are usually not immediately and fully drawn.

The following table shows the credit quality and the exposure to credit risk of the loan commitments which are part of the irrevocable facilities for the period.

• 1 Loan commitments for which no ECL is calculated (Fair Value loans or expired availability date).

Non-Performing Loans

Non-Performing Loans (NPL) are defined when any of the following occur: 

• When FMO judges that the customer is "unlikely to pay" its credit obligation to FMO and IRC decides on a specific impairment on a loan (Stage 3);

• Loans with interest, principal or fee payments that are past due for more than 90 days (Stage 3);

• One of the loans is classified as non-performing due to criteria mentioned above, all loans of the customer will be identified as non-performing (Stage 3);

• Forborne exposures which are economically performing but are still in probation (curing) period due to Regulatory Standards (Stage 2). Probation period before returning to performing status is one year;

• Additional forbearance measures are applied for forborne performing loans which have exited the NPL probation (Stage 2);

• Performing forborne loans which have exited the NPL probation period have past due amounts for more than 30 days (Stage 2).

As of 31 December 2021, FMO’s NPLs amounted to €483 million (2020: €464 million) or 9.5% as a percentage of FMO’s Loan Portfolio (2020: 9.1%)

NPLs remain concentrated in a few large facilities. Top three NPLs are 18% of the total, top ten are 45%. As a result, a limited number of large new NPLs result in large movements in the NPL percentage. In terms of sector, in absolute terms, NPLs are highest in Energy, at €181 million, followed by other sectors (€178 million), AFW (€77 million) and FI (€47 million). In relative terms (as percentage of the exposure in that sector) NPLs remain highest in other sectors, at 37%, followed by Energy (13%), AFW (9%) and FI (2%). FMO stopped providing Loans to other sector customers in 2017. NPLs excluding other sectors are 6.6%.

Geographically, NPLs remain highest in India. In response to the high NPL levels in India, FMO tightened the investment process for new loans in this country from 2017 onwards. Although India’s part of NPLs decreased from 27% as of 31 December 2018 to 20% as of 31 December 2021, it is deemed too early to conclude whether this will result in improved performance in India, considering the lead times between approval, signing and defaults. In 2021 NPLs increased in Myanmar to 10% of total NPLs (2020: 0%). The latter was due to deterioration of the country’s risk profile. NPLs also increased in Uganda, to 9% of total NPLs (2020: 0%), due to two Energy projects becoming non-performing. NPLs decreased in Argentina to 7% (2020: 17%) of FMO’s total NPLs, as a result of a write-off and a project becoming performing again. NPL levels in FMO’s portfolio partially reflect long recovery periods, which are inherent in markets where FMO operates.

Past due information related to FMO’s loans portfolio is presented in the tables below.

The table below presents the distribution of Stage 3 loans according to regions and sectors. 

Modified financial assets

Changes in terms and conditions usually include extending the maturity, changing the interest margin and changing the timing of interest payments. When the terms and conditions are modified due to financial difficulties, these loans are qualified as forborne. Refer to paragraph related to 'Modification of financial assets' in Accounting Policies section.

The Credit department reviews modified loans periodically in accordance with the watch-list process. When a loan is deemed no longer collectible, it is written off against the related loss allowance. In 2021, FMO’s write-offs including disposals equaled to €50.2 million (2020: €64.2 million).

The following table provides a summary of FMO’s forborne assets, both classified as performing and non-performing, as of December 31, 2021.

The following table shows the movement of gross outstanding amount and ECL impact of Stage 2 and Stage 3 loans which were modified during 2021. 

The table below includes Stage 2 and Stage 3 assets for which terms and conditions were modified including the related net modification result

Credit risk mitigation

As per December 31, 2021, the total carrying value of the FMO’s loan portfolio is €4.8 billion; of which €1.0 billion is guaranteed by either the Dutch government or highly rated guarantors. The following table shows a breakdown of guarantee amounts received and carrying values of guaranteed loans per credit ranking of the guarantors.

The total carrying value of defaulted (stage 3) loans in FMO’s loan portfolio is €205 million; of which €70 million is guaranteed by either the Dutch government or highly rated guarantors. The following table shows a breakdown of guarantee amounts received and carrying values of guaranteed loans.

