Note to Executive Board representatives

Focal points:

Technical questions: Dispatch of documentation:

Alvaro LarioAssociate Vice-PresidentChief Financial Officer and Chief ControllerFinancial Operations DepartmentTel.: +39 06 5459 2403e-mail: a.lario @ifad.org

Domenico NardelliDirector and TreasurerTreasury Services DivisionTel.: +39 06 5459 2251e-mail: d.nardelli@ifad.org

Deirdre McGrenraChiefGoverning BodiesTel.: +39 06 5459 2374e-mail: gb@ifad.org

Jose Morte MolinaChief Risk OfficerFinancial Operations DepartmentTel.: +39 06 5459 2561e-mail: j.mortemolina@ifad.org

Executive Board — 125th SessionRome, 12-14 December 2018

For: Information

Document: EB 2018/125/R.47/Add.1

EAgenda: 6(f)

Date: 31 October 2018

Distribution: Public

Original: English

Internal Control Framework forIFAD Investments

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Contents

Abbreviations and acronyms iiPreamble iiiI. Overview of internal control best practices 1II. Control environment: Organizational structure, roles and

responsibilities 1A. Actors and their roles 1B. Investment-related roles and responsibilities in IFAD 3C. Investment policies, procedures, guidelines and agreements 7

III. Risk assessment, control, information and communication, andmonitoring activities 10A. Risk identification 10B. Risk measurement and management 11C. Control, information and communication, and monitoring activities 17

Annexes

I. Rules of procedure and terms of reference of the Investment andFinance Advisory Committee (FISCO) (high-level committee) 19

II. Reference to the new principles in the COSO InternalControl – Integrated Framework in the context of IFAD’sinvestment-related activities 21

III. Glossary of risk measures and related terms 24

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Abbreviations and acronyms

ACD Accounting and Controller's DivisionAVP/FOD Associate Vice-President, Financial Operations DepartmentCM Cash Management teamCOSO Committee of Sponsoring Organizations of the Treadway CommissionCVaR Conditional Value at RiskERM Enterprise Risk ManagementFISCO Investment and Finance Advisory CommitteeFMD Financial Management Services DivisionFOD Financial Operations DepartmentICF Internal Control FrameworkIFI International Financial InstitutionIM Investment Management teamIPS Investment Policy StatementMLR minimum liquidity requirementPPL Portfolio Planning TeamRCF Risk and Compliance FunctionTRE Treasury Services Division

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Preamble1. The Internal Control Framework (ICF) for IFAD Investments was first presented to

the 104th Executive Board in December 2011 in conjunction with IFAD’s InvestmentPolicy Statement (IPS). While the IPS provides an overall framework for themanagement of IFAD investments, the ICF provides additional informationpertaining to the internal control structures in place.

2. The first annual review of the IPS was presented for approval at the 107th sessionof the Executive Board in December 2012. Prior to that session, at its 125th

meeting in November 2012, the Audit Committee requested that the annuallyrevised ICF accompany the annually updated IPS for completeness.

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Internal Control Framework for IFAD Investments

I. Overview of internal control best practices1. Internal controls form an integral part of any organization's financial and business

policies and procedures. The Internal Control Framework (ICF) for IFAD Investmentsis based on the widely used Internal Control – Integrated Framework issued by theCommittee of Sponsoring Organizations of the Treadway Commission (the COSOFramework). Although not independently audited or certified in compliance with theCOSO Framework, the ICF refers to the COSO Framework for guidance on format.

2. The COSO Framework sets out five components with 17 associated principles. Thesecomponents are defined as follows:

(i) Control environment: organizational values and culture; policies;organizational structure. The control environment is the foundation for allother components of internal control;

(ii) Risk assessment: identification and measurement of threats, and responsesto them;

(iii) Control activities: the policies and procedures that help ensure managementdirectives are carried out;

(iv) Information and communication: reliability, timeliness, clarity, usefulness;and

(v) Monitoring activities: processes used to assess the quality of internalcontrol performance over time.

3. This paper describes how these five components pertain to activities related to theICF. Section II focuses on aspects of the control environment, specific organizationalstructure, and roles and responsibilities of the various key players. Section IIIdescribes the risk assessment, control, information and communication, andmonitoring activities.

4. Annex II links the 17 COSO Framework principles to various investment-relatedpolicies and procedures as well as to relevant sections of the ICF itself.

II. Control environment: Organizational structure, rolesand responsibilities

A. Actors and their roles5. According to the Framework, everyone in an organization has responsibility for

internal control to some extent. Virtually all employees produce information used inthe internal control system or take other actions needed to effect control. Thisresponsibility extends to corporate governance, and translates, in the case of IFAD,to the following roles:

(i) The Governing Council, which is the supreme plenary organ of the Fund. It iscomposed of representatives of the Member States. All powers of the Fund arevested in the Governing Council. Subject to the limitations stated in the Fund’scharter, it may delegate powers to the Executive Board.

(ii) The Executive Board, and the Audit Committee, which is appointed by theBoard, supervise internal control and risk management. Assisted by the AuditCommittee, the Board is informed and updated on any changes to theoperating principles of internal control including the main features of the riskmanagement process, a summary of risks, control objectives and commoncontrol points for financial reporting.

(iii) The internal and external auditors of the organization also measure theeffectiveness of internal control. They assess whether the controls are properly

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designed, implemented and working effectively while makingrecommendations on how to improve internal control.

(iv) Management is responsible for designing, approving and implementing theinternal control and risk management process together with the Fund'sfinancial operations management team.

(v) The Enterprise Risk Management (ERM) Committee1 is responsible forsupporting and overseeing the risk management activities of the Fund. It is acritical element for the management of operational risk as it affects theinvestment activities of the Fund.

6. IFAD’s Management and staff are committed to IFAD’s Code of Conduct,2 which wasestablished to regulate their conduct and align it with the interests of IFAD.

7. The governance structure and reporting lines are presented in Chart 1.Chart 1Governance structure

8. Part B of this section examines in detail the flow of financial information within IFAD,the internal actors involved in the process of investment decision-making, and thespecific roles and responsibilities, as well as the flow of financial information as perchart 2.

1 See PB 2008/06.2 IFAD Human Resources Implementing Procedures – Chapter 1: Duties, obligations and privileges 1.7.9(vi).

Executive Board

Audit Committee Internal and external auditors

IFAD Management

Governing Council

Enterprise RiskManagement Committee

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B. Investment-related roles and responsibilities in IFAD9. IFAD’s internal flow of financial information in terms of investments is presented in

chart 2.

Chart 2IFAD’s internal flow of financial information

10. President. The President has oversight and decision-making responsibility for theinvestment of the assets based on the approved IPS. He or she may delegateauthority for specific investment-related activities.

