The Management of Risk

The Treasury's risk management practices use an approach modelled on the joint Australian/New Zealand Standard. Under this approach, a broad range of risks that affect our business are considered, including organisational risks arising from our strategic direction and our operating environment. The Treasury's risk approach is implemented through business processes such as strategy and priority setting, policy advice, operational planning monitoring and reporting and project management.

We oversee and manage our overall set of risks and risk management framework through a Risk and Audit Committee, which includes external members to provide independent perspectives. We are currently improving our risk management approach to ensure that we have a consistent understanding of the strategic risks we face in the context of delivering the results our stakeholders need.

The first stage in lifting our risk management practices is for our leadership to identify our strategic risks, agree their priority ranking and ensure regular review discussions take place. This process will commence with a facilitated workshop.

The Treasury undertakes a number of specialist functions and roles where additional risk management practices and processes are utilised. These include:

NZDMO

NZDMO is managing risks through the use of:

• specialist risk management roles
• a specific risk management framework for the portfolios managed by NZDMO, and
• an independent advisory board to provide quality assurance on NZDMO’s activities, risk management framework and results plan.

NZECO

NZECO is managing risks through the use of:

• expert underwriting analysis by international specialists who have institutional knowledge in risk assessment
• an independent advisory board of specialists in finance and insurance risk assessment, pricing and risk management to review the final analysis and make recommendations for approval of each transaction and undertake ongoing monitoring
• employing (in-house) staff with appropriate banking expertise
• applying robust systems and processes to ensure that risks are analysed consistently and in accordance with our mandate (including our delegation, international regulations, international Export Credit Agency best-practice and risk-based pricing), and
• actively managing risks with the commercial sector (exporters and banks) to mitigate potential issues.

Crown risks in the financial sector

The Treasury manages and administers two guarantee schemes on behalf of the Crown that relate to the financial sector:

• the Retail Deposit Guarantee Scheme (RDGS), and
• the Wholesale Funding Guarantee Facility (WFGF).

RDGS

The initial RDGS was announced on 12 October 2008 for a two-year period, expiring on 12 October 2010. In September 2009, the Government announced the introduction of an extended RDGS for the period from 12 October 2010 to 31 December 2011. Entry to the extended scheme is by application and is limited to deposit takers who have a credit rating of BB equivalent or better.

In addition, with effect from 1 January 2010, the Treasury introduced revised deeds governing the operation of the initial scheme for the period from 1 January 2010 to 12 October 2010. The revised deeds provided additional flexibility to the Treasury in managing the risks associated with the scheme, as well as giving guaranteed entities the option to issue unguaranteed debt securities. The ability to issue unguaranteed securities provides an opportunity for those entities not eligible to participate in the extended scheme to transition off the initial scheme before it expires on 12 October 2010.

Exposure to risks related to the initial scheme are being managed through the prudential regulation processes for registered banks, and by requiring non-bank deposit takers who sign the guarantee to agree to certain controls on their business, including:

• restrictions on distributions to shareholders
• requirements to provide assurance that related party and large transactions are undertaken on arms-length terms
• the ability for the Crown to appoint an inspector and to seek information from a range of parties, including the auditors and trustees of the entities
• the ability for the Crown to withdraw the guarantee on a range of grounds, including if an entity is not being managed prudently, has breached the terms of its trust deed or the Deed of Guarantee or if its business is being conducted in a manner that is otherwise inconsistent with the intentions of the Crown in entering into the guarantee, and
• personal undertakings from directors to ensure the non-bank deposit takers comply with the guarantee.

Non-bank deposit-taking institutions whose depositors are covered by the retail deposit guarantee are also subject to regular financial reporting requirements, on at least a monthly basis. That reporting forms the basis for ongoing monitoring under the guarantee scheme and, where appropriate, the Treasury follow-up of any issues identified on a case-by-case basis. Banks whose depositors are covered by the scheme are monitored under the prudential supervision regime that applies to banks under the Reserve Bank Act 1989.

WFGF

The Government announced the introduction of the WFGF in November 2008.

On 10 March 2010, the Government announced that the WFGF was being terminated with effect from 30 April 2010 and that no further guaranteed issuance would be approved from that date.

Although no new guaranteed issues are being approved after 30 April 2010, the guarantees for existing issues remain in force until the earlier of the scheduled maturity or five years from the date of issue.

The registered banks approved under the WFGF were also all approved under the Crown RDGS. In addition to the risk management under the retail scheme, the Government further manages its risk exposure by:

• limiting the availability of the scheme to financial institutions that have an investment grade credit rating (BBB- or better), and have substantial New Zealand borrowing and lending operations (but not to institutions that are simply financing a parent or related company)
• limiting the amount of debt covered by the guarantee to debt up to 125% of the total stock of eligible types of debt in issue prior to the intensification of the crisis
• establishing additional capital buffers by requiring an additional 2% Tier 1 capital buffer above the 4% regulatory minimum, and
• requiring the debt issuer to hedge and manage any foreign exchange risk.