Financing decisions are made by the Board of Directors and according to the authorisations delegated by the Board so that the amount of exposure and risk have an impact on the decision-making level. Finnvera’s Credit Committee makes decisions under its own authority, discusses proposals submitted to the Board of Directors for decision-making, and handles issues requiring a specific policy. The Credit Committee is chaired by the CEO. The Head of the Credit Decision Unit serves as the Vice Chair. Risk Control takes part in the Credit Committee’s work.
Monitoring of credit risks
Client monitoring takes place through annual analysis of the client enterprise’s financial statements, regular contacts with the client and through monitoring of the client’s payment behaviour and operations. In its monitoring, Finnvera utilises data from its own control systems, from beneficiaries of domestic guarantees and export credit guarantees, and from public registers on payment defaults. Elevated client risks are taken under special monitoring, and a special monitoring report on the most elevated client risks is drawn up every six months. The probability of credit losses and any needs for write-downs are assessed at the same time. In 2018, Finnvera will adopt the IFRS9-compliant write-down procedure.
The concentration of risks in counterparties, sectors and countries is monitored regularly. Owing to the purpose of the company’s operations, it is challenging to set precise limits for these risks. Risk appetite defines, in principle, maximum exposures for corporate counterparties and for country-related concentration risks. In SME financing, the credit policy defines the maximum exposure of an individual counterparty. Decisions greater than this maximum must be justified separately to the company’s Board of Directors and, whenever necessary, to the State owner. In export financing reinsurance agreements are used to hedge against risks associated with individual counterparties and concentrations.
Counterparty risks also arise in connection with asset and liability management operations. Finnvera’s goal is to keep the counterparty risks of asset management low by setting counterparty-specific limits, by concluding netting and security arrangements associated with derivative contracts, and by working with counterparties with high credit ratings.
Risk Control provides the Board of Directors and the management with quarterly reports on the risk-taking realised in relation to risk appetite and goals. In addition, the company’s reporting system generates constant reporting based partly on daily data and month-specific data. The main indicators in Finnvera’s risk management are the distribution of the current credit and guarantee exposure and the change in exposure by risk category, payment delays and non-performing receivables. In SME financing, the LGD estimate is largely based on the value of collateral, whereas in export credit guarantees, it is based on a separate estimate of recoveries. The level of risk-taking in relation to outstanding exposure, financing granted, and export credit guarantees is described by using the anticipated statistical value of credit losses (anticipated loss), the total loss, and the credit losses realised. These are reported quarterly. When estimating the total loss, Finnvera uses a VaR confidence interval of 99.5%.
Interest rate and currency risk
At Finnvera, interest rate risks arise when interest rates for borrowing and lending are determined at different times and when there are structural interest rate risks associated with equity. The interest rate of domestic lending intended for SMEs is mainly based on the 6-month Euribor. The interest rate in export financing is based either on the 6-month Euribor or on the 6-month USD-LIBOR. Interest determination dates are distributed fairly evenly over the various banking days throughout the year. Borrowing takes place in larger individual sums, and often with a fixed interest rate. In the event that borrowing is based on a reference rate other than the 6-month Euribor (or USD-LIBOR), the reference rate is converted to the 6-month Euribor (or USD-LIBOR) by using interest rate swaps when the loan is taken. The interest rate risk arising from differences in the timing of interest determination dates between borrowing and lending is controlled by striving to distribute the interest determination dates for borrowing evenly over different months.
Structural interest rate risks arise when Finnvera’s own funds, classified as being interest-free, are used in lending as one source of funding. Finnvera monitors the consequent interest rate risk and, if necessary, hedges this risk. The company’s Board of Directors has determined that the target for return on equity is based on the 6-month Euribor, which governs the size of the structural interest rate risk.
The entire lending portfolio of Finnvera’s SME financing is denominated in euros, whereas export financing uses both euros and dollars. Finnvera acquires funds from a number of markets and in a number of currencies. To control the currency risk, the funds acquired are converted into euros or dollars by using currency swaps. Cash assets are also invested in the relevant currencies. The remaining currency risk is hedged using currency derivatives, if necessary.
Finnvera’s goal is to keep both the interest rate risk and the currency risk low. Risks are monitored actively, and the company’s management and the Board of Directors receive regular reports on them.
Finnvera acquires long-term funding mainly within the EMTN programme. The programme is guaranteed by the State and has the same credit rating as the State of Finland. The company can also make use of a domestic commercial paper programme. These help distribute the acquisition of funds across several markets and investors.
Finnvera’s Board of Directors approves the principles of liquidity management. According to these principles, the liquidity buffer must at any given time cover the payments scheduled for the next 12 months. The principles also determine how much underfunding the company can accept in the longer term. Liquid assets are invested in objects that have a high credit rating Finnvera’s Asset Management is responsible for practical tasks associated with borrowing and liquidity management. The company’s accumulated own funds are an important element of the acquisition of funds for lending.
