Assessing and managing risk
The assessment and underwriting of risk is central to EFIC's financial management framework. All transactions underwritten by EFIC are reviewed by the Board or by management in accordance with delegated authorities from the Board.
Country risk is assessed by the Chief Economist. Large or complex transactions are reviewed by a Credit Committee.
Contingent liability and loan ceilings
EFIC operates within a strong regulatory environment. The controls imposed on EFIC include:
EFIC’s treasury activities are carried out within a control framework approved by the Board and compliant with the EFIC Act, the Commonwealth Authorities and Companies Act 1997 (Cth) ("CAC Act") and associated approvals required of the Australian Government. Within this framework, we aim to prudently minimise the cost of funding our loan assets on both the Commercial Account and National Interest Account and to prudently maximise the return on our investments, including funds representing our equity, reserves and working capital. In transacting on wholesale markets, our Treasury unit confines risk prudently within Board and management approved limits and does not trade speculatively.
The framework for EFIC's funding activities by Treasury are set out within section 61 of the EFIC Act which states that "EFIC must not borrow or raise money except under section 58 or 59". Section 58 allows the Finance Minister to lend money to EFIC, out of money appropriated by the Federal Parliament, and section 59 allows EFIC to borrow or raise money, subject to written approval of the Finance Minister. To date, EFIC has funded its activities under section 59 approvals.
EFIC borrows in the global debt capital markets to fund its lending operations. The core function of EFIC's Treasury is to prudently raise funding at competitive rates and to manage the investment of capital and reserves and the surplus liquidity portfolio. Treasury uses derivative products to minimise currency and interest rate risks arising from EFIC's core businesses and Treasury's funding and investing operations. EFIC's power to enter into derivatives transactions derives from its general powers in section 11 of the EFIC Act.
EFIC's management reports the results of its treasury operations regularly to the Board.
Foreign exchange and interest rate management
The loans we have provided to customers and the rescheduled debts are mostly denominated in foreign currencies.
EFIC does not take currency exposure on its assets and liabilities - it effectively eliminates this exposure by borrowing in the same currency as the assets or, typically, by borrowing in another currency and using cross-currency swaps and other foreign exchange instruments to remove the foreign exchange exposure.
Similarly, we use interest rate swaps and futures to match the interest rate profiles of our liabilities with those of our loans.
Under Section 62 of the EFIC Act, the Commonwealth guarantees the due payment by EFIC of any money that becomes payable, including our borrowings from third parties. The main borrowing instruments currently used are medium-term notes issued in the capital markets and euro-commercial paper. The main reason EFIC borrows money is to fund loans made to exporters or buyers of Australian exports on either the Commercial Account or the National Interest Account.
Funding may also be necessary when contingent liabilities, such as export finance guarantees provided to banks to support the financing of Australian export trade, are called and EFIC pays out the bank. For this reason, we are required to have additional funding capacity available to cover the possibility of borrower defaults and subsequent calls by lending banks on EFIC’s guarantees. EFIC also maintains a diversified funding capability with spare capacity in order to ensure that it has a flexible and robust funding model that can accommodate a degree of disruption to financial markets and to enable a range of pricing and risk management strategies.
We are authorised to raise funds from our approved commercial paper borrowing facilities in advance of loan funding needs. This facility was introduced in 1990 to maintain a minimum market presence and therefore enhance the effectiveness and robustness of EFIC’s funding model.
Investments and liquidity
EFIC’s treasury investments, which are treated from an accounting perspective as ‘available-for-sale’, are required to be ‘marked to market’ and gains or losses are to be reflected through equity, not profit and loss. While our policy is to hold our investments to maturity, they can be sold if necessary. Assuming no credit defaults, any ‘unrealised’ gains or losses caused by revaluations will not be realised. The investment approval issued by the Finance Minister under the CAC Act requires our treasury investments to be in entities rated AA– or better or ADIs rated BBB– or better.
