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Risks (continued)

Operational Risk

Operational risk is defined as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events. Risk events include resource failures or constraints, control and security breaches or failures, transaction errors, compliance breaches, the breakdown of key relationships and disasters.

NZDMO's generic objectives in respect of operational risk are to:

  • mitigate financial and reputational loss arising from operational failure by effectively managing operational risks where it is cost effective to do so, and
  • establish a culture of continuous improvement of operational policies and practices.

Operational risks in NZDMO are managed in a number of ways. Controls include general Treasury policies, NZDMO-specific policies, reporting and performance management requirements, delegations and systems access restrictions. They are supported by close communications and regular management meetings that, in turn, reinforce a strong team ethic. Independent experts provide additional support in managing operational risk.

Market Risk

Market risk is defined as the impact of changes in interest rates or exchange rates on portfolio value.

The objective of NZDMO’s market risk management is to limit this risk within parameters that allow for the achievement of its other financial objectives, including earning a satisfactory rate of return on liquid assets and adding value in its foreign currency execution activities.

NZDMO has implemented an asset and liability matching (ALM) policy to manage risk within its portfolios. The policy aims to minimise the currency and interest-rate risks to NZDMO's revenues and balance sheet, by matching the characteristics of its assets to those of its liabilities, where practicable. The range of instruments used to minimise exposure to market risk includes debt instruments, financial assets, foreign exchange contracts, currency swaps, interest-rate swaps and futures contracts.

NZDMO is exposed to market risk when assets and liabilities are imperfectly matched. The risk is managed through the use of VaR limits and stop-loss limits.

The VaR limit is expressed over daily, monthly and annual time horizons at 95% confidence level and reflects the risk tolerance of the Government in respect of NZDMO's activities. NZDMO uses back-testing to evaluate the performance of the VaR model, and stress-testing is carried out to understand how extreme or unusual events would impact on the portfolio. Monthly, quarterly and annual stop-loss limits are in place to protect NZDMO from further losses once actual losses reach a certain point.

Because NZDMO's liabilities exceed its assets, it also incurs market risk associated with the net volume of outstanding government debt. Fluctuations in the net market value of New Zealand-dollar debt as a result of interest-rate movements are not actively managed, and unmatched debt is accounted for on an amortised cost basis.

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