Risk Management Framework
The Board of Directors has overall responsibility for the establishment and oversight of the Group’s risk management framework. The Board has established the Audit Sub- Committee, which is responsible for developing and monitoring the Group’s risk management policies. The committee reports regularly to the Board of Directors on its activities.
The Group’s risk management policies are established to identify and analyse the risks faced by the Group, to set appropriate risk limits and control, and to monitor risks and adherence to limits. Risk management policies and systems are reviewed regularly to reflect changes in market conditions and the Group’s activities. The Group, through its training and management standards and procedures, aim to develop a disciplined and constructive control environment in which all employees understand their roles and obligations.
Risk management is also carried out by Group Finance & Audit Division (GFAD). The GFAD monitors compliance with the Group’s risk management policies and framework in relation to risks faced by each company in the Group. A Risk and Compliance Officer who is also part of the Audit Sub-Committee, is responsible for monitoring compliance with Group risk management policies and procedures and for reviewing the risk management framework in relation to the risks faced by the Group. The Group management team is assisted in these functions by an Internal Audit function (established by the Company and an outsourced internal audit team for Merchant Finance & Investment Company Limited) which undertakes both regular and ad-hoc reviews of management controls and procedures, the results of which are reported directly to the Audit Sub-Committee of the Board.
(a) Market risk
Market risk is the risk that changes in market prices, such as interest rate, equity prices, foreign exchange rates and credit spreads will affect the group’s income or the value of its holdings of financial instruments. The objective of market risk management is to control market risk exposures within acceptable parameters while optimising the return on risk.
Unfavourable changes to duty and tax regulations may expose the Group to a decline in revenues. To minimise this risk, the Group implements appropriate strategies to ensure that products and prices remain attractive. The Group operates in Fiji and Papua New Guinea, and changes to governments and the policies they implement affect the economic situation and ultimately the revenues of the Group. To address this, the Group reviews its pricing and product range regularly and responds appropriately to these changes.
(i). Foreign exchange risk
The Group undertakes certain transactions denominated in foreign currencies hence exposures to exchange rate fluctuations arise. Exchange rate exposures are closely managed within approved policy parameters. Major foreign exchange transactions relate to importation of goods and services with settlement based on spot rates. Foreign currency risk arises from recognised assets and liabilities that are denominated in a currency that is not the Group’s functional currency (refer note 2.4)
Pacific Cement Ltd and Basic Industries Ltd operate in Fiji and procure assets, raw materials and supplies from principal suppliers based predominantly in New Zealand, Australia and Japan. Basic Industries (PNG) Limited and Media Nuigini Limited operate in PNG and procure assets and supplies from principal suppliers based predominately in Fiji, New Zealand and Australia. As a measure, prompt settlement of liabilities (and assets if necessary) is exercised by management to minimise the exposure to foreign exchange losses. As an additional measure, the companies negotiate competitive rates with their bankers to minimise losses and maximise gains when foreign exchange receipts and payments become due.
The Group’s exposure to foreign exchange risk is not material.
(ii). Price risk
The Group is exposed to equity securities price risk because of investments held by the Group and classified on the consolidated balance sheet either as available-for-sale or at fair value through profit or loss. To manage its price risk arising from investment in equity securities, the Group diversifies its portfolio. Diversification of the portfolio is done in accordance with the limits set by the Group.
The Group’s investments in equity of other entities that are publicly traded are quoted on the South Pacific Stock Exchange.
(iii). Interest rate risk
The principal risk to which investments and lending portfolios are exposed is the risk of loss from fluctuations in future cash flows or fair values of financial instruments because of a change in market interest rates. Interest rate risk is managed principally through monitoring interest rate gaps and by having pre-approved limits from re-pricing bonds.
In Merchant Finance & Investment Company Limited (MFICL) the management of interest rate risk against interest rate gap limits is supplemented by management’s regular monitoring of the sensitivity of MFICL financial assets and liabilities to various standard interest scenarios and market offerings.
Interest rate risk is managed through: 1) investments; 2) loan pricing; and 3) deposit pricing. MFICL always tries to maintain an interest spread that it believes is sufficient to cater for the risk it is taking and is above the cost of its funds and is sufficient to cover operating costs. Interest spread is monitored monthly and is submitted to the Reserve Bank of Fiji (RBF) for monitoring purposes.
The carrying amounts of the Company’s and Group’s financial instruments are set out below:
As all the above loans are fixed interest, neither the Company nor the Group is subject to material interest rate risk.
(b) Credit risk
Credit risk is the risk of financial loss to the group if a customer or counterparty to a financial instrument fails to meet its contractual obligations, and arises principally from the group’s receivables and loans and advances to customers and investees.
Credit risk arises from cash and cash equivalents, deposits with banks and financial institutions, including outstanding receivables and committed transactions. For potential rental tenants, a screening process, similar to a due diligence is performed, prior to their being granted leases. Checks are made as to their background, as well as their credit histories, with the Data Bureau. For banks and financial institutions, only reputable parties are acceptable. As far as practicable, if wholesale customers are independently rated, these ratings are used. Otherwise, if there is no independent ranking, risk control assesses the credit quality of the customer, taking into account its financial position, past experience and other factors. Individual risk limits are set based on internal or external ratings in accordance with set limits. The utilisation of credit limits is regularly monitored. Sales to retail customers are settled in cash or using major credit cards.
The summary of the Group’s exposure to credit risk is as follow:
The details of impairment provisions for loans and receivables are provided for in Notes 12 and 13.