11. Investment committees. There are two investment committees charged with thesupervision and oversight of the various financial matters of the organization:

(i) The Investment and Finance Advisory Committee (FISCO) – the high-levelcommittee. The rules of procedure and terms of reference of FISCO arepresented in annex I; and

(ii) The FOD Management Team (FODMT) – assists and advises the AssociateVice-President, Financial Operations Department (AVP/FOD) in makingdecisions on financial or investment management matters under his/herauthority or under specific delegation of authority from the President of IFAD.The FODMT will provide strategic recommendations to FISCO for final decisionby the President.

12. Associate Vice-President, Chief Financial Officer and Chief Controller(AVP/FOD). As head of the Financial Operations Department (FOD), the AVP/FODis responsible for IFAD’s financial resource management. Through the Accountingand Controller's Division (ACD), the Financial Management Services Division (FMD),the Treasury Services Division (TRE) and the Risk and Compliance Function (RCF),the AVP/FOD:

President

Investment and Finance AdvisoryCommittee (FISCO)

Associate Vice-President FOD

TreasuryServices

Division (TRE)

Risk andCompliance

Function (RCF)

CashManagement(CM) Team

InvestmentManagement

(IM) Team

Policies andprocedures

Executive Board

FinancialOperationsDepartment

FinancialManagement

Services Division(FMD)

Accounting andController's

Division (ACD)

PortfolioPlanning

(PPL) Team

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(i) Manages and reports on IFAD’s financial resources in a framework of costefficiency, risk containment, transparency and accountability;

(ii) Invests and manages financial assets not immediately needed, in line withoperational requirements;

(iii) Safeguards and maximizes the resources available for operations throughprudent financial management and investment of financial resources, andthrough appropriate accounting, reporting and projection on IFAD’s use ofthese resources; and

(iv) Works with internal and external partners in sharing knowledge, harmonizingfinancial management systems and procedures, and/or enabling theircollaboration.

(v) Performs functions delegated by the President, including the update of theinvestment guidelines.

13. Accounting and Controller's Division (ACD). ACD is responsible for theaccounting and reporting of the Fund. It must ensure integrity, transparency andcontrol of the management of IFAD's resources, including trust funds,supplementary funds, funds of hosted entities and funds raised through innovativefinancing-related activities. The division provides leadership and interpretation on allmajor issues related to the formulation and implementation of accounting policiesand procedures, such as adoption of new International Financial ReportingStandards (IFRS). The main specialized services provided by ACD are the following:

(i) Maintaining adequate internal control systems to ensure that all IFAD’sfinancial transactions are properly, completely and accurately recorded andreported, and are consistent with IFAD’s Framework for Delegation ofAuthority and its policies and procedures and are in accordance with IFRS;

(ii) Compiling accurate and timely internal and external financial reports thatreflect and capture all the Fund’s financial transactions and results, and theoverall financial position;

(iii) Originating governing body and other official documents on financial matters,e.g. financial statements and draw-down requirements;

(iv) Monitoring and strengthening financial management and fiduciaryresponsibilities for IFAD's fund flows, supplementary funds administration,audit and reporting;

(v) Ensuring financial and budgetary management of extra budgetary funds andhosted entities; and

(vi) Liaising with the external auditors and the Audit Committee.

(vii) Ensuring operational risk management/controllership.

14. Financial Management Services Division (FMD). FMD is a specialized divisionresponsible for promoting and directly supporting the strengthening of financialmanagement practices in IFAD-financed operations, including financial reporting,project audits, project liquidity management and fiduciary compliance throughoutthe project lifecycle. The division manages IFAD’s financial management workforce,which includes IFAD staff and a roster of accredited financial managementconsultants. The division is structured to:

(i) Mainstream financial management procedures to form an integral part of thedevelopment process in all IFAD-financed and -managed operations to ensurethat funds are used for the intended purpose. FMD achieves this through theprovision of risk-based financial direction and oversight during the preparationand implementation of country strategic opportunities programmes and during

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the design, supervision and implementation support of IFAD projects,programmes and grant activities;

(ii) Provide corporate advisory and financial services for operational policies andprocedures, including but not limited to: IFAD financing terms and criteria,debt issues, risk management and financial administration;

(iii) Interact with international accounting and auditing bodies and donor partners,where desirable, to help countries strengthen their financial managementcapacity;

(iv) Engage IFAD's external stakeholders, including governments, projects, projectstaff and auditors, as well as IFAD's workforce (including accreditedconsultants) to promote financial management knowledge-sharing andcapacity-building;

(v) Lead financial management system and tool development, including directengagement with borrowers/recipients to facilitate the roll-out of IFAD's e-disbursement system, the IFAD Client Portal; and

(vi) Maintain strategic partnerships with other international financial institutions(IFIs) and multilateral platforms to promote sharing of best practices and toharmonize IFAD's financial management policies and operational practiceswhere applicable and desirable.

15. Treasury Services Division (TRE). TRE has a key fiduciary role in managingIFAD’s liquidity and the cash flows of both replenishment-based and borrowedresources. This includes strategic portfolio and liquidity planning and long-termfinancial projections of cash flows and resources. The specialized services providedby TRE are designed to:

(i) Formulate and implement financial policies and procedures, including theinvestment policy;

(ii) Manage IFAD's operational cash and liquidity requirements for all fundingsources;

(iii) Actively manage IFAD's investment portfolio;

(iv) Coordinate strategic portfolio and liquidity planning by setting the minimumliquidity requirement (MLR) and the resources available for commitment;

(v) Develop partnerships with the treasuries of other IFIs regarding the cash flowprocesses of disbursements and receipts through operational bank accounts.

16. TRE relies on three operating teams to deliver these services:

A. The Cash Management (CM) and Back Office team provides both cashmanagement and post-trading services on investments. Responsibilities areto:

(i) Manage and report on all cash flow operations and short-term liquidity ofoperational portfolios;

(ii) Ensure accurate processing for all financial and payments transactions inoperational bank accounts in compliance with relevant regulations andindustry standards;

(iii) Ensure accurate reconciliation of all financial transactions in IFAD andnon-IFAD non-investment operational accounts;

(iv) Initiate liquidity transfers between IFAD operational accounts to provideliquidity, and initiate requests for internal replenishments for InvestmentManagement (IM) team action;

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(v) Execute post-trade processing and investment settlement activities forall financial transactions traded by the IM team for the internallymanaged portfolios;

(vi) Develop, manage and maintain relationships with central and commercialbanks, and IFAD's global custodian regarding cash flow operations forheadquarters and IFAD Country Office accounts;

(vii) Manage TRE’s activities in support of IFAD’s decentralization, includingnegotiating banking arrangements and providing support for local bankaccounts;

(viii) Manage electronic fund transfer systems and cash management systems.