Capital adequacy guidelines
Under section 56 of the EFIC Act, the Board is required "to ensure, according to sound commercial principles, that the capital and reserves of EFIC at any time are sufficient" in order to (a) meet the likely liabilities of EFIC and (b) make adequate provision for defaults in loan payments . This requirement relates only to our Commercial Account activities.
EFIC guides itself in fulfilling this obligation by setting its own regulatory standards drawing upon both the standards of Australian Prudential Regulation Authority (APRA) and those set by the Bank of International Settlements through the BAsel Committee on Banking Supervision.
The Board treats EFIC's capital as equivalent to the regulatory capital under Basel and APRA guidelines and uses this as the basis for setting risk tolerances with regard to large exposures and capital adequacy. As recent changes to the EFIC Act which give the Minister for Trade and Investment power under Section 55A(2) to direct EFIC to pay specified dividends within a specific period means EFIC's capital base may not meet the regulatory definition of capital. When making this assessment, the Board is required to include as capital the $200 million of callable capital that is available from the Commonwealth in accordance with the provisions of section 54 of the EFIC Act.
Section 54(8) of the EFIC Act was also recently amended which gives the Minister power to increase EFIC's callable capital above $200 million. The decision on the maximum level of exposure to hold at any one time is based on a certain level of known capital. these risk tolerances apply to an individual counterparty, a specific country or a specific industry.
EFIC holds no capital against the National Interest Account business on the basis that the risks of business written on the National Interest Account are borne by the Commonwealth.
Large exposure guidelines
EFIC has modelled its large exposure policy on Basel and APRA guidelines. Australian banks are required to consult with APRA prior to committing to any aggregate exposures to non-government, non-bank counterparties exceeding 10 per cent of their capital base. APRA has also indicated a maximum exposure per non-bank counterparty (or related group of counterparties) of 25 per cent of capital but have emphasised that this is an upper limit. Only better-rated risks would be contemplated for these levels of exposures.
The Board has endorsed this limit of 25 per cent of capital and reserves (including callable capital) to apply to exposures graded ERS 1 (AAA/AA– or Aaa/Aa3) or ERS2 (A+/A– or A1/A3), but a 15 per cent target applies for risks graded ERS 3 (BBB+/BBB- or Baa1/Baa3) or worse within the general guideline of 25 per cent. Exceptions in excess of the 15 per cent target would require consideration by the Board in light of such issues as the creditworthiness of the relevant counterparty or group of related counterparties, the tenor of the exposure and the level of Australian content in the particular transaction.
In any event, under current delegations, the Board must approve all transactions that involve commitments in excess of $50 million.
As an exception to this policy, the Board has approved increases in exposure limits to single counterparties under risk transfer arrangements from a maximum 25 per cent to 37.5 per cent for risk transfer partners rated ERS 1 or 2; and from a maximum of 25 per cent to 50 per cent for risk transfer partners rated ERS 1 from government-backed export credit agencies.
For bank counterparties, APRA has indicated a maximum exposure of 50 per cent of capital. The Board has endorsed the application of this limit of 50 per cent of capital to all treasury activities with bank counterparties (defined by EFIC as authorised deposit-taking institutions under the Banking Act 1959 (Cth) and rated BBB– and above, and other financial entities rated AA– and above), provided any exposure in excess of 25 per cent of EFIC’s capital has a maturity of six months or less.
For large exposure purposes, the Board includes as eligible capital the $200 million of callable capital that is available from the Commonwealth in accordance with the provisions of section 56 of the EFIC Act.
EFIC publishes its financial statements each year in its Annual Report, which is tabled in Parliament. The financial statements are audited by the Australian National Audit Office.
Section 55 of the EFIC Act requires the Board, by written notice to the Minister for Trade and Investment, to make a recommendation that EFIC pay a specified dividend, or not pay a dividend to the Commonwealth for that financial year.
The Minister by written notice to EFIC either “approves” the recommendation or “directs” the payment of a different specified dividend.