Petroleum Fund of Timor-Leste Notes to the financial statements
for the year ended 31 December 2013
12. Financial risk and management objectives and policies
The Petroleum Fund’s activities expose it to a variety of financial risks: market risk including currency risk, fair value interest rate risk, cash flow interest rate risk and price risk, credit risk and liquidity risk.
The Petroleum Fund is also exposed to a range of operational risks that may temporarily or permanently impair the ability of the Fund’s managers to hold or transfer securities.
The Petroleum Fund’s overall risk management programme seeks to maximise the returns derived for the level of risk to which the Fund is exposed and seeks to minimise potential adverse effects on the Fund’s performance.
The management of these risks is carried out by the Investment Advisory Board and the Banco Central de Timor-Leste. The Investment Advisory Board develops investment mandates and benchmarks that reflect the Board’s understanding of the financial risk tolerance of the
Fund’s stakeholders and the capacity of the Fund’s day-to-day management to implement, and which are in accordance with the Board’s published Statement of Investment Beliefs. The mandates and benchmarks are approved by the Minister of Finance prior to implementation.
The Central Bank has policies and procedures for managing and monitoring financial and operational risks for its own operations, external managers, global custodian, and the Petroleum Fund’s other key service providers.
The financial risks associated with the Petroleum Fund are monitored by the Risk Management Division of the Petroleum Fund Management Department at the Banco Central de Timor-Leste, which prepares daily management reports for senior management and quarterly reports for
the Ministry of Finance and Investment Advisory Board. The Petroleum Fund is subject to periodic audit by the Internal Audit Office of the Banco Central de Timor-Leste, which has operational independence from the management of the Petroleum Fund. The Internal Audit Office
provides formal monthly reports to the Governor, and quarterly reports to the Governing Board of the Banco Central de Timor-Leste.
The Petroleum Fund Law sets limits on the use of derivative financial instruments whereby derivatives may only be used to reduce the risk to the Fund or to efficiently facilitate the desired exposure to an asset, and whereby the risk arising from the use of the derivatives may not be
higher than would result from direct exposure to the underlying assets. As such, the objective of using derivative instruments is to reduce financial risks and costs associated with implementing the investment strategy. The Petroleum Fund does not enter into or trade financial
instruments, including derivative financial instruments, for speculative purposes. The individual investment mandates set by the Investment Advisory Board include rules for the use of derivatives within these legal requirements.
Investment strategy
The Petroleum Fund’s objective is to meet benchmark returns on its capital within the risk limit provided in mandates and within the limits established in Articles 14 and 15 of the Petroleum Fund Law relating to Investment Policy and Investment Rules.
The investment strategy of the Petroleum Fund is determined by the Minister of Finance based on advice and recommendations from the Investment Advisory Board.
At the Investment Advisory Board meeting held on 28 June 2012 the decision was made by the Board to expand the public equity exposure by 0.83 a month over a period of two years to 30 June 2014 to achieve 40 equity exposure. The equity exposure as at 31 December 2013
was 36 26: 2012. The Petroleum Fund investment portfolio of assets at fair value through profit or loss including cash and cash equivalents complied with the
legislative and contractual requirements throughout the period.
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Petroleum Fund of Timor-Leste Notes to the financial statements
for the year ended 31 December 2013
12 Financial risk and management objectives and policiescontinued
a Operational risk
Operational risk is the risk of direct or indirect loss arising from a wide variety of causes associated with the processes, technology and infrastructure supporting the Petroleum Fund’s activities with financial instruments either internally within the entities that manage the
Petroleum Fund or externally with the Petroleum Fund’s service providers, and from external factors other than credit, market and liquidity risks, such as those arising from legal and regulatory requirements and generally accepted standards of investment management behaviour.
The Banco Central de Timor-Leste, as the operational manager of the Petroleum Fund, manages the operational risks associated with the operations of the Petroleum Fund. Operational risk management includes policies that describe the standard of conduct required of staff, and
specific internal control systems designed around the particular characteristics of the Petroleum Fund. Operational risk management is built into the policies and procedures of the Petroleum Fund Management Department, including periodically identifying and monitoring
operational risks at the Banco Central de Timor-Leste, the external managers, the global custodian and other key service providers.
The overall standards for the management of operational risk include the following: •
Requirements for appropriate segregation of duties between various functions, roles and responsibilities. •
Requirements for the monitoring of transactions •
Compliance with regulatory and other legal requirements •
Documentation of controls and procedures •
Requirements for the periodic assessment of operational risk faced •
Ethical and business standards The Banco Central de Timor-Leste’s assessment over the adequacy of the controls and processes in place at the external managers and other
service providers with respect to operational risk is carried out via ad hoc discussions with service providers and a review of the service providers’ ISAE16 reports on internal controls, if available.
Compliance with policies and departmental internal control systems is managed by an internal audit function, and there is specific provision in the daily management reports prepared by the Risk Management Division for the reporting of all issues that arise in connection with
operational matters. The purpose of this section of the reports is to notify senior management promptly of unexpected operational issues, and provide senior management with the opportunity to provide advice or take remedial action.
J.P. Morgan was appointed custodian of the Petroleum Fund in June 2008. As part of the custodial agreement their responsibilities include holding the Petroleum Funds assets. Substantially all the assets of the Petroleum Fund are held by J.P. Morgan. Bankruptcy or insolvency of
the Petroleum Fund’s custodian may cause the Fund’s rights with respect to the securities held by the custodian to be delayed or limited. Banco Central de Timor-Leste monitors the credit ratings and capital adequacy of its custodian and reviews custodial performance against the
measures in a service level agreement on a quarterly basis.
Specific due diligence on operational risk is also undertaken as part of the external manager appointment process, and ISAE16 reports are obtained from external managers that evidence the ongoing effectiveness of their internal control systems.
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