Risk management

Organization of risk management

For FMO, acting in its role as Fund Manager (hereafter ‘FMO’) to be able to carry out the Fund’s strategy, it is essential to have an adequate risk management system in place to identify, measure, monitor and mitigate financial risks. AEF (hereafter ‘the Fund’) has a pre-defined risk appetite translated into limits for group, customer, country, region and currencies exposures. Limit usages are monitored on a monthly basis and for each proposed transaction.

The Fund Manager reviews each transaction and provides consent to eligible proposals. The Investment Committee, comprising of senior representatives of several departments, reviews financing proposals for new transactions. Each financing proposal is assessed in terms of specific counterparty, product risk as well as country risk and ESG risk. 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. For small exposures, Credit department has the authority to review new transactions.

In addition, customers are subject to a periodic customer review, which are in general executed annually. Exposures requiring specific attention are reviewed by the Investment Review Committee (IRC). The large and higher risk exposures are accompanied by the advice of the Credit department. If the Investment Review Committee concludes that a customer has difficulty in meeting its payment obligations, the customer is transferred to the Special Operations department – responsible for the management of distressed assets – where it is intensely monitored.

Risk Taxonomy Framework FMO

Risk profile & appetite

The Fund actively seeks to take risk stemming from debt and equity investments in private institutions in developing countries.

Capital management

The Fund aims to optimize development impact. This can only be achieved with a sound financial framework in place, combining a healthy long-term revolvability of ≥75%. The Fund’s is based on a 100% contribution from the Dutch government. Total contribution to AEF from the Dutch government is €135.8 million at 31 December 2021 (31 December 2020: €125.8 million). Total fund capital – which is the sum of the contribution by the government, undistributed results from previous years, results from the current year, development contributions, and evaluations costs – increased to €161 million in 2021 (2020: €136 million).

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

Credit risk is defined as the risk that the Fund will suffer economic loss because a counterparty cannot fulfill its financial or other contractual obligations arising from a financial contract. Credit risk is the main risk within the Fund and occurs in two areas of its operations: (i) credit risk in investments in emerging markets and off-balance instruments such as loan commitments; and (ii) credit risk in the treasury portfolio, only consisting of bank accounts and money market instruments.

Management of credit risk is FMO’s core business, both in the context of project selection and project monitoring. In this process, a set of investment criteria per sector is used that reflects benchmarks for the required financial strength of FMO’s customers. This is further supported by internal scorecards that are used for risk classification and the determination of economic capital use per transaction. As to project monitoring, the Fund’s customers are subject to periodic reviews. Credit policies and guidelines are reviewed regularly and approved by the IRC.

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 has been removed in 2021.

Credit risk in the emerging markets loan portfolio

The Fund offers loans in emerging market countries. Diversification within the Fund’s portfolio is ensured through limits on individual counterparties (single client limit of €10 million), sectors and maximum tenor 20 years in debt transactions.

Internal credit approval process

Credit risk from loans arises from a combination of counterparty risk, country risk and product specific risks. These types of risk are assessed during the credit approval and credit review process and administrated via internal scorecards. The lending process is based on formalized and strict procedures. Decisions on authorizations depend on both the amount of economic capital and the risk profile of the financing instrument. For distressed assets, the Special Operations department applies an advanced workout and restructuring approach.

In measuring the credit risk of the portfolio at counterparty level, the main parameters are the credit quality of counterparties and the expected recovery ratio in case of defaults. Counterparty credit quality is measured by scoring counterparties on various dimensions of financial strength. Based on these scores, FMO assigns ratings to each counterparty on an internal scale from F1 (lowest risk) to F20 (default), equivalent to a scale from AAA to C ratings.

Maximum exposure to credit risk

  
 

2021

2020

On balance

  

Banks

15,847

20,296

Loans to the private sector

64,711

52,474

- of which: Amortized cost

36,777

31,802

- of which: Fair value through profit or loss

27,934

20,672

Current account with FMO

122

85

Other receivables

91

170

Total on-balance

80,771

73,025

   

Off-balance

  

Irrevocable facilities

33,988

21,467

Total off-balance

33,988

21,467

Total credit risk exposure

114,759

94,492

Credit quality analysis

In addition to on balance loans, irrevocable facilities (off-balance) represent commitments to extend finance to clients and consist of contracts signed but not disbursed yet which are usually not immediately and fully drawn.