Equity risk

Definition

Equity risk is the risk that the fair value of an equity investment decreases. It also includes exit risk, which is the risk that FMO’s stake cannot be sold for a reasonable price and in a sufficiently liquid market.

Risk appetite and governance

FMO has a long-term view on its equity portfolio, usually selling its equity stake within a period of 5 to 10 years. FMO can accommodate an increase in the average holding period of its equity investments and thereby wait for markets to improve again to materialize exits. The equity investment portfolio consists of direct investments, largely in the financial institutions and energy sectors, co-investments with aligned partners (mainly in cooperation with funds) and indirect investments in private equity funds. Equity investments are approved by the Investment Committee. In close cooperation with the Credit and Finance departments, the Private Equity department assesses the valuation of equity investments on a periodic basis which are approved by the IRC. Diversification across geographical area, sector and equity type across the total portfolio is evaluated before new investments are made. Based on this performance and the market circumstances, direct exits are pursued by involving intermediaries. For co-investments our fund managers do initiate the exit process as they are in the lead. Exits are challenging due to limited availability of liquidity differing per market and the absence of well-developed stock markets.

The risk of building an equity portfolio is driven by two factors:

• Negative value adjustments due to currency effects (EUR/USD and USD/Local FX), negative economic developments in emerging markets (EM) and specific investee related issues. This would negatively affect the profitability of FMO.

• Liquidity of the portfolio – in case FMO is not able to liquidate (part) of its maturing equity portfolio by creating sufficient exits for its direct and co- investment portfolio. This is also reflected in the fund portfolio where some fund managers have to hold longer to their portfolio due to the lack of good exit opportunities.

Developments

In 2021, equity market conditions clearly improved from the situation in 2020, when markets were impacted by COVID-19, the US–China trade war, and devaluation of the USD versus the EUR. The strong recovery, combined with the expansion of the money supply, resulted in higher market valuations and increased liquidity. 

FMO could benefit from the situation in which we experienced larger exits and higher-than-expected fund distributions. Another significant trend in 2021 was the remarkable increase in the value of the VC market in emerging markets. FMO benefits from this trend through its Venture Capital program, which we initiated a few years ago.

In 2021 our committed equity portfolio (including associates) increased to €2.8 billion (2020: €2.6 billion) due to an increase in underlying valuations of €225.0 million and FX results of €107.0 million, driven by the strengthening USD. This was partly offset by distributions from funds and direct exits, which returned more money than we paid-in during 2021. The percentage of direct investments versus fund investments dropped from 45% to 43% because we did more fund investments in 2021 and realized several large direct exits. Dividend income amounted to €22.1 million (2020: €32.9 million). We received less dividends in 2021, as banks – which in the past delivered the bulk of dividends – were restricted from paying out dividends in a lot of markets to keep their buffers at a healthy level.

Exposures

The total outstanding equity portfolio at December 31, 2021, amounts to €2.3 billion (2020: €2.0 billion) of which €1.1 billion (2020: €900 million) is invested in investment funds.

The equity portfolio is left unhedged for FX risk. For more information please refer to the sections on Currency risk and Structural Hedge.

Concentration risk

Definition

Concentration risk is the risk that FMO’s exposures are too concentrated within or across different risk categories. Concentration risk may trigger losses large enough to threaten the institution’s health or ability to maintain its core operations or trigger material change in institution’s risk profile.

Risk appetite and governance

Strong diversification within FMO’s emerging market portfolio is ensured through stringent limits on individual counterparties (single and group risk limits), sectors, countries and regions. These limits are monitored by Risk, reviewed regularly and approved by the IRC. Diversification across countries, sector and individual counterparties is a key strategy to safeguard the credit quality of the portfolio.

