The Agency is responsible for risk management of the Discretionary Portfolio. In relation to the Directed Portfolio, the Agency’s responsibility is to implement directions from the Minister for Finance and to value relevant securities for the purpose of the Fund’s financial statements, as such, references to the Fund in this note refer to the Discretionary Portfolio.

The base currency of the Fund is euro. The measured returns and monitored portfolio risks are aggregated in euro.

In the ordinary course of its activities, the Agency actively manages a variety of financial risks including investment risk, market risk, credit risk and liquidity risk.

The Agency Risk Management Policy and Framework defines mandatory, high-level minimum standards and definitions for risk management that apply to all parts of the Agency and across all risk categories. These standards are then implemented through the detailed policies and procedures that govern the management of individual risk categories and / or risk management processes.

The Agency Risk Management Framework is predicated on the three-lines-of-defence model and its organisational structure and risk committee structure are aligned in order to establish clear ownership and accountabilities for risk management.

As the first line of defence, the Agency’s Business Units and Corporate Functions are primarily responsible for managing risks on a day-to-day basis, taking into account the Agency’s risk tolerance and appetite and in line with its policies, procedures, controls and limits.

The second line, which includes the Agency’s Risk Management, Compliance and other control functions, is independent of first line management and operations and its role is to challenge decisions that affect the organisation’s exposure to risk and to provide comprehensive and understandable information on risks.

The third line includes the Internal Audit function which provides independent, reasonable, risk based assurance to key stakeholders on the robustness of the NTMA’s risk management system, governance and the design and operating effectiveness of the internal control environment.

All three lines of defence integrate at the Agency level. A number of Agency and management committees, including the Audit and Risk Committees and the Risk sub-committees, support the Agency in discharging its responsibilities in relation to risk management.

Agency committees:

NTMA Investment Committee

The Investment Committee comprises non-executive members and is responsible for overseeing the Fund’s investment strategy. The role of the Investment Committee is described in Note 14.2.

Agency Risk Committee (ARC)

The ARC comprises members of the Agency and reviews the Agency’s overall risk identification and assessment processes. It sets a standard for the accurate and timely monitoring of critical risks and reviews reports on any material breaches of risk limits and the adequacy of any proposed action.

Agency Audit Committee

The Agency Audit Committee assists the Agency in the oversight of the quality and integrity of the Agency’s financial statements and reviews and monitors the effectiveness of the systems of internal control, the internal audit process and the compliance function, and reviews and considers the outputs from the statutory auditor.

The ARC and the Agency Audit Committee merged on 1 February 2017.

Management committees:

Portfolio Management Committee (PMC)

The first line of defence includes the PMC which comprises senior members of the Fund investment team. The core functions of the PMC are to consider and make investment recommendations to the Agency Investment Committee and provide management oversight of the Fund’s investments. The Fund’s internal investment process seeks to ensure all investment opportunities are thoroughly evaluated in terms of commerciality, capacity to generate a suitable economic impact and appropriateness in the context of the overall Fund.

Enterprise Risk Management Committee (ERMC)

The ERMC is a management committee which oversees the implementation of the Agency’s overall risk appetite and senior management’s establishment of appropriate systems (including policies, procedures and risk limits) to ensure enterprise risks are effectively identified, measured, monitored, controlled and reported.

Counterparty Credit Risk Committee (CCRC)

The CCRC oversees and advises the EMRC on counterparty credit risk exposures. It provides dashboard reporting of relevant counterparty credit risk exposures and details to the ERMC. It formulates policy and it implements and monitors compliance with the Agency Counterparty Credit Risk Management Policy and ensures that all appropriate actions are taken in respect of any breaches.

Market and Liquidity Risk Committee (MLRC)

The MLRC oversees and advises the ERMC on market and liquidity risk exposures. It provides dashboard reporting of relevant market risk and liquidity risk exposures and details to the ERMC. It formulates, implements and monitors compliance with the market and liquidity risk aspects of the Agency’s Risk Management framework and policies and ensures that appropriate actions are taken in respect of relevant policy or any breaches.