The following tables provide insights in the credit risk allocation of loan portfolio and loan commitments according to internal ratings.

Loan portfolio at December 31, 2021 Indicative counterparty credit rating scale of S&P

Stage 1

Stage 2

Stage 3

Fair Value

Total

F1-F10 (BBB- and higher)

-

-

-

-

-

F11-F13 (BB-,BB,BB+)

-

-

-

8,130

8,130

F14-F16 (B-,B,B+)

10,553

11,755

-

10,933

33,241

F17 and lower (CCC+ and lower)

-

6,696

7,773

8,871

23,340

Sub-total

10,553

18,451

7,773

27,934

64,711

Less: amortizable fees

-334

-105

-24

-

-463

Less: ECL allowance

-263

-918

-3,102

-

-4,283

Plus: Fair value adjustments

-

-

-

-1,498

-1,498

Carrying value

9,956

17,428

4,647

26,436

58,467

      
      

Loan commitments at December 31, 2021 Indicative counterparty credit rating scale of S&P

Stage 1

Stage 2

Stage 3

Other 1)

Total

F1-F10 (BBB- and higher)

-

-

-

-

-

F11-F13 (BB-,BB,BB+)

-

-

-

4,614

4,614

F14-F16 (B-,B,B+)

18,812

1,556

-

3,923

24,291

F17 and lower (CCC+ and lower)

1,200

261

-

1,758

3,219

Sub-total

20,012

1,817

-

10,295

32,124

Less: ECL allowance

-148

-11

-

-

-159

Carrying value

19,864

1,806

-

10,295

31,965

Loan portfolio at December 31, 2020 Indicative counterparty credit rating scale of S&P

Stage 1

Stage 2

Stage 3

Fair Value

Total

F1-F10 (BBB- and higher)

-

-

-

-

-

F11-F13 (BB-,BB,BB+)

-

-

-

-

-

F14-F16 (B-,B,B+)

18,352

7,278

-

19,901

45,531

F17 and lower (CCC+ and lower)

302

-

5,636

727

6,665

Sub-total

18,654

7,278

5,636

20,628

52,196

Less: amortizable fees

-285

-20

-24

-

-329

Less: ECL allowance

-487

-317

-3,099

-

-3,903

Plus: Fair value adjustments

-

-

-

-138

-138

Carrying value

17,882

6,941

2,513

20,490

47,826

      
      

Loan commitments at December 31, 2020 Indicative counterparty credit rating scale of S&P

Stage 1

Stage 2

Stage 3

Other 1)

Total

F1-F10 (BBB- and higher)

-

-

-

-

-

F11-F13 (BB-,BB,BB+)

-

-

-

-

-

F14-F16 (B-,B,B+)

10,418

-

-

8,090

18,508

F17 and lower (CCC+ and lower)

1,440

-

-

-

1,440

Sub-total

11,858

-

-

8,090

19,948

Less: ECL allowance

-232

-

-

-

-232

Carrying value

11,626

-

-

8,090

19,716

  • 1 Other loan commitments include off balance items for which no ECL allowance is calculated.

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).

The Fund's NPL ratio decreased from 12.2% (2020) to 12.0% (2021). 

Loans past due and impairments 2021

     
 

Stage 1

Stage 2

Stage 3

Fair value

Total

Loans not past due

10,553

18,451

7,773

27,934

64,711

Loans past due:

     

-Past due up to 30 days

-

-

-

-

-

-Past due 30-60 days

-

-

-

-

-

-Past due 60-90 days

-

-

-

-

-

-Past due more than 90 days

-

-

-

-

-

Subtotal1

10,553

18,451

7,773

27,934

64,711

Less: amortizable fees

-334

-105

-24

-

-463

Less: ECL allowance

-263

-918

-3,102

-

-4,283

Plus: fair value adjustments

-

-

-

-1,498

-1,498

Carrying value

9,956

17,428

4,647

26,436

58,467

Loans past due and impairments 2020

     
 

Stage 1

Stage 2

Stage 3

Fair value

Total

Loans not past due

18,654

7,278

-

20,628

46,560

Loans past due:

-

-

-

-

-

-Past due up to 30 days

-

-

5,636

-

5,636

-Past due 30-60 days

-

-

-

-

-

-Past due 60-90 days

-

-

-

-

-

-Past due more than 90 days

-

-

-

-

-

Subtotal1

18,654

7,278

5,636

20,628

52,196

Less: amortizable fees

-285

-20

-24

-

-329

Less: ECL allowance

-487

-317

-3,099

-

-3,903

Plus: fair value adjustments

-

-

-

-138

-138

Carrying value

17,882

6,941

2,513

20,490

47,826

  • 1 Gross outstanding + accrued interest

Stage 3 loans - ECL distributed by regions and sectors

  

At December 31, 2021

Energy

Total

Africa

3,102

3,102

Total

3,102

3,102

Stage 3 loans - ECL distributed by regions and sectors

  

At December 31, 2020

Energy

Total

Africa

3,099

3,099

Total

3,099

3,099

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 the Accounting Policies chapter.

The watch-list process and the Credit department review modified loans periodically. When a loan is deemed no longer collectible, it is written off against the related loss allowance. In 2021, there were no write-offs (2020: € 0 million).

The following table provides a summary of the Fund's forborne assets, both classified as performing and non - performing.

At December 31, 2021

Performing

of which: performing but past due > 30 days and <=90 days

of which: performing forborne

Non Performing

of which: non performing forborne

of which: impaired

Sub Total

Less: amortizable fees

Less: ECL allowance

Plus: fair value adjustments

Carrying value

            

Loan portfolio measured at AC

29,004

-

8,898

7,773

7,773

7,773

36,777

-464

-4,282

-

32,031

Loan portfolio measured at FVPL

27,934

-

-

-

-

-

27,934

-

-

-1,498

26,436

Total

56,938

-

8,898

7,773

7,773

7,773

64,711

-464

-4,282

-1,498

58,467

At December 31, 2020

Performing

of which: performing but past due > 30 days and <=90 days

of which: performing forborne

Non Performing

of which: non performing forborne

of which: impaired

Sub Total

Less: amortizable fees

Less: ECL allowance

Plus: fair value adjustments

Carrying value

            

Loan portfolio measured at AC

25,932

-

-

5,636

5,636

5,636

31,568

-329

-3,903

-

27,336

Loan portfolio measured at FVPL

19,901

-

-

727

-

-

20,628

-

-

-138

20,490

Total

45,833

-

-

6,363

5,636

5,636

52,196

-329

-3,903

-138

47,826

Equity risk

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

The Fund has a long-term view on its equity portfolio, usually selling its equity stake within a period of five to ten years. The Fund can accommodate an increase in the average holding period of its equity investments and so wait for markets to improve again to realize exits. There are no deadlines regarding the exit date of our equity investments. Equity investments are assessed by the Investment Committee in terms of specific obligor as well as country risk. The Investment Review Committee assesses the valuation of the majority of equity investments quarterly. The performance of the equity investments in the portfolio is periodically analyzed during the fair value process. Based on this performance and the market circumstances, exits are pursued in close cooperation with our co-investing partners. The total outstanding equity portfolio including associates on December 31, 2021, amounts to €87 million (2020: €69 million) of €25 million is invested in investment funds (2020: €16 million). 

Concentration risk

Country risk

Country risk arises from country-specific events that adversely impact the Fund’s exposure in a specific country. Within FMO, country risk is broadly defined. It includes all relevant factors that have a common impact on the Fund’s portfolio in a country such as economic, banking and currency crises, sovereign default, and political risk events. The assessment of the country rating is based on a benchmark of external rating agencies and other external information.

FMO recognizes that the impact of country risk differs across the financial products it offers. Multiple countries and regions were subject to a downgrade throughout 2021. In 2021 Kenya downgraded by one notch from F14 to F15, in which AEF’s exposure amounted around 12% of the total committed portfolio. AEF has several investments which cover multiple countries, which are labeled as regional investments. Therefore, the downgrades of the regions Asia and Africa are noteworthy as well, as circa 36% of the total committed portfolio is labeled as regional investments in these two regions. 

