Summary of accounting policies
The Dutch Fund for Climate and Development (DFCD) (the "Fund") is established as a consortium led by FMO with consortium partners SNV Netherlands Development Organisation (SNV), World Wide Fund for Nature (WWF-NL) and Climate Fund Managers (CFM) to manage on behalf of the Dutch Ministry of Foreign Affairs.
Basis of preparation
The 2019 special purpose consolidated financial statements of DFCD have been prepared in accordance with the reporting requirements set out by Dutch Ministry of Foreign Affairs. Accounting policies are based on International Financial Reporting Standards (IFRS) as adopted by the European Union.
The special purpose consolidated financial statements are prepared under the historical cost convention, except for:
Equity investments that are measured at fair value;
A part of the loan portfolio which is measured at fair value.
The principal accounting policies adopted are set out below.
Basis of Consolidation
The 2019 consolidated financial statements of DFCD incorporates the activities of the FMO Land use facility, the Origination facilities managed by SNV Netherlands Development Organisation (SNV) and World Wide Fund for Nature (WWF-NL), as well as the Water facility managed by Climate Fund Managers (CFM). Where necessary, adjustments are made to the financial statements of consortium partners to bring the accounting policies used into line with the FMO accounting policies. All assets and liabilities, equity, income, expenses and cash ﬂows relating to transactions between consortium partners are eliminated on consolidation.
Issued but not yet adopted standards
The IASB has issued amendments of IAS 1 and IAS 8 to clarify the definition of material, specifically explaining obscuring, reasonable influence and primary users. The effective date for these amendments is for annual reporting periods beginning on January 1, 2020. The Fund has applied IFRS 9 Financial instruments and has used various material estimates for that matter based on the current definition of material. The amendment is not expected to have impact on the Fund.
On March 28, 2018 IASB presented the revised Conceptual Framework for Financial Reporting. The Conceptual Framework is not a standard itself but can be used as general guidance for transactions / events where specific IFRS standards are not available. Main improvements in the revised Conceptual Framework contains the introduction of concepts for measurement and presentation & disclosures, guidance for derecognition of assets and liabilities. In addition definitions of an asset & liability and criteria for recognition have been updated. These amendments will have minor impact on the Fund.
Significant estimates, assumptions and judgements
In preparing the special purpose consolidated financial statements based on the accounting principles of IFRS, management is required to make estimates and assumptions affecting reported income, expenses, assets, liabilities and disclosure of contingent assets and liabilities. Use of available information and application of judgment is inherent to the formation of estimates. Although these estimates are based on management’s best knowledge of current events and actions, actual results could differ from such estimates and the differences may be material to the special purpose annual accounts. For the Fund the most relevant estimates and assumptions relate to:
The determination of the fair value of financial instruments based on generally accepted modeled valuation techniques;
The determination of the Expected Credit Loss allowance in accordance with IFRS 9
Information about judgements made in applying accounting policies are related to the following:
Classification of financial assets: assessment of the business model within which the assets are held and assessment of whether the contractual terms of the financial assets are solely payments of principal and interest.
The inputs and calibration of the ECL model which include the various formulas and the choice of inputs, aging criteria and forward-looking information.
Foreign Currency translation
The Fund uses the euro as the unit for presenting its special purpose annual accounts. All amounts are denominated in thousands of euros unless stated otherwise. In accordance with IAS 21, foreign currency transactions are translated to euro at the exchange rate prevailing on the date of the transaction. At the balance sheet date, monetary assets and liabilities are reported using the closing exchange rate. Non-monetary assets that are not measured at cost denominated in foreign currencies are reported using the exchange rate that existed when fair values were determined. Exchange differences arising on the settlement of transactions at rates different from those at the date of the transaction and unrealized foreign exchange differences on unsettled foreign currency monetary assets and liabilities, are recognized in the profit and loss account under ‘results from financial transactions’.
Unrealized exchange differences on non-monetary financial assets (investments in equity instruments)are a component of the change in their entire fair value. When a gain or loss for non-monetary financial asset is recognized through FVOCI (fair value through other comprehensive income), any foreign exchange component of the gain or loss is also recognized through FVOCI.
Offsetting financial instruments
Financial assets and liabilities are offset and the net amount is reported in the balance sheet when there is a legally enforceable right to offset the recognized amounts and there is an intention to settle on a net basis, or realize the asset and settle the liability simultaneously.
