Strategic risk
Environmental, social and governance risks
Definition
ESG risk is defined as the risk that our investments realize adverse impacts on people and the environment, and/or contribute to corporate governance practices, that are inconsistent with FMO policy commitments. FMO is exposed to ESG risk via our investment selection (the risks associated with our investments, which include the investments of our customers/investees) and the effectiveness of customers’/investees’ ESG risk management, including the effectiveness of FMO’s engagement thereon. In addition to potential adverse impacts to people and the environment, ESG risk can for example result in financial (remediation, legal) costs to FMO or the customer, jeopardized access to capital for FMO (external investors), jeopardized license to operate/shareholder relations or reputation damage.
Risk appetite and governance
FMO has a cautious appetite for ESG risk in investments. FMO strives for investments to be brought in line with our ESG risk mitigation requirements within a credible and reasonable period of time. It is understood and accepted that customers/investees need knowledge and resources to implement ESG improvements, so full adherence cannot generally be expected at the start of the relationship. Consequently, the appetite for ESG risk is open during the initial phases of an investment and reduces over time. The appetite for unmitigated ESG risk is minimal for repeat investments. At the portfolio level, FMO also has a cautious appetite for ESG risk. In view of FMO’s own capacity to support and monitor customers/ investees in improving their ESG risk mitigation, FMO seeks a manageable mix of customers/investees with (partially) unmitigated ESG risk and customers/investees with adequate risk mitigation in place.
FMO accepts a limited gap in successful ESG risk management to our standards. This gap acknowledges residual risk posed by contextual and implementation challenges in our markets
As part of its investment process, FMO screens and categorizes all customers on ESG risk according to their gross ESG risk profile (i.e. risk that is inherent to the activity to be financed irrespective of a customer's risk management performance). For a detailed description of our ESG risk management process, refer to the section 'ESRS 2 - IRO management'.
For FMO’s high ESG risk investments and for investments where a FMO Corporate Governance officer is allocated, we monitor our net ESG risk, exposure through FMO’s proprietary Sustainability Information System (SIS); The net ESG risk exposure is the investment’s gross risk exposure corrected for by the customer’s performance managing down these risks. ESG risk performance tracking in SIS is integrated within the investment process and forms the basis of FMO’s ESG target. SIS ratings are monitored and updated throughout the lifetime of the investment as part of the annual review cycle of each customer, enabling FMO to have an up-to-date portfolio-wide view of the ESG risks in its portfolio.
FMO’s ESG target indicates portfolio alignment with our ESG risk appetite. Our ESG target of 90 percent refers to 90 percent of the ESG risks of our high ESG risk portfolio being managed adequately by our customers/investees.
Developments
Similarly, to the 2023 ESG target, the 2024 ESG target group covers high risk customers in our portfolio contracted prior to 2024 (‘target list’) and those supported by a corporate governance specialist. We continue to register the ESG risk assessments of the customers with high risk and report against the ESG target.
Business model risk
Definition
Business model risk is defined as the risk of a non-viable business model or strategy, in line with FMO’s 2024 RAF. For banks in general, long-term viability is achieved when a bank is able to cover all its costs and provide an appropriate return on equity, taking into account its risk profile. For FMO, as impact investor, business model risk is also related to the (in)ability to reach our impact goals.
Risk appetite and governance
FMO’s appetite for business model risk is minimal: both the organization’s continuity and its ability to achieve its impact targets are highly dependent on its ability to generate investments and produce impactful investments in often higher-risk environments and produce sufficient returns from these investments. At the same time, exposure to this risk cannot be entirely avoided, given the nature of FMO’s business model. FMO’s ability to invest is dependent on both demand-and supply-side factors (such as respectively demand for funding, and market liquidity and peers’ activities), not all of which are within FMO’s direct control. On the demand side, this is most notably the demand for funding provided by FMO, which is itself dependent on activity of other DFIs and impact investors as well as commercial market risk appetite. On the supply side, in addition to market liquidity FMO needs to attract public funding and funding from private investors willing to take higher risks. Additionally, the nature of FMO’s investments leads to investment risks. This in turn affects FMO’s ability to generate operating income and impact.
Developments
In 2024, FMO continued to perform in line with the business model risk indicators. FMO reviewed its progress against the Strategy pathway and identified potential business model risks that might undermine the organization’s strategic ambitions towards 2030. On the impact side, we noted the Reducing Inequalities (RI) portfolios were sufficiently on track to achieve the €10 billion ambitions by 2030. This was mainly caused by larger than expected RI-labelled portfolio outflows, shorter tenors of RI portfolio deals and difficulties in sourcing new RI investments with acceptable risk and return profile, especially in LDCs. In LDCs, particularly in the Energy sector, we have seen declining margins due to the increasing availability of concessional funding. At the same time, we noted that the PE portfolio was growing faster and debt portfolio slower than forecast in our 2030 Strategy, with potential negative effects on our Capital position. While our business model risk metrics were above or close to target throughout the year, we still initiated remediating actions to prevent risks from materializing further down the road. These were a) to refocus investment efforts on the Financial Institutions (FI) segment of our operations – with due attention to inclusive business deals to strengthen our RI-labelled portfolio – and b) to temper growth in the PE portfolio. The interventions are incorporated in the 2025 Business Plan and intended to increase investment volumes and returns, rebalance the debt and PE portfolio, and counter the RI-labelled portfolio outflows. LDC investments continue to be a concern due to lack of investable business and lower than expected margins. An LDC action plan has been set up to address internal bottlenecks, while exogenous factors are not fully within our control and an inherent risk to our business model.
Strategy execution risk
Definition
Strategy execution risk is defined as the risk of failed execution of strategic projects, initiatives or decisions. FMO is only willing to take strongly justified project risks. Some uncertainty and variation are expected. We prefer options that are most likely to result in successful delivery while also providing an acceptable level of risk-reward trade-offs, where the potential rewards will clearly contribute to our strategic ambitions and objectives. Example of risks related to projects are lack of experience, resource constraints, project interdependencies and complexity and dependency on external parties.
Risk appetite and governance
FMO’s performance is measured against the YTD realization of agreed deliverables (total overall FMO project portfolio level). Baseline and performance are measured in the PMO model, based on quantified data from project templates/reports. Please note that no weighting is applied for different types of deliverables.
Developments
In 2024, project selections were strongly aligned with FMO’s priorities set out in the annual business plan, as well as driven by regulatory requirements. Due to the high complexity of many projects in the project portfolio as well as human resource constraints, particularly in the data, ICT and operational team, strategy execution carried considerable risks. Mandatory deadlines of regulatory projects required some prioritization and replanning during the year. External staff were recruited to support project delivery. As a result of mitigating actions, more than 85 percent of project deliverables were achieved for the year.