The following tables present how the Fund’s loan portfolio is concentrated according to country ratings. The comparison with FMO demonstrates that loan portfolio of the Fund is concentrated in countries with higher ratings and is relatively prone to higher credit risk.

Overview country ratings

  

Indicative external rating equivalent 2021

AEF (%)

FMO-A (%)

F9 and higher (BBB and higher ratings)

0.0

2.5

F10 (BBB-)

0.0

7.3

F11 (BB+)

0.0

2.2

F12 (BB)

0.0

5.3

F13 (BB-)

6.7

11.5

F14 (B+)

0.0

26.6

F15 (B)

44.8

22.0

F16 (B-)

36.4

10.5

F17 and lower (CCC+ and lower ratings)

12.1

12.1

Total

100.0

100.0

Overview country ratings

  

Indicative external rating equivalent 2020

AEF (%)

FMO-A (%)

F9 and higher (BBB and higher ratings)

0.0

3.4

F10 (BBB-)

0.0

8.5

F11 (BB+)

0.0

2.3

F12 (BB)

0.0

5.9

F13 (BB-)

7.6

7.5

F14 (B+)

16.4

30.1

F15 (B)

50.8

24.2

F16 (B-)

9.6

8.1

F17 and lower (CCC+ and lower ratings)

15.6

10.0

Total

100.0

100.0

Gross exposure of loan portfolio distributed by region and sector

   
 

Energy

Multi-Sector Fund Investment

Total

At December 31, 2021

   

Africa

48,277

2,643

50,920

Asia

5,285

-

5,285

Latin America & the Caribbean

3,316

-

3,316

Europe & Central Asia

5,190

-

5,190

Non-region specific

-

-

-

Total

62,068

2,643

64,711

    

At December 31, 2020

   

Africa

35,033

-

35,033

Asia

4,404

-

4,404

Latin America & the Caribbean

4,951

-

4,951

Europe & Central Asia

4,691

-

4,691

Non-region specific

3,117

-

3,117

Total

52,196

-

52,196

Single and group risk exposures

In the fund risk appetite, the maximum customer exposure for AEF is set at €10 million.

Counterparty credit risk

Counterparty credit risk in the treasury portfolio stems from bank account holdings and placements in money market funds to manage the liquidity in the Fund. The Risk department approves each obligor to which the Fund is exposed through its treasury activities and sets a maximum limit to the credit exposure of that obligor. Depending on the obligor’s short and long-term rating, limits are set for the total and long-term exposure. The Fund pursues a conservative investment policy.

Liquidity risk

Liquidity risk is the risk of not being able to fulfil the financial obligations and meet financial commitments due to insufficient availability of liquid means. The Fund aims to maintain adequate liquidity buffers, enough to support the implementation of the Fund’s development agenda and impact objectives while avoiding putting pressure on Dutch Ministry of Foreign Affairs DGIS subsidy budget allocated to the Fund. To realize this ambition, the Fund benefits from the experience of FMO’s treasury and risk management functions in managing the liquidity risk, which primarily involves periodical forecasting of the Fund’s liquidity position under normal and stress scenarios. During these periodical exercises, the assumptions underlying the liquidity model are reviewed. Changes in expected cashflows, stemming from updated portfolio management strategies and changes in the Fund’s operating environment, are reflected in the said assumptions. As a result of the forecasting activity, the predicted liquidity shortfall is avoided through arrangements in investments portfolio. If possible this is done through the utilization of the subsidies available from the budget allocated to the Fund by the Dutch Ministry of Foreign Affairs DGIS (‘beschikkingsruimte’); and lastly, through the request of a loan from FMO, not exceeding 10% of the Fund’s net committed portfolio. In requesting subsidies that will be made available to the Fund’s utilization from Dutch Ministry of Foreign Affairs, the Fund administrators strictly follow the Ministry's directives.

Market risk

Market risk relates to interest rate risk and currency risk.

Interest rate risk

Interest rate risk is the risk of potential loss due to adverse movements in interest rates. Changing interest rates mainly have an effect on the fair value of fixed interest balance sheet items. Given the balance sheet and capital structure of the Fund interest rate risks are considered limited.