Fair value of financial instruments
The Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When available, the fair value of an instrument is measured by using the quoted price in an active market for that instrument. If there is no quoted price in an active market, valuation techniques are used that maximize the use of relevant observable inputs and minimize the use of unobservable inputs.
Amortized cost and gross carrying amount
The amortized cost of a financial asset or financial liability is the amount at which the financial asset or financial liability is measured on initial recognition minus the principal repayments, plus or minus the cumulative amortization using the effective interest method of any difference between that initial amount and the maturity amount and, for financial assets, adjusted for any expected credit loss allowance.
Gross carrying amount of a financial asset is the amortized cost of a financial asset before adjusting for any expected credit loss allowance.
Financial assets – Classification
On initial recognition, a financial asset is classified as measured at AC, FVOCI or FVPL.
A financial asset is measured at AC if it meets both of the following conditions and is not designated as at FVPL:
It is held within a business model whose objective is to hold assets to collect contractual cash flows; and
Its contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest (SPPI) on the principal amount outstanding.
A debt instrument is measured at FVOCI only if it meets both of the following conditions and is not designated as at FVPL:
It is held within a business model whose objective is achieved by both collecting contractual cash flows and selling financial assets; and
Its contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest (SPPI) on the principal amount outstanding.
For equity investments that are not held for trading an irrevocable election exists (on an instrument-by-instrument basis) to present subsequent changes in fair value in OCI.
All financial assets not classified as measured at AC or FVOCI as described above are measured at FVPL. In addition, on initial recognition The Fund may irrevocably designate a financial asset that otherwise meets the requirements to be measured at AC or at FVOCI as at FVPL if doing so eliminates or significantly reduces an accounting mismatch that would otherwise arise.
A financial asset is initially measured at fair value plus, for an item not at FVPL, transaction costs that are directly attributable to its acquisition.
Business model assessment
The Fund has made an assessment of the objective of the business model in which a financial asset is held at a portfolio level because this best reflects the way the business is managed and information is provided to management. The information that is considered includes:
How the performance of the portfolio is evaluated and reported to management of the Fund;
The risks that affect the performance of the business model (and the financial assets held within that business model) and how those risks are managed;
The frequency, volume and timing of sales in prior periods, the reasons for such sales and expectations about future sales activity. However, information about sales activity is not considered in isolation, but as part of an overall assessment of how the Fund stated objective for managing the financial assets is achieved and how cash flows are realized.
Financial assets whose performance is based on a fair value basis are measured at FVPL because they are neither held to collect contractual cash flows nor held both to collect contractual cash flows and to sell financial assets.
Contractual cashflow assessment
For the purpose of the contractual cash flow assessment, related to solely payments of principal and interest (SPPI), ‘principal’ is defined as the fair value of the financial asset on initial recognition. ‘Interest’ is defined as consideration for the time value of money, for the credit risk associated with the principal amount outstanding during a particular period of time and for other basic lending risks and costs (e.g. liquidity risk and administrative costs), as well as a profit margin. In assessing whether the contractual cash flows are solely payments of principal and interest, the Fund has considered the contractual terms of the instrument. This includes assessing whether the financial asset contains a contractual term that could change the timing or amount of contractual cash flows such that it would not meet this condition. In making the assessment, the Fund has considered among others:
Contingent events that would change the amount and timing of cash flows – e.g. prepayment and extension features, loans with performance related cash flows;
Features that modify the consideration for the time value of money – e.g. regulated interest rates, periodic reset of interest rates;
Loans with convertibility and prepayment features;
Terms that limit the Funds’ claim to cash flows from specified assets – e.g. non-recourse assets;
Contractually linked instruments.
Financial assets can be only reclassified after initial recognition in very infrequent instances. This happens if the business model for managing financial assets has changed and this change is significant to the Funds operations.
Financial assets – Impairment
The Fund estimates an allowance for expected credit losses for the following financial assets:
Impairment stages loans and banks
The Fund groups its loans into Stage 1, Stage 2 and Stage 3, based on the applied impairment methodology, as described below:
Stage 1 – Performing loans: when loans are first recognized, an allowance is recognized based on a 12-month expected credit loss;
Stage 2 – Underperforming loans: when a loan shows a significant increase in credit risk, an allowance is recorded for the lifetime expected credit loss;
Stage 3 –Credit-impaired loans: a lifetime expected credit loss is recognized for these loans. In addition, in Stage 3, interest income is accrued on the AC of the loan net of allowances;
The Funds ECL model is primarily an expert based model and this model is frequently benchmarked with other external sources if possible.