B. The Investment Management team monitors and manages IFAD’sinternally and externally managed portfolios. Responsibilities are to:

(i) Directly manage the internal portion of the investment portfolio. Thisinvolves market research, credit analysis of issuers, trade execution andoptimal portfolio construction;

(ii) Periodically review IFAD’s investment policy and guidelines to ensurealignment and compliance with IFAD’s investment strategies, in light ofchanging financial and market conditions;

(iii) Oversee and analyse the externally managed portion of the investmentportfolio;

(iv) Implement currency and asset allocation of the overall investmentportfolio;

(v) Implement foreign exchange and interest rate risk hedges;

(vi) Manage IFAD's relationships with trading counterparties, external fundmanagers and, jointly with CM, the global custodian;

(vii) Ensure the availability of funds for IFAD and non-IFAD operationsthrough prudent liquidity management in collaboration with CM.

C. The Portfolio Planning (PPL) team coordinates strategic portfolio andliquidity planning. Responsibilities are to:

(i) Formulate and implement financial policies and procedures;

(ii) Produce short-term (1 to 3 years) portfolio cash flow projections;

(iii) Analyse and recommend the minimum liquidity requirement (MLR);

(iv) Produce long-term financial/resource projections and scenarios. In thisregard, the team is responsible for managing and enhancing IFAD’sfinancial model;

(v) Determine the resources available for commitment based on asustainable cash flow approach;

(vi) Analyse investment performance versus the applicable benchmarks,including the construction and calculation of benchmarks for internallymanaged portfolios;

(vii) Manage and administer the pre-trade compliance system andintradivisional workflow automation.

17. The Risk and Compliance Function (RCF) unit reports directly to the AVP/FOD.This direct reporting line ensures segregation of duties of investment riskmanagement from the investment function performed in TRE. Responsibilities areto:

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(i) Actively monitor, analyse and periodically report on IFAD's investment riskbudget;

(ii) Liaise with TRE and provide credit risk analysis on existing and proposedinvestments;

(iii) Contribute to setting and managing the Fund's risk budget on an ongoing basisby monitoring, analysing and reporting on financial risk exposure and byidentifying potential new risk factors in IFAD's investments;

(iv) Perform stress tests and scenarios and propose mitigation strategies;

(v) Oversee the global custodian compliance monitoring system to ensure correctalignment with all investment guidelines;

(vi) Provide advice on potential risks to IFAD's financial soundness based onextended knowledge of IFI best practice and, inter alia, capital adequacy,credit and liquidity ratios;

(vii) Monitor adherence to the established capital adequacy ratios;

(viii) Provide periodic investment risk and compliance reports to the AVP/FOD andSenior Management; and

(ix) Supply input for technical and operational support provided by FOD front officeto the AVP/FOD as requested.

(x) Review and update the investment guidelines

C. Investment policies and procedures18. The overall framework for IFAD’s investment processes and controls is set by the

following policies, and procedures:

Financial Regulations of IFAD;

IFAD Policy on ERM;3

IFAD’s Investment Policy Statement;

IFAD’s Liquidity Policy;4

IFAD’s investment guidelines;

ICF for IFAD Investments;

International Financial Reporting Standards;

Investment management and master custody agreements;

Treasury Manual;

Rules of procedure and terms of reference of FISCO, referred to in annex I;

19. Financial Regulations of IFAD. The Financial Regulations of IFAD govern thefinancial administration of the Fund and are interpreted in accordance with theAgreement Establishing IFAD.

20. IFAD Policy on ERM. The ERM policy establishes a formal, systematic andintegrated approach to identifying, managing and monitoring operational, financialand compliance risks in IFAD and defines key roles and responsibilities for allstakeholders in ERM activities. Certain activities performed under IFAD’s ERMrelevant to the Fund’s investments include:

(a) Annual certification of compliance with the code of conduct anddeclaration of non-IFAD income, goods, services or assets. Consistent

3 See EB 2008/94/R.4.4 See EB 2006/89/R.40.

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with IFAD’s Code of Conduct,5 all staff members are required to submit anannual certification form declaring: (i) compliance with the Code of Conduct;(ii) conflicts of interest; and (iii) all sources of non-IFAD income, goods,services or assets.

(b) Management assertion and external audit attestation6 of internalcontrols over financial reporting. Since 2011, IFAD has issued an annualManagement assertion on the effectiveness of internal controls over financialreporting, while the first independent attestation from external auditors wasreceived for the financial year 2012, now reported on a yearly basis within theaudited consolidated financial statements.

(c) Financial disclosure statement for selected staff members. Since 2012selected staff members, based on their role and responsibilities, are alsorequired to submit a detailed financial disclosure statement.7

21. IFAD’s Investment Policy Statement. The IPS is updated annually by TRE andapproved by the AVP/FOD. It is then submitted to the Executive Board for finalapproval at its December session. The document provides the overarching principlesregulating IFAD’s key investment responsibilities, investment universe andacceptable risk parameters.

22. Specifically the IPS aims to:

(i) Define the duties, responsibilities and governance over IFAD’s investments;

(ii) Set out IFAD’s investment objectives for risk and return, including eligibleasset classes;

(iii) Define key components of investment guidelines;

(iv) Determine the risk budget for IFAD’s overall investment portfolio; and

(v) Establish formalized criteria to measure, monitor and evaluate performanceand risk.

23. IFAD’s Liquidity Policy.8 This policy provides a “means of monitoring and ensuringthat the Fund has adequate liquidity available at all times”.

24. IFAD investment guidelines. For each individual portfolio, IFAD’s investmentguidelines define the principles by which a fund is managed and monitored. The RCFunit, through daily oversight and monitoring, ensures strict compliance withinvestment guidelines through the compliance monitoring system provided by IFAD’sglobal custodian. In June 2018 the investment guidelines were updated andstandardized to the extent possible in light of diverse investment parameters of thevarious portfolios. The investment guidelines now require a yearly review by the ICFand, if changes are made, subsequent approval by the AVP,FOD .

25. These investment guidelines include at least the following components for eachportfolio:

(a) Investment objectives: defining expected return and risk;

(b) Risk budget (tracking error, etc.);

(c) Base currency;

(d) Eligible currencies;

(e) Eligible instruments;

5 IFAD’s Human Resource Implementing Procedures – Chapter 1: Duties, obligations and privileges 1.7.9(vi).6 EB 2010/99/R.30.7 IFAD Information Circular IC/ETH/01/2012 paragraph 3(b).8 See EB 2006/89/R.40.

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(f) Minimum and maximum portfolio duration;

(g) Minimum credit quality;

(h) Diversification requirements;

(i) Procedures for futures and options; and

(j) Comparative performance benchmark.

26. The benchmarks identified in the investment guidelines must be: (i) unambiguous,transparent and simple; (ii) investable and replicable; (iii) measurable and stable;(iv) appropriate to the investment purpose; (v) reflective of current investmentopinions; and (vi) specified in advance.

27. Investment management and master custody agreements. The agreementswith external parties ensure that the relationship falls within a verified andconstantly updated legal framework.