Interest re-pricing characteristics

      

December 31, 2021

<3 months

3-12 months

1-5 years

>5 years

Non-interest-bearing

Total

Assets

      

Banks

15,847

-

-

-

-

15,847

Loan portfolio

      

-of which: Amortized cost

8,855

2,635

-

20,541

-

32,031

-of which: Fair value through profit or loss

1,051

7,225

11,438

6,721

-

26,436

Equity investments

      

-of which: Fair value through OCI

-

-

-

-

-

-

-of which: Fair value through profit or loss

-

-

-

-

74,830

74,830

Investments in associates

-

-

-

-

14,018

14,018

Current accounts with FMO

-

-

-

-

122

122

Other receivables

-

-

-

-

91

91

Total assets

25,754

9,860

11,438

27,263

88,436

163,375

Liabilities and Fund capital

      

Accrued liabilities

-

-

-

-

355

355

Current accounts with FMO

-

-

-

-

-

-

Provisions

-

-

-

-

180

180

Fund Capital

-

-

-

-

162,840

162,840

Total liabilities and Fund capital

-

-

-

-

163,375

163,375

       

Interest sensitivity gap 2021

25,754

9,860

11,438

27,263

-74,314

 

Interest re-pricing characteristics

      

December 31, 2020

<3 months

3-12 months

1-5 years

>5 years

Non-interest-bearing

Total

Assets

      

Banks

20,296

-

-

-

-

20,296

Loan portfolio

      

-of which: Amortized cost

4,995

3,011

9,447

9,883

-

27,336

-of which: Fair value through profit or loss

612

5,725

4,884

9,269

-

20,490

Equity investments

      

-of which: Fair value through OCI

-

-

-

-

-

-

-of which: Fair value through profit or loss

-

-

-

-

58,480

58,480

Investments in associates

-

-

-

-

9,949

9,949

Current accounts with FMO

-

-

-

-

85

85

Other receivables

-

-

-

-

169

169

Total assets

25,903

8,736

14,331

19,152

68,683

136,805

Liabilities and Fund capital

      

Accrued liabilities

385

-

-

-

-

385

Current accounts with FMO

-

-

-

-

-

-

Provisions

-

-

-

-

192

192

Fund Capital

-

-

-

-

136,228

136,228

Total liabilities and Fund capital

385

-

-

-

136,420

136,805

       

Interest sensitivity gap 2020

25,518

8,736

14,331

19,152

-67,737

 

Currency risk

Currency risk is defined as the risk of having an adverse effect on the value of the Fund’s financial position and future cash flows due to changes in foreign currency exchange rates. The Fund offers debt, equity and guarantee instruments in denominated in USD, EUR and in emerging market currencies, while the main source of funding to the Fund, subsidies received from Dutch Ministry of Foreign Affairs is in EUR. Due to its commitment to the implementation of the Fund’s development agenda and impact objectives, the Fund does not exclusively look for investments that counter-balance this currency risk exposure in its portfolio; the Fund also does not use derivatives and other financial instruments to hedge against the currency risk. The Fund does not take active positions in any currency for the purpose of making a profit.

Currency risk exposure (at carrying values)

      

December 31, 2021

EUR

USD

TZS

KES

Other

Total

       

Assets

      

Banks

11,928

3,919

-

-

-

15,847

Loans to the private sector

     

0

-of which: Amortized cost

14,866

10,016

4,380

2,445

324

32,031

-of which: Fair value through profit or loss

3,746

22,690

-

-

-

26,436

Equity investments

      

-of which: Fair value through OCI

     

-

-of which: Fair value through profit or loss

31,678

43,152

-

-

-

74,830

Investments in associates

413

13,605

-

-

-

14,018

Current account with FMO

122

-

-

-

-

122

Other receivables

66

25

-

-

-

91

Total assets

62,819

93,407

4,380

2,445

324

163,375

Liabilities and Fund capital

     

0

Accrued liabilities

355

-

-

-

-

355

Current accounts with FMO

     

-

Provisions

141

39

-

-

-

180

Fund Capital

162,840

    

162,840

Total liabilities and Fund capital

163,336

39

-

-

-

163,375

Currency sensitivity gap 2021

 

93,368

4,380

2,445

324

 

Currency sensitivity gap 2021 excluding equity investments and investments in associates

 

36,611

4,380

2,445

324

 