Operational Risk and Control Committee (ORCC)

The ORCC is a management committee that reviews and recommends to the ERMC for approval the operational risk management framework and associated operational risk policies. The ORCC monitors, reviews and challenges the NTMA’s operational risks and reports on operational risk management to the ERMC.

15.1 Investment risk

Investment risk is the risk that actual investment performance deviates from relevant strategies. The Agency has an open appetite for investment risk where it is willing to consider all potential delivery options and choose the one that is most likely to result in successful delivery while also providing an acceptable level of risk-adjusted reward.

Any deviations from relevant investment mandates could result in sub-optimal investment returns or actual capital losses on original outlays. It is therefore vital the ongoing management of investment risk is fully integrated into the activities and objectives of the Fund. While investment risk may arise from insufficiently robust internal assessment or monitoring processes, it can also arise from a variety of external sources such as adverse macro-economic or market developments, regulatory shocks, underperformance of individual investments or fraud.

Investment risk includes the following sub-categories:

• Investment process risk: risk of incurring sub-optimal returns or capital losses due to insufficiently robust assessment or approval processes of investment proposals or subsequent monitoring of transactions;
• Economic impact risk: risk that the economic impact objective of the investment strategy does not materialise;
• Permanent capital loss risk: risk of loss of control over a particular investment or that there are illiquid markets at the time of investment exit; and
• Portfolio concentration risk: risk associated with an over-concentration as a result of the pursuit of an investment strategy including economic / industry sector, geography, counterparty etc.

The NTMA Investment Risk Policy is applicable to the Fund.

15.2 Market risk

Market risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. Sub-categories of market risk include interest rate risk, foreign exchange risk and market price risk.

The Fund has adopted a GPTS, which is designed to provide adequate liquidity to allow the Fund’s transition into an Irish focused portfolio in line with the ISIF’s mandate.

The Fund uses derivatives to manage its exposure to foreign currency, interest rate and other price risks. The instruments used include interest rate swaps, forward contracts, futures and options. The Fund does not apply hedge accounting.

i) Interest rate risk

Interest rate risk is the risk that movements in interest rates may adversely impact the value of an underlying financial instrument or may impact the cashflows of the Fund.

Interest rate exposure

The following table details the value of fixed-interest bearing securities in the Discretionary Portfolio exposed to the risk fair value may change consequent to a change in interest rates as at 31 December:

This table reflects the portion of financial securities exposed to the risk fair value may change as a result of changes in interest rates. For disclosure purposes, fixed-interest bearing assets are included in exposures to both price and interest rate risk. The table does not reflect any potential exposure to changes in interest rates relating to investments held in investment funds.

In addition to the interest-bearing securities detailed in the table above, the Fund holds investment cash including cash and cash equivalents of €0.4bn (2015: €1.7bn) (Note 12) and liquid funds of €1.0bn (2015: €1.5bn). These assets are interest-bearing and the future cash flows from these assets will fluctuate with changes in market interest rates.

Sensitivity analysis

The sensitivity analysis below reflects how net assets would have been affected by changes in the relevant risk variable that were reasonably possible at the reporting date. Management has determined that a fluctuation in interest rates of 50 basis points is reasonably possible, considering the economic environment in which the Fund operates.

The table below sets out the effect on the Fund’s fixed interest bearing securities of an increase of 50 basis points in interest rates at 31 December. A reduction in interest rates of the same amount would have resulted in an equal but opposite effect to the amounts shown. The impact results primarily from the decrease in the fair value of fixed rate securities. This analysis assumes a linear interest rate curve and that all other variables remain constant.

ii) Foreign exchange risk

Foreign exchange risk is the risk that movements in exchange rates affect the underlying value of assets, liabilities and derivative instruments that are denominated in a currency other than euro. The present value of future cash flows will fluctuate with changes in exchange rates which can also impact future cashflows.

The Fund has outstanding commitments in respect of property and private equity investments of USD 198m and JPY 16m at 31 December 2016 (USD 181m and JPY 16m at 31 December 2015).

Foreign exchange risk management

The Fund seeks to manage its foreign currency risk using forward foreign exchange contracts and cross currency swaps. The profit / loss on these forward foreign exchange contracts and cross currency swaps offsets the change in the value of the Fund’s non-euro investments due to exchange rate movements.