Developments

Following a 2% contraction in the developing market economy in 2020, 2021 showed clear signs of recovery, with an estimated GDP increase of 6.5 % (IMF WEO Jan 2022). In the coming years, emerging markets are expected to grow at a moderate rate of around 5% in 2022 and 2023. The projections are still clouded by uncertainty about the development and emergence of new covid-19 variants, which could have even more disruptive effects on global supply chains, travel restrictions, and rising energy prices. FMO has been closely monitoring its portfolio throughout 2021 and will continue to do so in the future. Given FMO's diverse exposure across more than 70 markets, it is well positioned to mitigate the negative effects of specific country crises.

Conflict in Ukraine

On Thursday 24th of February 2022, the Russian Federation started to invade Ukraine. The move followed shortly after Russian President Putin recognized two Eastern-Ukrainian provinces as independent states and invaded those areas for a “peacekeeping” mission on the 21st of February. Since then, large-scale missile attacks in Ukrainian cities have been carried out and parts of the country are controlled by Russian troops. The UK, US and EU have imposed sanctions to several individuals and taken actions to restrict the ability of the Russian state and government to access capital and financial markets. Flights from and to Russia are halted. Belarus has also been targeted with sanctions. FMO is deeply concerned with the developments.  

FMO has been active in Ukraine for decades. As per February 2022, FMO’s direct exposure to Ukraine is around EUR 200 million with 14 customers. This exposure is in debt products (56%), equity (37%) and guarantees (7%), within two of the three FMO’s strategic sectors, Energy and Agri Food and Water. Moreover, FMO has indirect exposure in Ukraine through debt funds amounting to 14 million. No direct exposure in the Financial Industry sector is held in Ukraine. FMO has no direct exposure and a limited indirect exposure to Russia. Furthermore, FMO has no cash or derivative contract in Russian Ruble or Ukrainian Hryvnia. The exposure towards Belarus is around 20 million, mostly in equity. A sensitivity analysis has been performed to assess the financial impact on FMO’s liquidity position and capital ratios. This assessment shows that even in a strongly adverse scenario FMO remains widely above all regulatory requirements and internal appetite.

As a response to the crisis and following an agreement to impose an enhanced monitoring regime, FMO has set-up a country crisis working group which includes members of FMO’s investment departments, Credit, the IRC, Risk and Compliance. On the 28th of February, the IRC approved a country rating downgrade from F15 to F18 (from B to CCC), consequently customer ratings have been adjusted accordingly. In line with further developments, this rating may be re-adjusted from time to time. For the time being, FMO has paused new activities in the country. It’s too early to know all the implication of this crisis, FMO is assessing the impact of the developments also for other customers in the region and, where appropriate, impairment assessments will be made.   

Country, regional and sector exposures

Country risk arises from country-specific events that adversely impact FMO’s exposure in a specific country. Within FMO, country risk is broadly defined. It includes all relevant factors that have a common impact on FMO’s portfolio in a country such as economic, banking and currency crises, sovereign defaults and political risk events.

To ensure diversification within FMO’s emerging market portfolio across regions, a country limit framework is in place to minimize 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. The assessment of the country rating (F-rating scoring in line with internal credit risk rating) is based on a benchmark of external rating agencies and other external information.

In determining the limit usage within a country for loans, the committed portfolio amount as well as underlying transaction specific elements - which may lead to effective reduction of country risk - are considered. The figure below provides an overview of the diversification over the countries of FMO’s gross outstanding in the loan portfolio.

In general, the loan portfolio remains well diversified across different countries. The single largest country exposure is under 10% of the total loan book. The three largest country exposures in the loan book at the end of 2021 were India, Turkey, and Argentina, together 19% of the total loan exposure. Throughout 2021, the ratings of these countries did not change throughout the year. Noteworthy changes in country ratings are downgrades of the African region to F16 (2020: F15), Kenya to F15 (2020: F14), Myanmar to F18 (2020: F15) and Sri Lanka to F18 (2020: F14), Côte d’Ivoire upgraded to F13 (2020: F14).

On top of country risk limits, FMO has additional limits in place to ensure adequate diversification across sectors and regions. Below an overview of the gross exposure of loans distributed by region and sector is given.