The potentially high claims arising from export credit guarantee operations may lead to a sudden need for liquidity that is greater than normal. Sudden changes in the financial markets may also impair the availability of financing. To prepare for the realisation of such liquidity risks, Finnvera has entered into contractual arrangements, for instance, with the State Guarantee Fund and the State of Finland.
Finnvera does not trade in instruments subject to the effect of market prices. However, a small amount of market risk arises on the balance sheet when liquid assets are invested and when measures are taken to hedge against currency and interest rate risks. The aim is to invest liquid assets in instruments where investments can be kept until maturity. Since the investments are classified as available for sale, changes in market prices do not affect Finnvera’s financial performance. Effort is also made to hedge risks so that the net effect of market changes on financial performance would be slight.
An operational risk is a risk of loss caused by insufficient or inoperable internal processes, systems, human resources or external events. Operational risks also include legal risks and the risk of damage to reputation. Loss resulting from an operational risk may materialise as higher costs, lower profits or lost reputation, for instance.
The management of operational risks has been developed systematically since 2006, and events caused by operational risks have been registered since the beginning of 2007. The process owners and units are responsible for developing the management of operational risks. The development of information security is steered and monitored by a separate Information Security Group, with the Security Manager and IT Manager, among others, as its members. Risk Control supports and coordinates the development of operational risk management. Potential risks have been charted and the severity of any consequences they might involve has been assessed for all business areas and support units. In addition, Finnvera has drawn up risk scenarios that, if realised, would have serious consequences for the company’s operations. Responsibility for the implementation of actions to avert the risk scenarios and other severe risks has been divided between the various organisational units in line with their tasks. The management of operational risks is closely linked to Finnvera’s continuous improvement of quality. Finnvera has an ISO 9001 quality certificate and meets the requirements set by central government for the increased level of information security. Safeguards are taken against operational risks, for instance, by introducing internal control mechanisms, by developing processes, information systems and the quality of operations, and by taking out insurance against risks.
Finnvera has a compliance function that is independent of business operations and responsible for ensuring that the company’s operations are in compliance with regulations.
Operational risks realised are registered into the management system of operational risks through a risk event portal that is accessible to the entire personnel. The reasons leading to the events and the measures taken to prevent the recurrence of similar events are described in the application. Finnvera’s management and Board of Directors receive regular reports on operational risks realised.
Venture capital investments
Within the Finnvera Group, venture capital investments are carried out by Veraventure Ltd and ERDF-Seed Fund Ltd. Investments made in these companies fall within the scope of Finnvera’s credit risk monitoring.
Risk management by the subsidiaries engaged in venture capital investments is based on enterprise analysis, limiting the size of investments, sharing the risk with other investors, and on sufficient diversification of the investment portfolio. The principles for liquidity investment are the same as those applied by the parent company.
The companies engaged in venture capital investments comply with the recommendations issued by the European Venture Capital Association (EVCA) on the valuation of portfolio companies and fund investments. Investments are carried at fair value in accordance with the above-mentioned recommendations.
Capital management, capital adequacy and external risk weight
Finnvera calculates its capital adequacy for SME financing according to the principles of the Basel III standard method even though Finnvera is not officially required to apply this method. Owing to the nature of its business, Finnvera must ensure that the amount of equity is sufficient in relation to the credit risks taken. The Ministry of Economic Affairs and Employment has set a goal of 12–20 per cent for Finnvera’s capital adequacy. Finnvera assesses the adequacy of capital through an internal process that includes, among other things, stress tests and scenario analyses, aimed at anticipating unfavourable circumstances.
Economic capital is calculated using a credit risk model that corresponds to the models generally used by banks. The model considers the probability of default for the risk objects and the loss resulting from the exposure should the default be realised. Internally, Finnvera’s aim is to attain as much economic capital as is needed to cover the annual losses arising from credit risks and counterparty risks with a certainty of 99.5 per cent. In addition, capital is reserved for operational risks.
Equity and retained earnings are allocated to the reserve for domestic operations and to the reserve for export credit guarantee and special guarantee operations. The State provides direct support for Finnvera’s domestic financing by paying credit and guarantee loss compensation for some of the credit losses incurred by Finnvera. At present, the compensation for credit and guarantee losses ranges from 35 to 75 per cent, depending on the project. The average is about 55 per cent of the outstanding credit and guarantee exposure. In export credit guarantee operations, the State of Finland is responsible, through bodies such as the State Guarantee Fund, for the losses that may arise during the financial period and exceed the assets in the reserve for export credit guarantee operations.
It has been ensured through legislation that, in the capital adequacy calculations of banks, the risk weight of Finnvera’s guarantees is the same as that applied to the liability of the State of Finland.