28. Treasury Manual. This manual provides a detailed description of the specializedservices provided by TRE, and defines how the Division’s workload is divided amongits various functions.

29. The manual is divided into two main sections: (i) the executive manual, providing abroad overview of the organization and its major processes; and (ii) the operationalmanuals (cash management and investment management), which constitute aworking document that provides the user with specific details, descriptions andexamples of processes and procedures. Table 1 gives an overview of the TreasuryManual.Table 1Overview of the Treasury Manual

Executive manual Operational manuals

What is it? An overview document that provides aconcise description of TRE’s functions andprocedures in a summary format.

A detailed description of the functions, tasks andprocesses that make up the responsibilities ofTRE staff.

How is it used? Contains embedded navigation links thattake the user directly to relevant sectionswithin the operating manual for additionalinformation.

Contains specific listings of duties, activities,detailed process flows, and other ‘how-to’material. Can be used as a step-by-stepinstruction guide for most procedures.

Who are theprospectiveusers?

Intended for use as a quick reference forthose interested in how TRE operates andwhat its major functional responsibilitiesare.

Intended for use as a detailed reference forthose tasked with carrying out TRE’s day-to-dayfunctions.

30. To maintain flexibility, accessibility and adaptability, the Treasury Manual ispublished on IFAD’s local area network in portable document format (PDF). Theelectronic file is controlled by the TRE front office. In view of the constant revision ofprocesses and the restricted nature of parts of the Treasury Manual, no hard copiesare distributed.

31. Confidentiality. Due to the confidential nature of the information presented, partsof the Treasury Manual are restricted and can be viewed by authorized users only.Approved users may not divulge its contents to third parties without specific writtenpermission by authorized senior staff. The public sections of the manual, i.e. theIFAD Treasury Executive Manual, are available to be viewed by all staff on the TREintranet site.

32. Investment committees. IFAD has two investment committees – FISCO andFODMT – as elaborated upon in annex I.

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III. Risk assessment, control, information andcommunication, and monitoring activities

A. Risk identification33. IFAD’s investments are exposed to a variety of financial risks. Marked-to-market

investments are affected by market risks, as well as liquidity, credit, counterpartyand operational risks. A detailed definition of these risks and a summary of the keymeasures used to measure such risks in IFAD’s investment portfolio are givenbelow.

34. Market risksMarket risk is defined as the risk of losses arising from exposure to changes infinancial market variables (prices and rates). IFAD is exposed to changes in interestand exchange rates.

35. Interest rate risk is defined as the potential risk that the value of a fixed ratesecurity will decline as a result of an upward movement in the absolute level ofinterest rates, based on the spread between the two rates, and the overall shape ofthe yield curve. Interest rate risk is monitored on the overall portfolio and on theindividual portfolios. Risk measurements include duration, standard deviation, exante tracking error (active risk), value at risk and conditional value at risk (CVaR).

36. Currency risk arises from the change in price of one currency against another.IFAD faces currency risk as its future commitments may be in different currency tothat of its assets. Currency risk is monitored, and reported on, on a monthly basis.

37. Liquidity risk is defined as the risk stemming from the lack of marketability of aninvestment that cannot be readily sold in the secondary markets to generate thenecessary liquidity to meet contractual obligations. At any point in time, IFAD mustbe able to meet its disbursement obligations for loans and grants.

38. The liquidity risk is addressed through the MLR.9 This amount must be available atany point in time to ensure IFAD’s ability to meet its disbursement obligationpromptly and without additional costs.

39. Credit risk is defined as the risk of loss of the loan principal or loss of a financialreward stemming from a borrower's failure to repay a loan or otherwise meet acontractual obligation.

40. Credit risk is actively managed by the RCF unit in coordination with TRE and ACD.The minimum rating floors in the respective investment guidelines are an indicatorof risk and used as a tool in managing credit risk. The eligibility of individualsecurities and issuers is determined on the basis of ratings given by the three majorcredit rating agencies Fitch, Moody’s, and Standard and Poor’s. Credit analyses bysecurity and issuer are performed on an ongoing basis by TRE in conjunction withthe RCF unit for all internally managed investments. In addition, such analyses, on aselective basis, are carried out on externally managed assets and commercial andcentral banks, through the use of financial information systems, credit analysts andother related sources. Moreover with the adoption of the impairment requirement ofIFRS 9, an impairment allowance has been set up to reflect the expected credit lossof financial instruments designated at amortized costs. Monitoring activities of thiscredit risk are performed by ACD in conjunction with TRE and RCF.

41. Counterparty risk/trading counterpartiesCounterparty risk is defined as the risk to each party of a contract that thecounterparty will fail to perform its contractual obligations.

9 See EB 2006/89/R.40 and EB 2013/110/R.15.

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42. Counterparty risk is managed for all investments through the establishment of aminimum rating for eligible counterparties, including banks for operational cash andfor short-term investments and trading counterparties.

43. Counterparty risk is also managed by capping exposure to each issuer/bank.Counterparty risk analyses are performed internally for the purpose of trading andshort-term investments with banks; in the case of commercial and central banks,financial information systems, credit analysis providers and other sources are used.

44. Country riskCountry risk is a collection of risks associated with investing in a country. Theserisks include political risk, exchange rate risk, economic risk, sovereign risk andtransfer risk.

45. Country risk is managed for all investments through the establishment of maximumcountry exposure concentrations within the guidelines of every individual portfolio.Country exposures are monitored on a daily basis through the internal compliancesystem.

46. Industry (or sector) riskThis is the risk related to investing in a specific industry or sector. This risk isaddressed by ensuring industry and sector diversification and by settingconcentration limits in the investment guidelines.

47. Operational riskOperational risk is defined by the Basel Committee on Banking Supervision as "therisk of loss resulting from inadequate or failed internal processes, people andsystems or from external events." Operational risk is the risk which is not inherentin financial, systematic or market-wide risk. This includes legal risk and reputationalrisk.

48. Operational risk is addressed by defining a sound framework of responsibility andaccountability within IFAD’s financial structure, by establishing back-up proceduresand by performing legal reviews of all official policies.

49. On a broader organizational level, IFAD’s Policy on Preventing Fraud and Corruptionin its Activities and Operations10 aims to: “(i) affirm and communicate the Fund’sresolve to prevent and combat fraud and corruption in its activities and operations;(ii) describe the ongoing efforts of the Fund in this area; and (iii) outline actions thatthe Fund will be taking in implementing this policy”.

50. In addition, IFAD’s Human Resources Implementing Procedures specify that“Screening will be conducted with professional rigour … and selection processesensuring that candidates are assessed on the basis of the highest standards ofcompetence, integrity, and appropriate experience to carry out IFAD’s objectives andavoid potential conflicts of interest”.11

B. Risk measurement and managementRisk budgeting and risk tolerance

51. The aforementioned points are addressed through a risk-budgeting frameworkwhich represents the overall risk appetite and tolerance of the organization. Thistranslates into risk metrics as defined in the IPS, investment guidelines, liquiditypolicy as well as other policies and internal procedures.