Single and group risk exposures

Regarding single and group risk exposures, FMO has set stringent internal limits where the maximum loss possible for one single clustomer or group is set as a percentage of FMO’s shareholders’ equity. At year-end, all exposures are well within these limits. These internal single and group risk limits are set to be more stringent than the regulatory limits such as the ones foreseen under the CRR norm of 25% of eligible regulatory capital.

Climate Change risk

FMO defines climate-related risk as the risks posed by direct exposure to climate change, or indirect exposure through counterparties that may potentially be affected by, or contribute to, climate change. These include two strongly interlinked perspectives:

• An inside-out perspective, defined as the impact BY FMO and its customers to climate (which is mainly covered by the ESG risk framework);

• An outside-in perspective, defined as the impact ON FMO due to transition and physical risks, of which:

• • Physical Risk: are the risks arising from the physical effects of climate change, either chronic or acute; 

  • Transition Risk: are the risks arising from the uncertainty related to the timing and speed of the process of adjustment to an environmentally sustainable economy; this can materialize through policy and regulation, technology, market, or behavioral changes.

FMO has initiated project activities to embed climate-related and environmental risks within the organization. The focus initially is on climate risk specifically, based on the “ECB Guide on Climate Related and Environmental Risks”. In the future, also environmental risks will be included in the scope for implementation.

The implementation is based on the development of an integrated and consistent climate risk framework, not only looking at the assessment of FMO’s current portfolio and new investments, but also at how climate risks impact strategy, at creating awareness, organize training, setting up governance through roles, responsibilities and committees and integrating climate risk in risk documentation and disclosure. This will also require a change in the way how climate related risks are considered within FMO’s risk appetite and taxonomy, since climate-related risk is not a separate risk type but an external causal factor of FMO’s existing risk types. For further information regarding the topic, please also refer to the separate Task Force on Climate-related Financial Disclosures (TCFD) report. 

Counterparty credit risk

Definition

Counterparty credit risk in the treasury portfolio is the risk that FMO will suffer economic losses because a counterparty fails to fulfill its financial or other contractual obligations from open positions in the portfolio.

Risk appetite and governance

The main responsibility of FMO’s Treasury department is to fund the core business of FMO and to efficiently and effectively mitigate risks in line with the Treasury’s mandate. The main goal of the treasury portfolio is to maintain a liquidity buffer such that FMO can serve its liquidity needs in both on- going business and in stressed circumstances. FMO’s Treasury department does not have its own trading book and does not actively take open positions in the pursuit of profits. FMO aims to balance between keeping losses within its limited risk tolerance and supporting FMO's business strategy, thereby minimizing credit risk and concentration risk in the treasury portfolio, derivative portfolio, and several bank accounts.

The Treasury department 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.

Developments

There have been developments in the (L)IBOR transition to new benchmark rates affecting the valuations of transactions with all counterparties. Furthermore, the internal limit monitoring framework for exposures to derivatives counterparties got reviewed in 2021. For more details, please refer to the section ‘Interest rate risk in the banking book’. 

Exposures

Counterparty risk exposures in FMO’s treasury portfolios originate from short-term investments (deposits, investment in money market funds, commercial papers (CP's), and collaterals related to transacted derivatives), interest-bearing securities (bonds), and transacted derivatives for hedging purpose. The tables below show outstanding positions as of 31 December.

Supra-nationals are international organizations or unions in which member states delegate part of their national powers to a collective decision-making body.

FMO mitigates its counterparty credit risk through various means. Minimum requirements of credit quality are set for counterparties of treasury activities. Netting and collateral agreements are also utilized to reduce counterparty credit risk originating from derivative transactions. FMO has Credit Support Annexes (CSAs) with all derivative counterparties. Additionally, part of the derivative portfolio, particularly EUR and USD interest rate swaps, is cleared through central counterparties, as required by the European Market Infrastructure Regulations (EMIR).

The exposure of derivative financial instruments is presented for only derivatives with positive market value, if possible, netted with derivatives with a negative market value if it concerns the same counterparty. For this reason, the total amount shown in the table above does not equal the exposure presented in the other tables.

The disclosures as set out in the tables below include financial assets and financial liabilities that:

• are offset in the consolidated balance sheet of FMO; or

• are subject to an enforceable master netting arrangement or similar agreement that covers similar financial instruments, irrespective of whether they are offset in the consolidated balance sheet.