Foreign exchange risk exposure

The following table details the asset value in the Discretionary Portfolio exposed to currency risk both before and after the impact of the currency hedge. In relation to holdings in investment funds, it details the base currency of the relevant fund. When appropriate, the Agency manages the exposure generated by the underlying investments of a fund in addition to its base currency.

*Other is made up of several currencies including Malaysian ringgit, Indonesian rupiah and Thailand baht.

Sensitivity analysis

The table below sets out the effect on the net assets of a reasonably possible weakening of the US dollar against the euro by 5% (2015: 5%) at 31 December 2016. The analysis assumes that all other variables, in particular interest rates, remain constant.

A strengthening of the US dollar against the euro would have resulted in an equal but opposite effect to the amounts shown above.

iii) Market price risk

Market price risk is the risk resulting from a change in the value of investments due to changes in the prices of securities unrelated to interest rate or exchange rate changes, such as equities and commodities.

Market price risk exposure

The asset value in the Discretionary Portfolio exposed to market price risk at 31 December is the value of financial investments as detailed in the following table:

Market price risk management

A geographical analysis of the Fund’s Discretionary Portfolio exposed to market price risk is shown below. Fund investments are shown based on their relevant country of incorporation. The Agency monitors the market price risk inherent in the investment portfolio by ensuring full and timely access to relevant information from the Fund’s investment managers. The Agency meets investment managers regularly and at each meeting reviews relevant investment performances.

Exposure

The following table sets out the concentration of the Discretionary Portfolio’s financial assets and liabilities of the Fund exposed to market price risk by instrument type as at the reporting date.

Sensitivity analysis

The table below sets out the effect on the net assets of the Discretionary Portfolio of a reasonably possible weakening in market prices of 5% at 31 December 2016. The estimates are made on an individual investment basis. The analysis assumes that all other variables, in particular interest and foreign currency rates, remain constant.

15.3 Credit risk

Credit risk arises from the risk that a borrower or counterparty will fail to perform on an obligation leading to a loss of principal or financial reward.

The main direct credit risk to which the Fund is exposed arises from the Fund’s investments in debt securities. The Fund is also subject to counterparty credit risk on cash and cash equivalents, balances due from brokers, trading derivative products, trade and other receivables and loans and receivables.

Credit risk management

In managing credit risk the Agency seeks to minimise the impact of credit default on the Fund’s financial assets. The Fund aims to mitigate its credit risk exposure by monitoring the size of its credit exposure to, and the creditworthiness of, counterparties. Counterparties are selected based on their overall suitability, financial strength, regulatory environment and specific circumstances.

To control the exposure to the Fund in the event of default, investments are made across a variety of industry sectors and issuers to reduce credit risk concentrations.

The Fund’s Global Custodian, Bank of New York Mellon, holds the Fund’s securities in segregated accounts, where required, minimising the risk of loss of the securities held by the Global Custodian. In the event of the Global Custodian’s failure, the ability of the Fund to transfer the securities might be temporarily impaired. The Fund’s Global Custodian is a member of a major securities exchange and at 31 December 2016, held a long-term Moody’s credit rating of A1. The Agency monitors the credit rating and Service Organisation Control (SOC 1) reporting of its Global Custodian on a regular basis.

At 31 December 2016, cash held at the Central Bank of Ireland was €139m (2015: €1,169m) and with the Global Custodian was €255m (2015: €112m) (Note 12).

The direct exposure to credit risk in the Discretionary Portfolio at 31 December 2016 is the carrying value of the financial securities as set out below.

i) Cash and cash equivalents

The Fund’s cash and cash equivalents are held mainly with the Central Bank of Ireland and the Global Custodian, which are respectively rated AAA (2015: AAA) based on ECB rating and A1 (2015: A1) based on Moody’s ratings.

ii) Balances due from brokers

Balances due from brokers represent margin accounts, cash collateral for borrowed securities and sales transactions awaiting settlement. Counterparty credit risk relating to unsettled transactions is considered small due to the short settlement period involved and the high credit quality of the brokers used. As at 31 December 2016, €39m was due from brokers.

iii) Debt securities

At 31 December, the Fund had invested in debt securities issued by entities with the following external credit rating*:

*Where Moody’s credit rating is not available Standard and Poor’s rating is used.

iv) Loans and receivables

The credit risk of loans and receivables is reviewed as part of the impairment review process.

v) Trade and other receivables

Primarily comprises of accrued interest on fixed income securities and amounts due within one year from the sale of private equity investments.

vi) Derivatives

The table below outlines an analysis of derivative assets outstanding at 31 December:

Collateral and other credit enhancements, and their financial effect

The Fund mitigates the credit risk of derivatives and reverse sale and repurchase agreements by entering into master netting agreements and holding collateral in the form of cash and marketable securities.

Derivatives

Derivative transactions are either transacted on an exchange (through a broker) or entered into under International Derivatives Swaps and Dealers Association (ISDA) master netting agreements. Under ISDA master netting agreements in certain circumstances, e.g. when a credit event such as a default occurs, all outstanding transactions under the agreement are terminated, the termination value is assessed and only a single net amount is due or payable in settlement of all transactions.

Derivative financial instruments generating counterparty credit risk arise from the Fund’s forward foreign exchange contracts and cross currency swap contracts. The Fund’s forward foreign exchange contracts and cross currency swaps were entered into only with approved counterparties within defined limits. In order to mitigate the credit risks arising from derivative transactions, the Fund enters into Credit Support Annexes (CSA) with its market counterparties. CSAs require the posting of collateral by counterparties in specified circumstances.

Forward foreign exchange contracts and cross currency swaps are settled through Continuous Linked Settlement (CLS) where trades are pre-matched ahead of settlement date limiting the risk of settlement failure.

The Fund’s activities may give rise to settlement risk, which is the risk that on a settlement date a counterparty fails to pay the Fund the agreed terms of a transaction. For the majority of transactions, the Fund mitigates this risk by conducting settlements through a broker to ensure that a trade is settled only when both parties have fulfilled their contractual settlement obligations.

15.4 Liquidity risk

Liquidity risk is the possibility that over a specific time horizon, the Fund will have insufficient cash to meet its obligations as they fall due. Sub-categories of liquidity risk include funding liquidity risk, refinancing risk, maturity concentration risk and market liquidity risk.

The Fund’s policy in managing liquidity is to ensure, as far as possible, it will always have sufficient liquidity under both normal and stressed conditions without incurring unacceptable losses or risking damage to the Fund’s reputation.

The Agency Liquidity Risk Management Policy is applicable to the Fund. This policy sets out the minimum acceptable standards to be adhered to by those responsible for treasury transactions which give rise to liquidity risk within the Agency.

The Fund’s investments in listed securities are considered to be readily realisable because they are traded on major stock exchanges.

The Fund’s financial assets include unlisted equity investments, which are generally illiquid. In addition, the Fund holds investments in unlisted investment funds, which may be subject to redemption restrictions. As a result, the Fund may not be able to liquidate some of its investments in these instruments in due time to meet its liquidity requirements.

At 31 December 2016, the Fund was predominantly invested in readily realisable assets.

15.5 Operational risk

Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events which would affect the Fund’s ability to execute its business strategy. Sub-categories of operational risk include people risk, governance risk, third party risk, business continuity management and legal and compliance risk.

An Operational Risk Management and Risk and Control Self-Assessment Framework is applicable to the Agency as a whole. The objective of this framework is to ensure that operational risk is managed in an appropriate and integrated manner across the organisation. This framework outlines the strategy, processes, risk criteria, controls and governance structures in place for managing operational risks within the Agency.

The framework also sets out the methodology for the Risk and Control Self Assessment process which describes the process for adequate and timely identification, assessment, treatment, monitoring and reporting of the risks posed by the activities of the Agency.

The NTMA Business Continuity Management Committee is a sub-committee of the Operational Risk and Control Committee. The role of this committee is to ensure an appropriate and consistent approach to business continuity management across the Agency and providing a supporting role in establishment, implementation, monitoring and improvement of business continuity management activities.

The assessment of the adequacy of the controls and processes in place at the Fund’s service providers with respect to operational risk is carried out via regular discussions with the relevant service providers and a review of the service providers’ SOC 1 reports on internal controls, if any are available. The Agency reviews the findings documented in the SOC 1 report on the Global Custodian’s internal controls annually.