52. Specifically, risk budgeting is the procedure of allocating risk within and betweenfunds. It entails setting predetermined limits for the investment portfolio – on anaggregate level and at the level of individual managers – monitoring these

10 See EB 2005/85/R.5 and subsequently revised EB 2005/86/INF.8.11 IFAD’s Human Resources Implementing Procedures, chapter 2: Staff recruitment and appointment 2.3.1 (ii).

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measures and adjusting the portfolio whenever they exceed the tolerance level. Inmore detail, risk budgeting is the process of:

(i) Measuring and decomposing the aggregate risk of a portfolio into itsconstituents on a quantitative basis;

(ii) Setting risk limits (risk budgets) for the overall investment portfolio andindividual portfolios, ex ante through the definition of ranges of selected riskmetrics in line with the organization's risk appetite and tolerance level;

(iii) Allocating risks across the assets in compliance with risk budgets;

(iv) Monitoring the use or misuse of risk budgets on an ongoing basis;

(v) Expanding asset liability management;

(vi) Analysing the results (ex post); and

(vii) Changing investments when necessary to align the portfolio with the desiredrisk level.

53. IFAD’s IPS sets the risk budget for IFAD’s overall investment portfolio. The riskbudget for individual portfolios is set in IFAD’s investment guidelines and approvedby the President of IFAD, unless otherwise delegated. Additional limits are set in theMLR, investment policies and other internal procedures. Table 2 details the riskmeasures selected for the risk management framework and their tolerance level asdefined in these IFAD policies and guidelines. The table, together with chart 3, alsopresents the internal procedures established under the risk management frameworkto monitor and manage the risks within the new risk-budgeting framework.

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Table 2IFAD’s investment risks, established limits and control framework*

Risk typeRisk measure andsource Established limit

Monitoringfrequency/tool Reporting frequency Alert level/action taken

Interest rate risk Manager’s duration(determined in IFAD’sinvestmentguidelines)

Duration must be no lower than zero(i.e. divesting into cash, lower limit) andno higher than two years above thebenchmark duration (upper limit).

Daily throughcompliance system.

Monthly in the risk report tothe Treasurer and theAVP/FOD.

Quarterly in the Report onIFAD’s investment portfolio tothe Executive Board.

Should the duration upper or lower limit bebreached, the issue will be reported by the RCF tothe IM, the Treasurer and the AVP/FOD. The IMwill immediately liaise with the investmentmanager to:

Verify the reason for the durationposition/strategy.

Agree on a reasonable time frame for themanager to restore duration within allowablelimits.

Upon execution of required trades, requestwritten confirmation by the manager of the newduration level.

The RCF will then re-evaluate the duration leveland report to the Treasurer and the AVP/FOD.

1-year forward-looking ex antetracking error(determined in IFAD’sinvestmentguidelines)

According to the specific investmentguidelines.

Weekly through riskmanagement system.

At least monthly in the riskreport to the Treasurer andthe AVP/FOD. More frequentlyif the variance is close to theestablished limit.

Quarterly in the Report onIFAD’s investment portfolio tothe Executive Board.

Should the tracking error on any manager exceedits threshold the issue will be reported by the RCFto the IM team, the Treasurer and the AVP/FOD.The IM team will immediately liaise with theinvestment manager to: Verify the reasons underlying the discrepancy

in tracking error. If deemed necessary for risk mitigation, agree

on a reasonable time frame for the manager torestore tracking error within allowable limits.

Upon execution of required trades, requestwritten confirmation by the manager of the newtracking error.**

The RCF will verify the tracking error level andreport to the Treasurer and the AVP/FOD.

* Table 2 presents the internal procedures established under the risk management framework to monitor and manage risks within the corresponding risk-budgeting framework. The established limitsare detailed only for reference purposes, however the limits might change when the corresponding policy or guideline is updated.

** It should be noted that a high tracking error does not necessarily indicate a higher risk, but only a higher degree of difference when compared with the benchmark. For example, should abenchmark contain sub-prime mortgage-backed securities, a portfolio indexed against this benchmark and not containing such securities may show a high tracking error but a lower risk level inabsolute terms.

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Risk type Risk measure and source Established limit Monitoring frequency/tool Reporting frequency Alert level/action taken

Interest rate risk(continued)

1-year conditional value-at-risk at 95 per centconfidence level (stated inIFAD’s IPS and, forindividual portfolios, inIFAD’s investmentguidelines)

Overall portfolio: maximum 3%

Individual portfolios: according to thespecific investment guidelines.

Monthly through riskmanagement system.

At least monthly in therisk report to theTreasurer and theAVP/FOD. Morefrequently if alert level formeasure is reached.

Quarterly in the Reporton IFAD’s investmentportfolio to the ExecutiveBoard.

Should the CVaR on the overall portfolio or on anysingle manager exceed its threshold the issue willbe reported by the RCF Unit to the IM, theTreasurer and the AVP/FOD. The following actionswill be taken:

The RCF will perform a break-down analysis toidentify the sources of increased CVaR.

Depending on the result of thebreak-down analysis, the RCF will recommendto the AVP/FOD and to the Treasurer correctivemeasures on the overall portfolio or for a singlemanager. These measures may include, but arenot limited to, increasing the cash exposure,decreasing duration and divesting from a certainsector.

The measures will be discussed within TRE andRCF an action plan will be presented to theAVP/FOD and to the Treasurer.

Upon approval, the recommendations will beimplemented with the concerned counterparty.

Currency risk Percentage deviation fromtarget currency ratios

While the aim of the framework is tominimize any variance (i.e. zerovariance), any deviation of morethan 10 per cent per currency isconsidered above the absolute limit.

(Currently under review)

Monthly through internalanalysis.

At least monthly to theTreasurer and theAVP/FOD. Morefrequently if the varianceis close to theestablished limit.

Quarterly in the Reporton IFAD’s investmentportfolio to the ExecutiveBoard.

Should the percentage deviation in any singlecurrency exceed the absolute limit, the followingactions will be taken:

The RCF will recommend a realignment strategyby one of the following tools: foreign exchangetransactions on internally managed cash orchange in currency composition of one or moreof the externally managed individual portfolios.

An execution time frame for the realignment willbe communicated by the RCF to the Treasurerand the AVP/FOD and to the concerned teams(the IM and/or the CM).

The concerned party will be instructed toexecute the trades.

Upon execution, a new analysis will beperformed to verify the realignment of theassets.

Liquidity risk Percentage of grossdisbursement (determinedin IFAD’s minimum liquidity

Minimum liquidity requirement(composed of IFAD’s investmentportfolio) set at 60 per cent of the

Quarterly through internalanalysis.