Details relating to MFICL are set out below:
Financial assets relating to MFICL classified as neither past due nor impaired are fully operational loan facilities. Management reviews all accounts at balance date and where necessary makes a provision for impairment.
Financial assets classified as past due but not impaired are further classified as Standard or Special Mention with arrears below 60 days. These accounts are closely monitored to ensure that they do not deteriorate further. Security inspections are undertaken on these accounts to verify the value of the collateral pledged. These assets are monitored by specialist collection teams on a daily basis and further monitored by management at each month end. Where necessary management restructures these loans to enhance recovery.
Individually assessed loans are those that have arrears exceeding 60 days and/or those which in the view of management have a higher probability of failure in the near term beyond its control and where a loss is expected to arise.
In order to manage credit risk, MFICL closely monitors existing customers in ensuring a debt service ratio greater than 1 and loan value ratio of 85% is maintained and ensuring that all new customers go through comprehensive credit screening including Data Bureau checks. Furthermore, customer accounts are graded internally and all existing customers are categorised as excellent, good, satisfactory or limited. Further the individual accounts/customer groups are classified as Standard, Special Mention, Sub Standard, Doubtful and Loss for credit risk management purposes. All loans and advances are secured by collateral.
MFICL employs a range of policies and practices to mitigate credit risk with the most common practice being the taking of collateral with guidelines on the acceptability of specific classes of collateral for credit risk mitigation. The principal collateral types for loans and advances are:
- Mortgages over residential properties.
- Hire Purchase Agreements and Bill of Sale over vehicles and machinery.
- Charges over business assets such as premises, inventory and accounts receivable.
- Charges over financial instruments such as debt securities and equities and term deposits.
Longer-term finance and lending to corporate entities are generally secured. In addition, in order to further minimise the potential for credit loss MFICL will seek additional collateral from the counterparty once impairment indicators are identified for the relevant individual loans and advances.
Collateral held as security for financial assets other than loans and advances depends on the nature of the instrument.
Credit risk concentration
The credit risk concentration for MFICL is as follows:
Credit concentration is determined based on the industry for which the loan is given.
(c) Liquidity risk
Liquidity risk is the risk that the Group will encounter difficulty in meeting its obligations arising from its financial liabilities. Prudent and careful management of the Group’s liquidity position is essential in order to ensure that adequate funds are available to meet the Group’s ongoing financial obligations.
A summary of the contractual maturity analysis of the Group’s borrowings and other non-derivative financial liabilities as at 30 June is set out below on an undiscounted basis including estimated interest payments:
Additional details relating to MFICL are set out below:
In order to comply with the Reserve Bank’s requirements and the Banking Act 1995, MFICL must hold as liquid deposits an amount equivalent to 10% of its total borrowed funds. The MFICL Board ensures that the investment standalone is sufficient to meet the Unimpaired Liquid Assets Ratio requirements which are covered entirely by long term bonds.
The daily liquidity position is monitored. For MFICL, the key measure used for managing liquidity risk is the ratio of net liquid assets to deposits from customers. Monthly maturity mismatch reports are prepared and analysed. Maturity reports of term deposits are actioned via pre-analysis (calling customer to determine the status of re-investment) and MFICL Board Asset and Liability Committee (ALCO) is kept informed.
MFICL Liquidity exposure is measured by calculating its Net Liquidity Gap and by comparing current ratios with targets. MFICL Board/ ALCO monitors the Company’s liquidity position by reviewing the Net Liquidity Gap expressed as a percentage of liabilities:
The Cash Reserve ratio is calculated by expressing cash reserves (comprising of cash book balance and short term deposits) as a percentage of total deposits. Other ratios are calculated according to RBF guidelines on liquidity risk management for credit institutions. The loans to deposit ratio and unimpaired liquid assets ratio are monitored daily whilst other ratios are monitored monthly.
Any variance in the above ratios are actioned immediately by management.
Capital risk management
The Group’s objectives when managing capital are to safeguard the Group’s ability to continue as a going concern in order to provide returns for shareholders and benefits for other stakeholders and to maintain an optimal capital structure to reduce the cost of capital and be in compliance with statutory requirements.
In order to maintain or adjust the capital structure, the Group may adjust the amount of dividends paid to shareholders, return capital to shareholders, issue new shares or sell assets to reduce debt.
The Group monitors capital on the basis of the gearing ratio. This ratio is calculated as net debt divided by total capital. Net debt is calculated as total borrowings (including ‘current and non-current borrowings’ as shown in the consolidated statement of financial position) less cash and cash equivalents. Total capital is calculated as ‘equity’ as shown in the consolidated statement of financial position plus net debt.
The gearing ratio of the Group at balance date is as follows:
MFICL is subject to externally imposed capital requirements by the Reserve Bank of Fiji. MFICL’s objectives when managing capital are:
- To comply with the capital requirements set by the Reserve Bank of Fiji:
- To safeguard the company’s ability to continue as a going concern so that it can continue to provide returns for shareholders and benefits for other stakeholders; and
- To maintain a strong capital base to support the development of the business.
Capital adequacy and the use of regulatory capital are monitored daily by MFICL’s management, employing techniques based on the guidelines developed by the Basel Committee as implemented by the Reserve Bank of Fiji, for supervisory purposes.
The Reserve Bank of Fiji requires MFICL to (a) hold at least 10% of its total holdings in liquid assets and (b) maintain a ratio of total regulatory capital to risk-weighted assets at or above 15%. MFICL complied with these requirements during the year.
MFICL also measures its Credit Loss Reserve requirement on an annual basis and during the current year transferred an amount of $621,000 to this reserve in compliance with Reserve Bank of Fiji guidelines.