FMO receives and pledges only cash collateral with respect to derivatives.

Liquidity risk

Definition

Liquidity risk is defined as the risk for FMO not being able to fulfill its financial obligations due to insufficient availability of liquid means.

Risk appetite and governance

FMO’s risk appetite is to maintain adequate liquidity buffers to fulfill FMO’s current and future financial obligations. The appetite follows a similar rationale as for capital and it is aimed to maintain enough liquidity to ensure FMO would never need to fall back on the guarantee provided by the Dutch State to our investors. To realize this ambition, minimum liquidity requirements apply as prescribed by the regulator.

FMO’s Liquidity Risk Policy Framework is built on four pillars.

1. Survival period and minimum liquidity buffer under stress

2. Maturity matched funding

3. Diversified funding

4. Regulatory ratio requirements

Based on these four pillars. FMO’s risk appetite levels are defined to ensure a minimum buffer above the 7-months minimum survival period under stress, a liquidity coverage ratio (LCR) to exceed 135%, a Net Stable Funding Ratio (NSFR) to exceed 110%, and restrictions on failed funding periods and cost of wholesale funding above peers. Additional thresholds such as matching funding and liquidity in specific currencies are also in place for managing and monitoring the risk profile of the bank. These monitoring metrics are delegated to Director Risk and Director Treasury and are subject to a formal sign- off procedure and reported to the ALCO. The ALCO is also responsible to approve the Liquidity Risk Policy.

FMO traditionally has a conservative liquidity policy and funding strategy that is well suited to its business. Stress tests are conducted on FMO’s liquidity position on weekly basis to ensure this conservative position is maintained. During the  Internal Liquidity Adequacy Assessment Process (ILAAP), FMO performs additional stress tests including scenarios provided by DNB and includes reverse stress testing. A continuous review is performed on the liquidity position, FMO’s assumptions, internal expectations and external market conditions to ensure that FMO’s liquidity planning is accurate.

The Liquidity Contingency Plan sets out FMO’s strategy for addressing liquidity needs in the case of a crisis, ensuring that various sources of emergency liquidity are available to meet all current and future financial obligations, whilst avoiding excessive funding costs, incurring unacceptable losses and significantly changing the business profile. The liquidity sources include a long-term bond portfolio and a portfolio of short-term instruments such as cash, Money Market Funds, Commercial Paper (CP) and Treasury Bills. The long-term bonds and CP can be used as collateral in repurchase agreements to obtain short-term cash from the Dutch Central Bank or from commercial parties.

Developments

FMO's liquidity position remained comfortably above regulatory requirements and internal managerial limits in 2021, with an LCR never falling below 384 %. The amending Regulation (EU) 2019/876 ('CRR2') went into effect in June 2021, and FMO began reporting its Net Stable Funding Ratio (NSFR) in accordance with the new reporting requirements. FMO's NSFR increased slightly as a result of the new regulation, owing primarily to the new weighting factors in required stable funding. 

In addition, over the past few years, FMO has established a key role in local currency frontier markets and is keen to continue issuances in 2022, fostering capital markets development in line with its mandate. In total, FMO issued approximately US$ 129.0 million of equivalent funding in local currency transactions during 2021.

Liquidity position

Throughout the course of 2021, FMO's liquidity position has been compliant with internal and regulatory metrics.

The following table shows the categorization of the balance sheet per maturity bucket. This table shows the timing of the undiscounted principal cash flows, and not the market values, per instrument. The totals per instrument may therefore differ from the totals on the balance sheet. Expected cash flows resulting from irrevocable facilities being drawn are not included in the liquidity gap. For internal liquidity planning and management, cash flows from irrevocable facilities are included in the cash flow forecasts.

The tables below are based on the final availability date of the contingent liabilities and irrevocable facilities.

• 1 FMO expects that not all of these off-balance items will be drawn before expiration date.