ECL measurement Stage 1 and Stage 2
IFRS 9 ECL allowance reflects unbiased, probability-weighted estimates based on loss expectations resulting from default events over either a maximum 12-month period from the reporting date or the remaining life of a financial instrument. The method used to calculate the ECL allowances for Stage 1 and Stage 2 assets are based on the following parameters:
PD: the Probability of Default is an estimate of the likelihood of default over a given time horizon. The Fund uses an scorecard model based on quantitative and qualitative indicators to assess current and future clients and determine PDs. The output of the scorecard model is mapped to the Moody’s PD master scale based on idealized default rates. For IFRS 9 a point in time adjustment is made to these PDs using a z-factor approach to account for the business cycle;
EAD: the Exposure at Default is an estimate of the exposure at a future default date, taking into account expected changes in the exposure after the reporting date, including repayments of principal and interest, scheduled by contract or otherwise, expected drawdowns and accrued interest from missed payments;
LGD: the Loss Given Default is an estimate of the Fund's loss arising in the case of a default at a given time. It is based on the difference between the contractual cash flows due and any future cashflows or collateral that the Fund would expect to receive;
Z-factor: the z-factor is a correction factor to adjust the client PDs for current and expected future conditions. The z-factor adjusts the current PD and PD two years into the future. GDP growth rates per country from the IMF, both current and forecasted, are used as the macro-economic driver to determine where each country is in the business cycle. Client PDs are subsequently adjusted upward or downward based on the country where they are operating.
Macro economic scenarios in PD estimates
In addition to the country-specific z-factor adjustments to PD, the Fund applies probability-weighed scenarios to calculate final PD estimates in the ECL model. The scenarios are applied globally, and are based on the vulnerability of emerging markets to prolonged economic downturn. The scenarios and their impact are based on IMF data and research along with historical default data in emerging markets.
The three scenarios applied are:
Positive scenario: Reduced vulnerability to an emerging market economic downturn;
Base scenario: Vulnerability and accompanying losses based on The Funds best estimate from risk models;
Downturn scenario: Elevated vulnerability to an emerging market economic downturn.
ECL measurement Stage 3
The calculation of the expected loss for Stage 3 is different when compared to the Stage 1 and Stage 2 calculation. Reason for this is that loan-specific impairments provide a better estimate for Stage 3 loans in the Fund’s diversified loan portfolio. The following steps are taken which serve as input for the IRC to decide about the specific impairment level:
Calculate probability weighted expected loss based on multiple scenarios including return to performing (and projected cash flows), restructuring, and write-off or sale;
Apply the impairment matrix (based on LGD, arrears and client rating);
Take expected cash flows from collateral and “firm offers” into account. The cashflows from collateral and "firm offers" serve as a cap for the provision (or a floor for the value of the loan).
Staging criteria and triggers
Financial instruments classified as low credit risk
The Fund considers all financial instruments with an investment grade rating (BBB- or better on the S&P scale or F10 or better on the Funds internal scale) to be classified as low credit risk. For these instruments, the low credit risk exemption is applied and irrespective of the change of credit risk (as long as it remains investment grade) a lifetime expected credit loss will not be recognized. This exemption lowers the monitoring requirements and reduces operational costs.
No material significant increase in credit risk since origination (Stage 1)
All loans which have not had a significant increase in credit risk since contract origination are allocated to Stage 1 with an ECL allowance recognized equal to the expected credit loss over the next 12 months. The interest revenue of these assets is based on the gross amount.
Significant increase in credit risk (Stage 2)
IFRS 9 requires financial assets to be classified in Stage 2 when their credit risk has increased significantly since their initial recognition. For these assets, a loss allowance needs to be recognized based on their lifetime ECLs. The Fund considers whether there has been a significant increase in credit risk of an asset by comparing the lifetime probability of default upon initial recognition of the asset against the risk of a default occurring on the asset as at the end of each reporting period. Interest revenue for these financial assets is based on the gross amount. This assessment is based on either one of the following items:
The change in internal credit risk grade with a certain number of notches compared to the internal rating at origination;
The fact that the financial asset is 30 days past due;
The application of forbearance.
