7

Risk management and internal control

The objective of risk management is to avoid unexpected losses and safeguard the continuation of operations. The government’s objective is to manage all risks in a systematic manner.

Primary risks:

  • Financing risk (long-term refinancing and short-term liquidity risk)
  • Market risk (interest rate risk and exchange rate risk)
  • Credit risk
  • Operational risk
  • Legal risk

The risk management process consists of identification of risks, quantification and evaluation of risks, risk monitoring and reporting as well as steering of risk positions.

Guidelines for debt management set by the Ministry of Finance specify the risk management framework, e.g. objectives and limits for risk management.

Financing risk

Financing risk management covers both long-term refinancing and short-term liquidity risk.

In order to manage the long-term refinancing risk, the Finnish government diversifies its funding by instruments, investor type and geographic areas and manages the maturity profile of the debt. The foundation of government funding is built upon benchmark bonds that secure funding even in extensive volumes. The government launches new benchmark bonds in medium- and long-term maturities via syndication. The issuance strategy strives towards a smooth redemption profile and avoids concentrations in redeeming debt. Buybacks may also be executed in order to reduce refinancing risk.

Repayment profile Zoom Repayment profile of central government debt graph

Short-term liquidity risk (i.e. risk below 12 months) is managed by short-term funding and maintaining an invested liquidity buffer. Liquidity management is based on cash flow forecasts covering the entire government administration. The Ministry of Finance has set limits on the magnitude of uncovered net cash flows. When investing the surplus, the government aims to minimise credit risk, e.g. via collateralised investments. The short-term funding instruments are short-term credits as well as Treasury bills denominated in both euros and US dollars.

Market risks

The central government takes no exchange rate risk in its new debt management operations and there was no open exchange rate risk relating to the old debt outstanding at the end of 2017.

Concerning the interest rate risk, the strategic target of the government has been expressed in the form of a benchmark portfolio since the beginning of 2005. The benchmark portfolio also enables the government to evaluate the performance of operative debt management carried out by the State Treasury. The targeted interest rate risk profile is defined in terms of average fixing (the average period of repricing/refixing the debt). The State Treasury is allowed to deviate from the benchmark’s risk profile within the limits set in the guidelines of the Ministry of Finance. In order to fine-tune the government’s interest rate risk exposure, the State Treasury executes mainly interest rate swaps. At the end of 2017, the average fixing of the central government debt was 5.10 years (duration 4.75 years).

Interest expenses of budgetary debt Zoom Interest expenses of budgetary debt graph
Interest rate sensitivity of central government debt at year end Zoom Interest rate sensitivity of central government debt at year end

Credit risk

Credit risk results from investment of cash funds and derivative positions. Credit risk is managed through limits and increasingly through collateral with respect to both derivatives and cash investments. The issue of credit risk is especially relevant due to the large amount of cash funds. The government requires high credit ratings of its counterparties and the guidelines of the Ministry of Finance stipulate counterparty limits in accordance with these credit ratings. The minimum requirement for short-term uncollateralised investments up to 2 months is a rating of BBB. In order to reduce credit risk associated with cash investments, the State Treasury places funds mainly on a short-term basis with certain EU governments and, to a larger extent, uses collateralised investments, primarily in the form of triparty repo transactions.

Long-term credit risk resulting from derivative transactions is mitigated by the State Treasury through collateral. Like many other sovereign borrowers, Finland uses collateral agreements under the ISDA agreements (CSA, Credit Support Annex). Under the collateral system, the counterparty pledges bonds or cash as collateral for government receivables. At the end of 2017, the State Treasury had collateral agreements in place with 26 banks. The collateral agreements are unilateral, as the obligation to pledge collateral has concerned only the counterparty bank.

Operational risk

Operational risk is defined as a risk that results from external factors, technology, or deficient functioning of personnel, the organisation or processes. One area that needs special attention is information security including the security of documents as well as the security of IT systems.

The principles of operational risk management are implemented in the daily operations. Descriptions of realised risk events and close calls are compiled and reported to management. The State Treasury monitors the risk factors and risk events on a regular basis and makes risk assessments.

Legal risk

Legal risk is the risk resulting from non-compliance with legislation and established market practices as well as from non-implementation, invalidity, nullity, voidability or the lack of documentation of contracts, agreements and decisions. The State Treasury has internal guidelines concerning management of legal risk. The cornerstones of legal risk management are knowledge of both domestic and foreign legislation, utilisation of frame and standard agreements and the government’s own model agreements. In addition, steps are taken to ensure that employees are familiar with the legislation, regulations and market practices concerning their activities.

Internal control

Internal control is an integral part of management of the State Treasury. The aim of internal control is to reach reasonable assurance that operational functions are effective and efficient, internal and external reporting is reliable and laws and regulations are complied with. A sound system of internal control helps all parts of the organisation to reach their targets.

As part of internal control all main processes are evaluated on a regular basis. The assessment pays special attention to the clarity of objectives, risks and control procedures.