Currency risk exposure (at carrying values)

      

December 31, 2020

EUR

USD

TZS

KES

Other

Total

       

Assets

      

Banks

18,103

2,193

-

-

-

20,296

Loans to the private sector

      

-of which: Amortized cost

6,551

10,958

3,072

6,322

433

27,336

-of which: Fair value through profit or loss

4,878

15,569

43

-

-

20,490

Equity investments

      

-of which: Fair value through OCI

-

-

-

-

-

-

-of which: Fair value through profit or loss

20,405

38,075

-

-

-

58,480

Investments in associates

685

9,264

-

-

-

9,949

Current account with FMO

85

-

-

-

-

85

Other receivables

125

44

-

-

-

169

Total assets

50,832

76,103

3,115

6,322

433

136,805

Liabilities and Fund capital

      

Accrued liabilities

385

-

-

-

-

385

Current accounts with FMO

-

-

-

-

-

-

Provisions

146

46

-

-

-

192

Fund Capital

136,228

-

-

-

-

136,228

Total liabilities and Fund capital

136,759

46

-

-

-

136,805

Currency sensitivity gap 2020

 

76,057

3,115

6,322

433

 

Currency sensitivity gap 2020 excluding equity investments and investments in associates

 

28,718

3,115

6,322

433

 

Sensitivity of profit & loss account and fund capital to main foreign currencies

  
 

December 31, 2021

 

Change of value relative to the euro

Sensitivity of profit & loss account

Sensitivity of fund capital

USD value increase of 10%

9,337

-

USD value decrease of 10%

-9,337

-

TZS value increase of 10%

438

-

TZS value decrease of 10%

-438

-

KES value increase of 10%

245

-

KES value decrease of 10%

-245

-

Sensitivity of profit & loss account and fund capital to main foreign currencies

  
 

December 31, 2020

 

Change of value relative to the euro

Sensitivity of profit & loss account

Sensitivity of fund capital

USD value increase of 10%

7,606

-

USD value decrease of 10%

-7,606

-

TZS value increase of 10%

312

-

TZS value decrease of 10%

-312

-

KES value increase of 10%

632

-

KES value decrease of 10%

-632

-

Non-financial risk

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 customer 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 customer, 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.

As part of the investment process, all customers are screened on ESG risk and categorizes them according to the ESG risk that their activities represent. FMO assesses in detail customers with a high ESG risk category to identify ESG impact and risks and to assess the quality of existing risk management and mitigation measures. Due diligence also includes an analysis of contextual and human rights risk. In case of gaps in ESG risk management, FMO works with customers to develop and implement an Action Plan to avoid adverse ESG impacts and/or to improve ESG risk management over time. Key ESG risk items are tracked during the tenor of the engagement. FMO’s ESG risk management support to customers is an important part of development impact ambitions.

In addition, for customers with a high ESG category, FMO monitors customer performance on key ESG risk themes (against the IFC Performance Standards) using the ESG Performance Tracker (ESG-PT). The ESG-PT keeps track of key ESG risks and customer performance level, enabling FMO to have a portfolio-wide view of its ESG risks.

Compliance risk

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’s services and activities.

Fund’s customers follow FMO’s procedures to mitigate compliance risk. FMO’s standards and policies and good business practices foster acting with integrity. FMO’s standards and policies and good business practices foster acting with integrity. FMO is committed to its employees, customers, and counterparties, adhering to high ethical standards. FMO has a Compliance framework which entails identifying risks, designing policies, monitoring, training, and providing advice. FMO has policies on topics such as financial economic crime (including KYC, sanctions, anti-bribery, and corruption) conflicts of interest, anti-fraud, private  investments, protection of personal data and speak-up. FMO also regularly trains its employees to raise awareness by means of e.g., virtual classroom trainings and mandatory compliance related e-learnings. Employees are also encouraged to speak up in case of suspected integrity violations conducted by a FMO employee.