Quarterly in the Reporton IFAD’s investmentportfolio to the Executive

Should IFAD’s investment portfolio decrease toreach the level of 70 per cent of grossdisbursements, the issue will be reported by the

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Risk type Risk measure and source Established limit Monitoring frequency/tool Reporting frequency Alert level/action takenrequirement). total of annual gross disbursements

(cash outflows) and potentialadditional requirements due toliquidity shocks.

(Currently under review)

Board. RCF to the AVP/FOD and the Treasurer andimmediately communicated to the ProgrammeOperations Department in order to revise the planfor future disbursements.

Credit risk Credit rating (determinedin IFAD’s investmentguidelines) andfundamental analysiscarried out in-house.

Minimum credit floor in investmentguidelines for managed portfolios isBBB- (i.e. investment grade).

(Currently under review)

Daily through compliancemonitoring system.

At least monthly in therisk report to theTreasurer and theAVP/FOD.

On a quarterly basis acredit rating analysis byportfolio will be presentedin the Report on IFAD’sinvestment portfolio tothe Executive Board.

Should a security be downgraded below IFAD’sminimum credit floor,

Credit risk is reported and analysed by the RCF.TRE also analyses the credit risk for internallymanaged investments, and, on a selective basis,for externally managed assets. Credit risk analysesfor commercial and central banks are performed byusing financial information systems, credit analysisproviders and other market sources.

Credit risk for securities designated at amortisedcost is also monitored by the impairment allowancecreated to reflect the expected credit loss. Activitiesare carried out by ACD, TRE and RCF.

Counterparty risk Credit rating forcounterparties (determinedin IFAD’s investmentguidelines).

Minimum credit rating for eligiblecounterparties.

Monthly through internalanalyses.

Ad hoc basis, but if thereis a credit event (e.g.downgrade) then a reportwill be written.

Should counterparty be downgraded below IFAD’sminimum credit floor, the issue will be reported bythe RCF to the Treasurer, the AVP/FOD and the IMand CM. Immediate action will, as appropriate, betaken with the investment manager.TRE performs analysis of counterparties for allinvestment activities, including trading, derivativesand banks eligible for investments. Monitoring isalso performed on commercial and central banks’credit ratings and financial soundness.

Industry (orSector) risk (forequities portfolio)

Maximum industryexposure andconcentration limits(determined in IFAD'svarious investmentguidelines).

Depending on investment portfolioguidelines.

Daily through compliancemonitoring system.

Monthly in investmentportfolio reports to FISCOand quarterly to theExecutive Board.

Should a country concentration be exceeded, theissue will be reported by the RCF to the Treasurer,the AVP/FOD and the IM and CM . Immediateaction will be taken, as appropriate, with theinvestment manager.

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Risk type Risk measure and source Established limit Monitoring frequency/tool Reporting frequency Alert level/action takenCountry risk Maximum country risk

exposure andconcentration limits(determined in IFAD'sinvestment guidelines).

Depending on investment portfolioguidelines.

Daily through compliancemonitoring system.

Monthly in investmentportfolio reports to FISCOand quarterly to theExecutive Board.

Should a country concentration be exceeded, theissue will be reported by the RCF to the Treasurer,the AVP/FOD and the IM and CM. Immediate actionwill be taken, as appropriate, with the investmentmanager.

Operational risk Segregation of dutieswithin TRE, back-upprocedures, legal control(determined in theTreasury Manual andOperational RiskManagement for Treasury,and Cash and Investment).

Segregation of duties ofTRE and the RCF reportedin this ICF document andvarious investmentguidelines.

Not applicable. Continuous. Annually, through therevision of the TreasuryManual and theOperational Risk report(from 2012).

With regard to payments, segregation of duties forcore financial procedures within FOD existsbetween ACD, Administrative Services Division(ADM) travel unit and TRE. ACD and ADM have theauthority to instruct movements of IFAD funds toexternal parties. The TRE CM unit authorizes theexecution of all financial and payment transactionsthrough operational bank accounts.

ACD and TRE independently post accountingentries in the Fund's general ledgers which arereconciled on, at least, a monthly basis.

With regard to internally managed investments,within TRE segregation of duties exists between theIM which recommends (for the Treasurer’sapproval) and executes trades, and the CM teamwhich performs trade settlement. RCFindependently reports on the investment activities.

Additionally, with regard to the investment portfolio,the first level of sign-off is performed between theexternal portfolio managers and IFAD’s GlobalCustodian, thereby ensuring accountability andsegregation of duties.

Procedures are reported in the Treasury Manual.

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C. Control, information and communication, and monitoringactivities

54. TRE reports externally certain risk measurement metrics and analyses to theExecutive Board and the Audit Committee through the quarterly and annualinvestment portfolio report. Comprehensive monthly risk reports are also producedby the Unit and shared internally with the Treasurer and AVP/FOD, and if deemedrelevant, with FISCO.

55. These comprehensive monthly risk reports inform, communicate and monitoractivities that cover the following areas of risk monitoring:

(i) Currency risk;

(ii) Market and credit monitoring, and risk levels compared to predetermined riskbudget levels;

(iii) Compliance monitoring versus investment guidelines and subsequent actionsif any; and

(iv) Portfolio and benchmark performances.

56. Whenever a risk measure reaches the "alert level", as defined in table 2, the RCFwill inform the IM, the Treasurer and the AVP/FOD. Appropriate risk-mitigatingstrategies will be recommended and actions will be taken, as described in table 2.Upon completion of the actions, the RCF will verify the risk level and report the newlevel to the concerned parties. The process is illustrated in chart 3.

57. In addition to the risk measures established in IFAD’s IPS for risk-budgetingpurposes, a comprehensive set of risk measures is analysed through the riskmanagement system. Whenever one of the risk measures, either on the overallportfolio or on a single manager, is deemed to be excessive or shows a significantchange from the previous period, the RCF will bring the issue to the attention ofthe AVP/FOD, the Treasurer and the IM.

58. The additional measures (whose definitions are given in annex III) include:

(i) Annualized standard deviation or returns by manager, individual portfolio,benchmark and for the overall portfolio and benchmark;

(ii) CVaR with a one-year forward-looking horizon and a 95 per cent confidencelevel, by manager, by individual portfolio benchmark, and for the overallportfolio and the overall benchmark;

(iii) Historical monthly CVaR for the historical period of the past two years;

(iv) Overall risk decomposition, by risk type; and

(v) Risk-adjusted return indicators (Sharpe ratio, tracking error, informationratio, beta and alpha).