15.6 Capital management

The Fund is not subject to externally imposed capital requirements.

15.7 Fair Values of Financial Instruments

i) Valuation models

The fair values of financial assets and financial liabilities that are traded in active markets that the Fund can access at the measurement date are obtained directly from an exchange on which the instruments are traded. For all other financial instruments, the Fund determines fair values using other valuation techniques.

For financial instruments that trade infrequently and have little price transparency, fair value is less objective and requires varying degrees of judgement depending on liquidity, uncertainty of market factors, pricing assumptions and other risks affecting the specific instrument.

The Fund measures fair values using the following fair value hierarchy that reflects the significance of the inputs used in making the measurements:

• Level 1: Inputs that are quoted market prices (unadjusted) in active markets for identical instruments;
• Level 2: Inputs other than quoted prices included within Level 1 that are observable either directly (i.e. as prices) or indirectly (i.e. derived from prices). This category includes instruments valued using quoted market prices in active markets for similar instruments, quoted prices for identical or similar instruments in markets that are considered less than active or other valuation techniques in which all significant inputs are directly or indirectly observable from market data; and
• Level 3: Inputs that are unobservable. This category includes all instruments for which the valuation technique includes inputs not based on observable data and the unobservable inputs have a significant effect on the instrument’s valuation. This category includes instruments that are valued based on quoted prices for instruments but for which significant unobservable adjustments or assumptions are required to reflect differences between the instruments.

Valuation techniques may include net present value and discounted cash flow models, comparison with similar instruments for which observable market prices exist and other valuation models. Assumptions and inputs used in valuation techniques may include risk-free and benchmark interest rates, credit spreads and other premia used in estimating discount rates, bond and equity prices, foreign currency exchange rates, equity indices, earnings multiples and revenue multiples and expected price volatilities and correlations.

The objective of valuation techniques is to arrive at a fair value measurement that reflects the price that would be received to sell the asset or paid to transfer the liability in an orderly transaction between market participants at the measurement date.

The Fund uses widely recognised valuation models for determining the fair value of common and simple financial instruments that use mainly observable market data and require little management judgement and estimation. Observable prices and model inputs are usually available in the financial markets for listed debt and equity securities, exchange traded derivatives and simple OTC derivatives. The availability of observable market prices and model inputs reduces the need for management judgement and estimation and reduces the uncertainty associated with the determination of fair values. The availability of observable market prices and inputs varies depending on the products and markets and is prone to changes based on specific events and general conditions in the financial markets.

ii) Valuation framework

The Fund has a management control framework for the measurement of fair values. The valuation process is overseen by the Valuation Committee (“the Committee”), a management committee responsible for developing the Fund’s valuation processes and procedures, conducting periodic reviews of those procedures and evaluating their consistent application. During the year, the Committee comprised of the Chief Financial and Operating Officer, the Chief Risk Officer and other ISIF and Agency senior management personnel. The Valuation Committee assists the Agency in the determination of the valuation of investments of the Fund.

The valuation process and procedures are defined depending on the instrument type. Where third party information is used to measure fair value, reviews are undertaken and documented to support the resulting valuations. This includes:

• verifying that the broker or pricing service is approved by the Fund for use in pricing the relevant type of financial instrument;
• understanding how the fair value has been arrived at and the extent to which it represents actual market transactions;
• when prices for similar instruments are used to measure fair value, understanding how these prices have been adjusted to reflect the characteristics of the instrument subject to measurement; and
• if a number of quotes for the same financial instrument have been obtained, reviewing how fair value has been determined using those quotes.

In addition, an external independent review is conducted of the existence and valuation of the investment positions included in the ISIF Discretionary Portfolio as at 31 December.

The table below analyses financial instruments measured at fair value at the reporting date by the level in the fair value hierarchy. The amounts are based on the values recognised in the Statement of Financial Position. All fair value measurements below are recurring.

The following table shows a reconciliation from the opening balances to the closing balances for fair value measurements in Level 3 of the fair value hierarchy:

< NOTE 14

NOTE 16 >