Risk audit and management

The principal risk management objectives

  • Analysing and managing all risks (financial, human, information system, strategic risks…) to avoid vertical segmentation effects and all potential impacts from such risks (financial and non-financial impacts such as reputation, know-how…). The scope of analysis covers the FRR and its stakeholders: its custodian/account-holder (Caisse des Dépôts), external asset managers, index providers and other suppliers. One of the sources of added value of this approach lies in aggregating all of the major risks and ensuring the global consistency of the risk analysis and organisational action plans.
  • Alerting the Executive Board of the potential occurrence of major risks and risks deemed to be unacceptable.
  • Propose and coordinate the roll-out of action plans designed to reduce or change the profile of these risks.
  • Assist with the dissemination of best practices and a risk management culture within the FRR.
  • Give the Executive Board an independent opinion on the management indices chosen by the Finance Division of the Fund for its own management.
  • Propose or validate risk thresholds by major risk type or area of activity.
  • Prior to launch, analyze new investment processes from the perspective of financial and operational risks. Set limits for these new investment processes.
Risks Committee
  • The committee deals with all risks of a financial or operational nature. The committee convenes once a month and can also be summoned on an exceptional basis.
  • The committee analyses the main risks in the FRR portfolio as well as in the organisation. This is done on the basis of performance reports, financial risks, compliance and operations. This reporting is produced by the Department for Financial Risk Management and the Head of the Operational Risk Department, both of which are completely separated from the financial management functions of the FRR.
  • The committee examines the new investment proposals from the financial risk perspective and defines the prudential and risk frameworks applicable within the FRR.
  • In general the committee sees to the development of a risk culture and the implementation of best practice and methods within the FRR.
  • The Risk committee reports directly to the Board of Directors on these decisions and analysis which are the subject of a written report presented at Board meetings.
  • The committee is presided over by a member of the Board.
  • The Directors of the FRR, the Heads of department, are members of the committee.
  • The minutes are held by the Department for Financial Risk Management with eventual contributions from the other member Departments.
Operational Risks
The FRR constantly monitors the prudential rules to which it is subject (rules derived from the decree to implement the law of 2001). This regulatory provision is supplemented by numerous internal rules that have significantly reinforced the risk control system.
Performance and risk calculations, and therefore investment choices, depend on the quality of the data fed into the FRR’s information system.
The FRR selects a large number of external managers to manage its asset portfolio. A rigorous selection procedure as part of public requests for proposals, extensive due diligence carried out at managers’ premises and regular monitoring (and supervision, if necessary) all help to reduce this risk. Back-up solutions are also available in the event of problems, especially those concerning managers.
To safeguard the assets entrusted to it by the nation as effectively as possible, the FRR monitors developments in the financial markets and their volatility on a daily basis so that it can act swiftly if necessary. In performing its mission, it is therefore of paramount importance that the FRR should be able to carry out its principal activities without disruption in the event of a serious incident (epidemic, flooding, fire, etc.). Backup and fallback plans have been defined and are tested regularly to deal with such incidents.
The FRR pays close attention to its choice of investment vehicles to ensure that it does not support fraudulent practices or money laundering.
Financial Risks
Prior to changing its strategic asset allocation (payouts initially planned for between 2020 and 2040), the principal risk for the FRR was in themis-match between its strategic allocation and its long-term financial objectives. As from the end of 2010, following the pensions reform, the approach to asset-liability management risk had to take account of the forthcoming payments to be made as from 2011, to ensure that the FRR is able to honour its commitments.
For fixed income mandates, minimum ratings are imposed on managers. In the case of short-term investments in securities for cash management purposes, the FRR must comply with both rating and equity capital constraints vis-à-vis the issuer (or level of GDP in the case of a country).
For hedging purposes, the FRR is required to negotiate, through its managers, OTC derivatives with banking counterparties. Minimum ratings (Moody’s, Standard & Poor’s and Fitch) and minimum equity capital requirements apply to its choice of counterparties. The FRR also requires margin calls to be put in place for certain derivatives, in addition to compliance with maximum levels of exposure per counterparty. A monitoring system comprising alerts, risk indicators and regular reports on these active counterparties has been implemented. Furthermore, settlement risk relating to all these forward currency transactions with banking counterparties is significantly reduced because the FRR uses the services of CLS Bank. CLS acts as a trusted third party and makes payments between two counterparties only after it has carried out all checks and has cleared transactions. The risk of delivering currencies to an insolvent company that is unable to honour its payment is therefore significantly reduced.
The FRR’s portfolio is partly invested in foreign currencies. In the case of the performance portfolio, the Fund has hedged 90% of its currency exposure through forward currency contracts, which are renewed regularly, with the exception of positions in emerging currencies, whose upward trend constitutes a contributing factor to overall medium and long-term growth. As regards liability hedging assets, the risk hedging rate represented by currency exposure increased to 100% in 2011. This hedging statistically improves the risk/return ratio for developed country currencies because it reduces the portfolio’s volatility without having a significant impact on net performance.
    These risks are at two levels:
  • Absolute risks: these are absolute losses to which the Fund may be subject over the short term. The level of these short-term losses is measured on a regular basis by the FRR staff.
  • Relative risks: these risks relate to the under-performance of an asset manager versus the defined benchmark index. This relative loss is monitored and contained by enforcing compliance with a maximum ex-ante tracking error.
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