59. ACD executes full data control and reconciliation of financial records against thecustodian and/or third parties.

60. The risks in IFAD’s investments are currently monitored with a variety of tools:

(i) Enhanced risk management system. IFAD is constantly strengthening itsanalytical resources to monitor risk in the investment portfolio, and enablethe TRE and the RCF unit to perform ex ante analyses as well as stress testson assets, on the individual portfolios and on individual managers;

(ii) Compliance monitoring system. This web-based application supplied bythe global custodian enables the RCF to verify on a daily basis the complianceof external portfolio managers with the respective investment guidelines. Themajority of guidelines are currently coded in the system, and the applicationflags breaches or alert levels on a daily basis. Guidelines that cannot be

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coded in the system are monitored through internal analyses and manualprocedures;

(iii) Compliance checks on the internally managed portfolios are, for reasons ofsegregation of duty, performed by the global custodian who alerts the RCFUnit as soon as a breach occurs and produces a monthly report;

(iv) In addition to the above, the IM performs qualitative analyses on selectedissuers and counterparties; and

(v) Performance reporting by the global custodian.Chart 3Flow of control framework for investment risks

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Rules of procedure and terms of reference of theInvestment and Finance Advisory Committee (FISCO)(high-level committee)

1. Purpose

1.1. To assist and advise the President in deciding on strategic financial mattersand in determining the overall investment strategy and policy.

1.2. The scope of FISCO’s review for information and/or for final decision by thePresident includes:

1.2.1. Financing and resource requirements;

1.2.2. Financing mechanisms;

1.2.3. Investment policy and minimum liquidity requirement;

1.2.4. Financial risk management;

1.2.5. Direct charges against investment income;

1.2.6. Appointment of investment managers and Global Custodian;

1.2.7. Financial market developments;

1.2.8. Any other financial matters deemed strategically important.

2. Membership

2.1 The membership of the Committee shall be determined by the President andshall include: The President (Chairperson)

Vice-President, Office of the President and the Vice-President

Associate Vice-President, Programme Management Department

Associate Vice-President Financial Operations Department, ChiefFinancial Officer and Chief Controller

Associate Vice-President, Strategy and Knowledge Department

Associate Vice-President, Corporate Services Department

Associate Vice-President, External Relations and GovernanceDepartment

Director and Chief of Staff, Office of the President and the Vice-President

Director and Treasurer, Treasury Services Division (Secretary)

Director, Financial Management Services Division

Director, Accounting and Controller’s Division

General Counsel, Office of the General Counsel

Director, Partnership and Resource Mobilisation

Director, Office of Audit and Oversight (Observer)

Other members at the discretion of the Chairperson

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3. Meetings

3.1 Members and observers will attend all meetings. In the event they are unableto attend, qualified representatives shall be designated and communicated inwriting to the Secretary.

3.2 Other IFAD staff directly concerned with the matters to be discussed may beasked by the Secretary to attend as observers, subject to the approval of theChairperson.

3.3 A quorum shall consist of the President as Chairperson or, in the event of thePresident’s inability to attend, his/her representative (under a specificdelegation of authority from the President); the Director and Treasurer, TRE,as Secretary or his/her representative, the Associate Vice-President, FinancialOperations Department or his/her representative and four other members ofthe Committee.

3.4 Meetings will be held every eight weeks in conjunction with the regularmeetings of the Executive Management Committee, and more often if thebusiness of the Fund so requires.

4. Agenda, documentation and minutes

4.1 The Director and Treasurer, TRE, will act as Secretary of the Committee andshall be responsible for the following:

4.1.1 Scheduling meetings;

4.1.2 Drafting the agenda in consultation with the Associate Vice-President Financial Operations Department, Chief Financial Officerand Chief Controller;

4.1.3 Coordinating and distributing documentation to the Committee atleast four working days prior to the meeting date;

4.1.4 Providing information on the strategic financial or operationalmatters indicated in 1.2, as deemed necessary by the Chairpersonor FISCO members;

4.1.5 Preparing minutes of the meeting for the Chairperson’s approval –which shall include decisions taken by the Chairperson, substantiveobservations by members, actions to be undertaken by responsibleofficers – and distributing signed minutes to all participants;

4.1.6 Preparing an updated tracker of actions for the Committee.

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Reference to the new principles in the COSO InternalControl – Integrated Framework in the context of IFAD’sinvestment-related activities

I. Control environment1. The organization demonstrates a commitment to integrity and ethical

values: Specific policies and procedures that fall under IFAD’s Policy on EnterpriseRisk Management (ERM) require (a) an annual certification of compliance with theIFAD Code of Conduct and declaration of non-IFAD income, goods, services orassets; (b) Management assertion and external audit attestation of internalcontrols over financial reporting; and (c) financial disclosure statement for selectedstaff members. These points – referred to in section II.C of the ICF – demonstratea commitment to integrity and ethical values.

2. The board of directors demonstrates independence from Management andexercises oversight of the development and performance of internalcontrol: IFAD’s Governing Council, Executive Board and Audit Committee areindependent from Management and exercise oversight as referred to in sectionII.A.

3. Management establishes, with Board oversight, structures, reporting lines,and appropriate authority and responsibilities in the pursuit of objectives:Section II. B describes the investment-related roles and responsibilities of keyparties responsible for oversight and decision-making of investment-relatedactivities. Chart 1 illustrates IFAD's governance structure and chart 2, the internalflow of financial information in terms of investments.

4. The organization demonstrates a commitment to attract, develop andretain competent individuals in alignment with objectives: IFAD’s HumanResources Implementing Procedures state that “Screening will be conducted withprofessional rigour … and selection processes ensuring that candidates areassessed on the basis of the highest standards of competence, integrity, andappropriate experience to carry out IFAD’s objectives and avoid potential conflictsof interest.”12

5. The organization holds individuals accountable for their internal controlresponsibilities in the pursuit of objectives: Section 3.1 of IFAD’s HumanResources Policy13 states that IFAD staff accepts responsibility to “discharge theirfunctions and regulate their conduct solely with the interest and objectives of theFund in view.”

II. Risk assessment6. The organization specifies objectives with sufficient clarity to enable the

identification and assessment of risks relating to objectives: The GoverningCouncil adopted the Financial Regulations of IFAD. Regulation VIII, paragraph 2states that “in investing the resources of the Fund the President shall be guided bythe paramount considerations of the security and liquidity. Within these constraints… the President shall seek the highest possible return in a non-speculativemanner”.

12 IFAD’s Human Resources Implementing Procedures – Chapter 2: Staff recruitment and appointment 2.3.1(ii).13 See EB 2004/82/R.28/Rev.1.

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7. The organization identifies risks to the achievement of its objectivesacross the entity and analyses risks as a basis for determining how therisks should be managed: Through the IPS the organization identifies aninvestment universe to achieve the above-mentioned objective as detailed insection III.A, whereby it stipulates asset classes, credit rating floors, durations andcorresponding benchmarks. Section III.A identifies various risks (i.e. market risk,currency risk, liquidity risk, credit risk, counterparty risk and operational risk)associated with IFAD’s investment portfolio and describes how these risks aremitigated and managed by IFAD. Table 2 summarizes established limits,monitoring/reporting frequencies and what alert actions are to be taken.

