4.59 Financial risk and management objectives and policies continued

Notes to the financial statements for the year ended 31 December 2015 46

12. Financial risk and management objectives and policies continued

c Liquidity risk Liquidity risk is the risk that the Petroleum Fund may not be able to generate sufficient cash resources to settle its obligations, which would primarily be to fund the state budget account, in full, or can only do so on terms that are materially disadvantageous. To manage this risk, the Ministry of Finance has agreed in the Management Agreement to provide the Central Bank with a forecast of the future cash requirements of the government, including the projected timings and amounts to be transferred from the Fund. Liabilities at the year end were US20.8m 2014: US14.8m and consists of payables for securities purchased but not settled at the year end and management fees payable. These are expected to be settled within 30 days of the year end, but are not considered to create a liquidity risk for the Fund due to available cash which is sufficient to cover these liabilities. The Central Bank monitors the Petroleum Fu nd’s liquidity position on a daily basis. Where there are potential shortfalls, financial assets will be sold to meet anticipated shortfall. The Fund invests primarily in marketable securities and other financial instruments which, under normal market conditions are readily convertible to cash. d 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 BCTL, 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 BCTL, 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 BCTL’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 carri ed 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. BCTL 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 e Derivative financial instruments Derivative financial instruments are used by the Petroleum Fund for risk reduction and asset management purposes. For example, to reduce benchmark risk by equitizing small cash balances which would be uneconomic to invest, hedging settlement exposures, or to hedge various positions and exposures during asset transitions. The Minister has approved the use of equity index futures, fixed income index futures, money market futures, and currency forward contracts.