Organization of risk management
The risk management framework of the Dutch Fund for Climate and Development (“DFCD”, or “the Fund”) is based on two pillars: (i) prudent financial risk management, and (ii) preventing non-financial risks such as reputational risk, environmental, social and governance risk, compliance risk, operational risk and legal risk. For FMO, acting in its role as Lead Partner, to be able to carry out the Fund’s strategy, it is essential to have an adequate risk management system in place to address both pillars of risks across all three Fund facilities.
With respect to financial risk management, the DFCD has a pre-defined risk appetite translated into limits for country, region and maximum exposures per client/ project. Limit usages are monitored on a monthly basis and for each proposed transaction. The assessment of the financial risk of each proposed financing is further defined for each of the three Finance Facilities and delegated to their respective managers. As there is a range of financial products provided across the three facilities, from grant finance in the Origination Facility to equity finance in the CFM Facility, the specialized and delegated financial risk assessment approach of the DFCD provides for an appropriate, project-specific assessment of financial risk.
The approach for compliance (including business integrity) and reputational risks is set out in the policies that each of FMO, CFM, WWF-NL and SNV have implemented in their respective organizations. FMO, as the Fund Manager, receives reporting on the specific risks and mitigations assessed for each project financed by each of the Finance Facilities.
Financial risk management for the Fund is delegated to each of the facility managers.
As the Origination Facility provides grant finance, rather than loans or investments, the core focus of the financial risk approach is ensuring financial alignment with counterparts. Financial risk is minimized by assessing the financial figures of an organization or project entering the Origination Facility, ruling out unviable businesses. The Origination Facility provides financing in the form of grants, for which the recipient of the grants is required to co-fund, typically for 50%. WWF-NL and SNV apply their internal financial monitoring and risk management systems and procedures.
For FMO and CFM’s role of providing loans and equity finance, the assessment of financial risk is embedded in the project assessment and approval process. FMO reviews each transaction and provides consent to eligible proposals. Departmental Investment Committees, comprising of senior representatives of several departments, review financing proposals for new transactions. Each financing proposal is assessed in terms of specific counterparty, product risk as well as country risk. All financing proposals are accompanied by the advice of the credit department before approval. This department is responsible for credit risk assessment of both new transactions and the existing portfolio.
In addition, the loans and equity investments of FMO are subject to periodic reviews, which are in general executed annually. Fair values of equity investment are reviewed periodically. Exposures that require specific attention are reviewed by the Investment Review Committee. The larger and higher risk exposures are accompanied by the advice of the Credit department. If the Investment Review Committee concludes that a client has difficulty in meeting its payment obligations, the client is transferred to the Special Operations department – responsible for the management of distressed assets – where it is intensely monitored.
CFM manages financial risk of its equity investments both at fund level and at individual investment level. At fund level CFM minimizes portfolio risk through diversification requirements, including limiting investments to a maximum of 25% of its capital into one single country and investing no more than fifteen percent of the total commitments into one project. Further financial risks at fund level are managed within the CFM’s Risk Appetite Framework. The fair value of each equity investment is reviewed periodically.
Reputation risk is inevitable given the nature of the Fund's operations in developing countries, focusing on water and land-use specific interventions. FMO has a moderate appetite for reputation risk, accepting that reputational impact of activities may incidentally lead to negative press coverage, NGO attention or undesirable client feedback, as long as these activities clearly contribute to FMO’s mission.
These risks cannot be completely avoided, but they are mitigated as much as possible through strict policies, upfront assessment and, when necessary, through agreements with the Fund’s clients. Potential impact is conducted by feasibility studies and impact assessments, evaluated either by professionals of FMO, CFM, WWF-NL or SNV, or as needed, by specialist third party consultants.
FMO has in place a Sustainability Policy, as well as statements on human rights, land rights, and gender positions. FMO and CFM have established an Independent Complaints Mechanism consisting of an Independent Expert Panel for assessing issues and breaches of their respective policies.
Environmental, social and governance (”ESG”) 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 refer primarily to the governance of the client’s business activities. 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 DFCD actively manages ESG risks in its projects, which becomes in particular relevant for the investment facilities of CFM and FMO. The risk appetite for deviations from the exclusion list and human rights violations is zero. The Fund expects the highest standards in professional conduct. Each of the Fund’s investments complies with international standards for managing environmental and social impacts and risks, such as IFC Performance Standards, ILO Core Conventions, or the UN Guiding Principles on Human Rights. By taking an active role in the project development, CFM supervises, monitors and reviews project companies on an ongoing basis. In an event of an incident occurring, CFM will conduct a full investigation and a corrective action plan will be prepared.
Compliance Risk is the risk of failure to comply with laws, regulations, rules, related self-regulatory organization, standards and codes of conduct applicable to Fund’s services and activities. The management of each of FMO, CFM, WWF-NL and SNV have already fully implemented and operationalized compliance frameworks and relevant policies. For FMO as a regulated bank, the most important applicable laws in relation to products and customers, are the Dutch Financial Supervision Law (WFT); AML (WWFT); Sanctions Law and General Data Protection Regulation. Fund’s customers follow FMO’s procedures e.g. customer onboarding; assessment of compliance risks, periodic Know Your Customer (KYC) reviews as well Event Driven KYC Reviews.
FMO’s standards, policies and good business practices foster acting with integrity and 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 know your customer(KYC)& sanctions, anti-bribery and corruption, conflicts of interest, internal fraud, private investments, privacy and speak-up. ManagementisperiodicallyinformedviatheComplianceCommitteeorwhenrequiredonanad-hocbasis,on integrity related matters at client or employee level.
The financing provided through all facilities comply with strict anti-money laundering and KYC practices. To underpin this approach, quality counterparts are screened through an AML/KYC process which identifies any known instances of malpractice of counterparts from an early-stage using open source internet searching, sanctions list screening, trade registry verification, as well as the identification of Ultimate Beneficial Owners and Politically Exposed Persons.
Operational risk is the risk of loss resulting from inadequate or failed processes, people and systems or loss caused by external events. 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, financial losses or misstatements in the financial reports, and reputational damage.
FMO has in place an operational risk framework that governs the process of identifying, measuring, monitoring, reporting and mitigating operational risks, based on the ‘three lines of defense’ governance principle. Management of the first line 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 departments and committees, the second line of defense. Internal Audit, as the third line, provides independent assurance on the effectiveness of the first and second lines.
Legal risk is defined as the risk of a counterparty (client, supplier, stakeholder or otherwise) not being liable to meet its obligations under law or FMO being liable at law for obligations not intended or expected, caused by lack of awareness or misunderstanding of, ambiguity in, or indifference to the way law and regulation apply to business, relationships, processes, products and services, leading to financial or reputational loss.
Given the specific nature of legal risks that can occur, no risk appetite metrics are assigned to this risk type. Instead, the most relevant developments are included in the risk appetite report on a quarterly basis. FMO’s Legal team is responsible for the review of the legal aspects of the Fund’s contracts with its clients and for mitigating legal risks arising from Fund’s businesses and operations. Where applicable, the team seeks external expertise.