FMO complies with DNB’s Pillar 2 liquidity requirements methodology for Less Significant Institutions (LSIs) which have been applied from the Supervisory Review and Evaluation Process (SREP). The liquidity requirements are a survival period of at least 6 months based on internal stress testing methodology, a Net Stable Funding Ratio (NSFR) of 100% and a specific Liquidity Coverage Ratio (LCR) requirement of 100%. FMO's internal liquidity appetite levels include a safety cushion over and above these minimum requirements as described in the section above.

Following the risk appetite, FMO's liquidity position has been well above regulatory requirements and internal appetite levels throughout 2021. Per reporting date, FMO has a survival period exceeding > 8 years (2020:> 8 years), of LCR 970% (2020: 1116%) and a NSFR of 117% (2020: 127%).

FMO’s major liquidity exposures are in EUR and USD currencies. However, some transactions are denominated – and may be settled – in local currencies. These exposures are specifically hedged using financial instruments to minimize liquidity and settlement risks.

Funding and sustainability bonds

Treasury aims to ensure good market access by diversifying FMO’s funding sources. The result of this is a balanced funding mix in terms of currency, instrument and maturity.

Eurodollar (i.e. USD investors outside the United States) constitute key markets for FMO. Treasury has identified USD and EUR as strategic funding markets. Other markets to attract funding include Australia, Sweden, UK, Japan and local frontier currencies. Typical investors in FMO debentures and notes, either through public or private issuances, hold these instruments till maturity. A final important factor to note about FMO funding, except for our Tier II issuance, is that it is plain vanilla and generally senior unsecured funding. 

ESG bonds are an important part of FMO’s funding strategy, that accounted for about 31% of the funding portfolio in 2021. The FMO Sustainability Bonds Framework was updated in March 2020 and allows us to issue Green Bonds, Social Bonds or Sustainability Bonds to support FMO’s Strategy. 

Market risk

Market Risk is the risk that the value and/or the earnings of the bank decline because of unfavorable market movements. At FMO, this includes interest rate risk and currency risk.

Interest rate risk in the banking book

Definition

Interest rate risk is the risk of potential loss due to adverse movements in interest rates. Changing interest rates mainly influence the fair value of fixed interest balance sheet items and affect the bank’s earnings by altering interest rate-sensitive income and expenses, affecting its net interest income (NII).

Risk appetite and governance

FMO has no trading book and all assets (loans and investments) are part of the banking book. FMO’s policy is to match assets and liabilities within defined limits. As the loan portfolio is more granular, loans are pre-funded and new funding is obtained periodically and matched to the asset portfolio in terms of expected maturity and interest rate sensitivity. Interest rate risk arises from the residual tenor mismatch, mismatch in fixed rate assets funded by floating rate liabilities, and differences in reference rates or currencies resulting in basis risk. FMO has little optionality in its portfolio and has no material exposure to rates-driven prepayment risk. The volatility of the market value of assets and liabilities over the holding period due to interest rate movements is of less concern as these are held until maturity.

Interest rate risk management falls under the responsibility of the ALCO. Treasury department acts as the first line of defense and is responsible for the day-to-day management of interest rate risk and daily transactions. The quantification, monitoring and control of market risk is the responsibility of Risk. Interest rate risk is monitored using earnings-based metrics and value-based metrics.

Earnings-based methods capture short-term effects of interest rate re-fixing or re-pricing that may impact net interest incomes. The metrics below are used for this purpose.

• The interest rate gap provides a static overview of the full balance sheet’s repricing and refinancing characteristics. The gap is monitored over different time buckets where limits are in place both per bucket and on cumulative level, for all currencies (aggregate and currency-by-currency).

• Earnings-at-Risk (EaR) provides a dynamic projection of net interest income sensitivity to yield curve shocks. FMO monitors EaR on a 2-year forward looking basis and applies different scenarios simultaneously that allow for identification of basis risk as well.

Economic value methods capture changes in net present values of assets, liabilities and off-balance sheet items to changes in yield curves. Value-based metrics measure long-term effects of interest rate changes over the full tenor of the balance sheet. The following economic value metrics are calculated:

• Basis Point Value (BPV) provides the change in market value of assets, liabilities and interest-rate risk sensitive off-balance items for a one basis point change in yield curves. Limits are in place for the whole balance sheet, and for main currencies (EUR and USD) separately.