Definition of default (Stage 3)
A financial asset is considered as default when any of the following occurs:
The client is past due more than 90 days on any material credit obligation to the Fund, including fees (excluding on-charged expenses);
Reversed staging relates to criteria which trigger a stage transfer to Stage 1 for loans which are in Stage 3 or Stage 2. The following conditions must apply for a transfer to stages representing lower risk:
Loans which are in stage 3 will revert to stage 2 when the specific impairment is released by the IRC and there are no obligations past due for more than 90 days;
Loans which are in stage 2 will only revert to stage 1 when internal ratings have improved to the level lower than the minimum notch downgrade from origination that led to transition to stage 2, the forbearance probation (curing) period of minimum two years has passed and no material amounts are past due for more than 30 days.
Written-off financial assets
A write-off is made when a claim is deemed non-collectible, when the Fund has no reasonable prospects of recovery after, among others, enforcement of collateral or legal enforcement with means of lawsuits. Furthermore, a write-off is performed when the loan is being forgiven by the Fund. There are no automatic triggers, which would lead to a write-off of the loan; specific impaired loans are assessed on individual basis depending on their circumstances.
Write-offs are charged against previously booked impairments. If no specific impairment is recorded on the basis of IRC decision making in the past, the write-off is included directly in the profit and loss account under ‘Impairments’.
Modification of financial assets
Modification of terms and conditions arise from lending operations where the Fund enters into arrangements with clients, which implies modifications to existing contractual cash flows or terms and conditions. Such arrangements are usually initiated by the Fund when financial difficulty occurs or is expected with a borrower. The purpose of such an arrangement is usually to collect original debt over different terms and conditions from the borrower. Modifications may include extending the tenor, changing interest rate percentages or their timing, or changing of interest margin.
During the modification assessment, the Fund will evaluate whether the modification event leads to a derecognition of the asset or to a modification accounting treatment. Generally loans that are sold to a third party or are written off lead to a derecognition. When existing debt is converted into equity, a derecognition of the debt will occur and recognized again on the balance sheet as equity. For modifications in interest percentages or tenor changes of existing amortized cost loans do not pass the SPPI test, the loan will also be derecognised and will be recognised as new loans on the Fund's balance sheet according to the new classification.
When modification measures relate to changes in interest percentages or extensions of tenors and the loan is at amortized cost, the Fund will recalculate the gross carrying amount of the financial asset by discounting the modified expected cash flows using the original effective interest rate and recognizes the difference in the gross carrying amount as a modification gain or loss under 'interest income related to financials assets at amortized cost'. However when the NPV of the original loan is substantially different than the NPV of the modified loan, the original loan is derecognized and rerecognized on the balance sheet. The Fund considers a variance of greater than 10% as substantially different.
Modification of contractual terms versus forbearance
Forbearance is not an IFRS term, but relates to arrangements with clients which imply modifications to existing terms and conditions due to financial difficulties of the client. Financial difficulties include, among others, prospects of bankruptcy or central bank intervention. Forbearance must include concessions to the borrower such as release of securities or changes in payment covenants that implies giving away payment rights. Forbearance measures do not necessarily lead to changes in contractual cash flows.
Theoretically, modification of contractual cash flows or terms and conditions, does not necessarily apply to clients in financial difficulties or due to potential higher credit risk, however at the Fund, a modification of the contractual terms is usually initiated when financial difficulty occurs or is expected. Therefore only in exceptional cases, changes in modifications of contractual terms not following from credit risk related triggers, will not lead to forbearance e.g. in case of an environmental covenant breach. For the Fund, generally modifications will follow from financial difficulties of the borrower and will be classified as forborne assets.
Cash and cash equivalents
Cash and cash equivalents consist of banks and short-term deposits that usually mature in less than three months from the date of acquisition.These financial instruments are very liquid with high credit rating and which are subject to an insignificant risk of changes in fair value. There is no restriction on these financial instruments and the Fund has on demand full access to the carrying amounts.
Loans originated by the Fund include loans to the private sector in developing countries for the account and risk of the Fund.