Management is periodically informed via the Compliance Committee or when required on an ad-hoc basis, on integrity related matters at customer or employee level. In case of signals of violations, e.g., money laundering, fraud or corruption, management will take appropriate actions. For example, initiating a dialogue with the customer, if possible and appropriate given the circumstances, to understand the background to be able to assess and investigate the severity. When FMO is of the opinion that there is a breach of law that cannot be remedied or that no improvement by the customer will be achieved (e.g. awareness, implementing controls) or that the risk to FMO’s reputation is unacceptably high, FMO may be able to exercise certain remedies under the contract such as the right to cancel a loan or suspend upcoming disbursements and will report to regulatory authorities if deemed necessary.

The governance of compliance also entails the following key risks:

Financial Economic Crime, incl. sanctions

FMO’s financial economic crime procedures include, amongst others, screening of customers on compliance with applicable anti-money laundering, counter financing of terrorism and international sanctions laws and regulations. Due diligence is performed on customers, which includes checks such as identifying and verifying the ultimate beneficial owners of the customer we finance, identifying politically exposed persons, and screening against relevant international sanctions lists. These checks are also performed regularly during the relationship with existing customers.

In 2021, FMO continued the FEC Enhancement program initiated in 2019 and met the agreed deadline with DNB to finalize the remediation project on December 31, 2021. All active KYC-files are remediated – using a new KYC tool - and meet the standards of the renewed CDD-AML Policy and CDD-AML Manual. In the second half of 2021, the renewed KYC organization was implemented in the front-office (first line) and business as usual processes were restarted, amongst others periodic reviews of KYC-files. Independent external validation confirmed that the remediated efforts and KYC files are demonstrably compliant with the relevant requirements, after which the Management Board provided a compliance statement to DNB end of 2021. The validation identified several recommendations that FMO will follow up on in 2022.

There is always a risk that a customer is involved or alleged to be involved in illicit acts (e.g., money laundering, fraud, or corruption). If such an event occurs, FMO will initiate a dialogue with the customer, if possible and appropriate given the circumstances, to understand the background to be able to assess and investigate the severity. When FMO is of the opinion that there is a breach of law that cannot be remedied or that no improvement by the customer will be achieved (e.g. awareness, implementing controls) or that the risk to FMO’s reputation is unacceptably high, FMO may be able to exercise certain remedies under the contract such as the right to cancel a loan or suspend upcoming disbursements and will report to regulatory authorities if deemed necessary.

General Data Protection Act (GDPR)

In 2021, FMO started a project to further develop and enhance privacy data protection capabilities including engaging a dedicated privacy officer and privacy champions within various departments. Specific trainings will be deployed to stimulate awareness. The project aims to finish in 2022. The privacy officer monitors FMOs privacy compliance periodically. The privacy officer is involved in i.e., change management activities and new projects to advise on privacy risks and risk mitigation

Corruption

Corruption is a global problem, requiring a global response. FMO is guided by the OECD Convention on Combating Bribery and the UN Convention against Corruption and is dedicated to fighting corruption and bribery not only to adhere to the law, but also because such acts undermine sustainable development and the achievement of higher levels of economic and social welfare. Good governance, fair business practices and public trust in the private sector is necessary to unlock the full potential of an economy and its citizens. Corruption can be best prevented collaboratively and FMO actively supports the Transparency International’s Netherlands branch and the International Chamber of Commerce to share best practices and stimulate the dialogue between Dutch corporates on best practices in doing international business.

Operational risk

Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people, and systems, or from external events, including legal risks, excluding strategic risks. 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, losses, misstatements in the financial reports, and reputational damage.

Overall, FMO is cautious with operational risks. Safe options, with low inherent risk are preferred, despite consequence of limited rewards (or higher costs). There is no appetite for high residual risk. Risk metrics are reported on a quarterly basis. These metrics cover operational risks in general, such as the amount of loss per quarter and timely follow-up of management actions, and specific metrics for risk-(sub)types.

Management of the first line of defense 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 functions that make up the second line of defense. Internal Audit in its role of the third line of defense provides independent assurance on the effectiveness of the first and second lines.

Departmental risk control self-assessments are conducted annually to identify and assess risks and corresponding controls. The strategy and business objectives are also reviewed annually by the Directors in a risk perspective. Based on among others these Risk and Control Self Assessments, the Directors sign a departmental In Control Statement at the year-end, which provides the underpinning for the management declaration in the Annual Report. Despite all preventive measures, operational risk events will occur. FMO systematically collects risk event information and analyses such events to take appropriate actions.