• Equity Value at Risk (EVaR) provides changes in the economic value of the shareholder’s equity given certain shifts in yield curves. The impacts of a 200 basis-points parallel shift and a 200 basis-points gradual shift and SA-IRRRB scenarios are reported.

The interest rate gap and BPV exposure are monitored on weekly basis against limits set by the ALCO. Limits are defined dynamically to accommodate a 200 basis-points shock within 5% of shareholder’s equity. The EVaR limit is defined in the Risk Appetite Framework and set at 5% of shareholder’s equity. The EaR is used for monitoring purposes only and thresholds are defined based on 5% of projected net interest income.

Developments  

After extensive preparations for the (L)IBOR transition to new benchmark rates, the transitions for non-cleared derivatives (cross-currency and interest rate swaps) went as planned: The following transitions occurred in Q4 2021: transition from EONIA to ESTR discounting, transition from FedFunds to SOFR discounting. FMO's interest rate position was not significantly impacted as a result of the transition. The FMO's BMR&IBOR ending project is still closely monitoring the benchmark rate reform and the discontinuation of LIBOR.

Exposures

The limits with respect to interest rate risk were not breached in 2021. The following table summarizes the interest re-pricing characteristics for FMO’s assets and liabilities.

• 1 Fair value of individual components (e.g. individual swap legs) of derivative financial instruments is allocated to the relevant interest re-pricing category.

• 1 Fair value of individual components (e.g. individual swap legs) of derivative financial instruments is allocated to the relevant interest re-pricing category.

Currency risk

Definition

Currency risk is defined as the risk that changes in foreign currency exchange rates have an adverse effect on the value of FMO’s financial position and future cash flows. FMO also reviews currency risk in terms of impact on the capital ratios.

Risk appetite and governance

FMO offers loans and attracts funding in a wide range of currencies. This is done to provide financing in the currency best fitting FMO’s customers and to reduce currency risks on their side.

FMO has limited appetite for currency risk. 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. Both the individual and overall open positions are monitored by Risk on a daily basis. Additionally, FMO maintains a deliberately unhedged foreign currency position for the purpose of structural hedge which is reported to the ALCO monthly. Please refer to the structural hedge sub-section for further details.

Developments

No material developments occurred in 2021.

Exposures

Individual and total open currency positions were within risk appetite in 2021. The table below illustrates that the currency risk sensitivity gap per December 2021 is almost completely part of FMO's equity investments and investments in associates.

• 1 Fair value of individual components (e.g. individual swap legs) of derivative financial instruments is allocated to the relevant currency category.

• 1 Fair value of individual components (e.g. individual swap legs) of derivative financial instruments is allocated to the relevant currency category.

As described above, FMO’s loan assets in local currencies, such as Indian Rupee (INR), are fully swapped to US dollar on a cash flow basis. The positions in these currencies are therefore fully hedged. For IFRS reporting, however, the loans are recorded at (amortized) cost, while the related swaps are recorded at fair value, leading to an accounting mismatch in these currencies.

• 1 The sensitivities employ simplified scenarios. The sensitivity of profit & loss account and shareholders’ equity to possible changes in the main foreign currencies is based on the immediate impact on the financial assets and liabilities held at year-end, including the effect of hedging instruments.
• 2 Shareholders’ equity is sensitive to equity investments valued at fair value through other comprehensive income.

Structural Hedge

FMO maintains a deliberately unhedged foreign currency position in private equity investments for purpose of managing the volatility of the capital ratio. These foreign currency positions act as a hedge against an adverse effect of the exchange rate on the regulatory capital ratios. A depreciation of FMO's reporting currency (Euro) can significantly affect the capital ratio since FMO’s assets - and hence also the risk weighted assets - are mainly denominated in foreign currencies. The long open position in the equity portfolio thereby functions as a partial hedge for FMO’s regulatory capital ratios. In addition, the uncertainty in the size and the timing of the cash flows for equity investments makes micro- hedging less effective, hence these positions are better fit for use as a capital ratio hedge.