Loans on the balance sheet of the Fund include:
Loans measured at AC which comply with the classification requirements for AC as indicated in the section Financial assets – classification. These loans are initially measured at cost, which is the fair value of the consideration paid, net of transaction costs incurred. Subsequently, the loans are measured at AC using the effective interest rate method.
Loans mandatorily measured at FVPL which do not comply with the classification requirements for AC as indicated in the section Financial assets – classification. These are measured at fair value with changes recognized immediately in profit and loss.
Equity investments on the balance sheet of the Fund include:
Equity investments are measured at FVPL. The Fund has a long-term view on these equity investments, usually selling its stake within a period of 5 to 10 years. Therefore these investments are not held for trading and are measured at fair value with changes recognized immediately in profit and loss;
Equity investments designated as at FVOCI. The designation is made, since these are held for long-term strategic purposes. These investments are measured at fair value. Dividends are recognized as income in profit and loss unless the dividend clearly represents a recovery part of the cost of the investment. Other net gains and losses are recognized in the fair value reserve (OCI) and are never reclassified to profit and loss.
This special purpose reserve contains the consolidated capital provided by the State to finance the portfolio of loans and equity investments. Only when this capital is claimed from the State, it is recognized in the Fund Capital. The remaining part of
the committed capital is not recognized until claimed from the State.
The assets, liabilities, income and expenses of foreign operations are translated using the closing and weighted average exchange rates. Differences resulting from the translation are recognized in the translation reserve.
The other reserves include the cumulative distributable net profits. Dividends are deducted from other reserves in the period in which they are declared.
Consolidated Profit and Loss
Net interest income: interest income and expense
Interest income and interest expenses from financial instruments measured at AC are recognized in the profit and loss account for all interest-bearing financial instruments on an accrual basis using the ‘effective interest’ method based on the fair value at inception. Interest income and interest expenses also include amortized discounts, premiums on financial instruments.
When a financial asset measured at AC is credit-impaired and regarded as Stage 3, interest income is calculated by applying the effective interest rate to the net AC of the financial asset. If the financial asset is no longer credit-impaired, the calculation of interest income reverts to the gross basis.
Interest income and interest expenses from financial instruments measured at FVPL reflect fair value gains and losses mainly related to the derivatives portfolio. Moreover, interest income from loans measured at FVPL are also recognized under 'Interest income from financial instruments measured at FVPL.
Fee and commission income and expense
The revenue recognition for financial service fees depends on the purpose for which the fees are charged and the basis of accounting for the associated financial instrument. Fees that are part of a financial instrument carried at fair value are recognized in the profit and loss account. Fee income that is part of a financial instrument carried at AC can be divided into three categories:
Fees that are an integral part of the effective interest rate of a financial instrument (IFRS 9)
These fees (such as front-end fees) are generally treated as an adjustment to the effective interest rate. When the facility is not used and the commitment period expires, the fee is recognized at the moment of expiration. However, when the financial instrument is to be measured at fair value subsequent to its initial recognition, the fees are recognized as interest-income;
Fees earned when services are provided (IFRS 15)
Fees charged by the Fund for servicing a loan (such as administration fees and agency fees) are recognized as revenue when the services are provided. Portfolio and other management advisory and service fees are recognized in line with the periods and the agreed services of the applicable service contracts;
Fees that are earned on the execution of a significant act (IFRS 15)
These fees (such as arrangement fees) are recognized as revenue when the significant act has been completed.
Dividends are recognized in dividend income when a dividend is declared. The dividend receivable is recorded at declaration date.
Results from equity investments
Gains and losses in valuation of the equity investment portfolio are recognized under 'Results from equity investments'. These gains and losses include foreign exchange results of equity investments which are measured at fair value.
Grants and development contributions
Grants disbursed to recipients are recognised as an expense in the profit and loss account when the Fund incurs an irrevocable obligation to disburse the amount. Development contributions which contain repayment rights which meet the recognition criteria of an asset are treated in accordance with the policy on financial assets described above. Development contributions which do not contain a right to payment that meets the asset recognition criteria are recognised as an expense in the profit and loss account when the Fund incurs an irrevocable obligation to disburse the amount.
Operating expenses include direct and overhead costs. Expenses are recorded on accrual basis as they incur.
Statement of cash flows
The statement of cash flows is presented using the direct method.