8. The organization considers the potential for fraud in assessing risks to theachievement of objectives: IFAD addresses this through its Policy on PreventingFraud and Corruption in its Activities and Operations,14 which aims to: “(i) affirmand communicate the Fund’s resolve to prevent and combat fraud and corruption inits activities and operations; (ii) describe the ongoing efforts of the Fund in thisarea; and (iii) outline actions that the Fund will be taking in implementing thispolicy”.

9. The organization identifies and assesses changes that could significantlyimpact the system of internal control: The annual review of the IPS and ICFprovides a framework to identify the adequacy of IFAD’s internal controls, which isthen reported to the Executive Board and Audit Committee. IFAD’s investmentcommittee, FISCO, meets regularly to review emerging challenges and risks and todiscuss and endorse mitigation strategies.

III. Control activities10. The organization selects and develops control activities that contribute to

the mitigation of risks to the achievement of objectives to acceptablelevels: Sections III.B and III.C stipulate IFAD’s risk assessment, controls andmonitoring activities to mitigate risks. These are further summarized in table 2.

11. The organization selects and develops general control activities overtechnology to support the achievement of objectives: Section III.C highlightsthe control and monitoring activities, specifically in relation to IFAD’s riskmanagement and compliance monitoring systems (a web-based applicationsupplied by IFAD’s global custodian). Furthermore, IFAD is continuing to developand improve the internal information technology systems pertaining to financialrisks and controls.

12. The organization deploys control activities through policies that establishwhat is expected and procedures that put policies into action: Section II.Coutlines the IFAD investment-related policies and procedures that govern IFAD'sinvestment processes and controls. It makes reference to IFAD’s FinancialRegulations, the ERM policy, the IPS, the liquidity policy, investment guidelines,the ICF, investment management and master custody agreements, the TreasuryManual and FISCO. Table 2 summarizes established risk limits,monitoring/reporting frequencies and procedures/actions to be taken in the eventrisk levels are breached.

14 See EB 2005/85/R.5 and subsequently revised EB 2005/86/INF.8.

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IV. Information and communication13. The organization obtains or generates and uses relevant, quality

information to support the functioning of internal control: As summarized intable 2, specifically under column "monitoring frequency/tool", quality informationis regularly collated by IFAD to generate compliance and risk reports to support thefunctioning of internal control.

14. The organization internally communicates information, includingobjectives and responsibilities for internal control, necessary to supportthe functioning of internal control: Section II.B. of the ICF, illustrates anddetails how financial information (in terms of investments) is communicated withinthe organization. This includes objectives and responsibilities for internal control.Risk levels are also reported to the FOD Management Team. Chart 3 presents theflow of control and communication for investment risks to internal parties includingbut not limited to the Treasurer and AVP/FOD.

15. The organization communicates with external parties regarding mattersaffecting the functioning of internal control: The IPS and ICF, together withthe annual revisions, provide a channel for the organization to communicatematters affecting the internal control over investment-related activities to externalparties.

V. Monitoring activities16. The organization selects, develops, and performs ongoing and/or separate

evaluations to ascertain whether the components of internal control arepresent and functioning: The effective functioning of internal controls overinvestments are subject to separate independent reviews by IFAD’s Office of Auditand Oversight, together with periodic reviews by IFAD’s external auditors.

17. The organization evaluates and communicates internal control deficienciesin a timely manner to those parties responsible for taking correctiveaction, including senior management and the board of directors, asappropriate: On an annual basis the IPS and ICF is reviewed to identify anypotential deficiencies with IFAD’s internal controls in relation to its investmentactivities, with proposed improvements and changes reported to the AuditCommittee and Executive Board. Furthermore table 2 summarizes the frequencyand timeliness of communicating any investment-related internal control breach torelevant parties, including the Treasurer, AVP/FOD, IFAD’s investment committeesas well as the Executive Board and Audit Committee.

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Glossary of risk measures and related terms

Active risk: The risk a portfolio or fund acquires when it is actively managed, especiallywhen its managers attempt to outperform some benchmark. More specifically, the morea fund or portfolio differs from the benchmark upon which it is based, the more likely itis to underperform or outperform that same benchmark. This extra risk is active risk. Forexample, a one-year forward-looking active risk of 0.2 per cent means that, over thecoming year, the portfolio excess return over the benchmark is expected to be in therange of +/- 0.2 per cent of its mean value.

The active risk can be predictive (or ex ante), based on expected return, or ex post,derived from the actual returns of the portfolio.

Alpha: Alpha is a risk-adjusted measure of the so-called "excess return" on aninvestment. It is a common measure of assessing an active manager's performance as itis the return in excess of a benchmark index or "risk-free" investment.

Benchmark: A benchmark is a standard against which the performance of a security ormanager can be measured. The benchmark should be an investment instrument that hascertain characteristics of transparency and replicability so as to best represent theperformance of a certain investment universe. In financial markets, the most popularindices are used as benchmarks. For example, the Standard & Poor’s 500 is a widelyused benchmark for United States "large-cap" equities markets.

Beta: Beta is a measure of the volatility, or systematic risk, of a security or a portfolio incomparison with the financial market as a whole.

Conditional VaR: CVaR is a measure of the average expected loss of a portfolioassuming that the value at risk has been reached. Since assumption is made that theportfolio loss has exceeded the VaR, the CVaR gives an indication about the magnitudeof the losses in ‘the tails’ of the distribution, i.e. in extreme loss cases. The higher theCVaR, the more a portfolio is expected to lose in extreme scenarios and, hence, theriskier it is.

Confidence level: This is the range (with a specified value of uncertainty, usuallyexpressed in percentage terms) within which the true value of a measured quantityexists. It is also the level of certainty to which an estimate can be trusted.

Duration: This is a measure of the sensitivity of a bond’s price to changes in the level ofmarket yields. For bonds, prices and yields have an inverse relationship. If the yieldsincrease, the bonds’ prices decrease. A bond with longer duration is more sensitive tochanges in market yields meaning that, all else equal, its price will decline more for agiven increase in yields than the price of a bond with shorter duration.

Fat tails: A fat-tailed probability distribution is one in which extreme events are moreprobable.

Historical simulation: Historical simulation is a procedure for predicting the values of aportfolio deriving such values from historical portfolio data.

Information ratio: This is a measure of risk-adjusted performance. The informationratio measures the relation between the portfolio’s average excess return (in excess ofthe benchmark return) and it's tracking error. A higher information ratio indicates abetter reward for the portfolio’s tracking error, thereby indicating also more successfulinvestment management skills.

Risk-adjusted return: This is a measure of how much an investment returned inrelation to the amount of risk it took on. It is often used to compare a high-risk,potentially high-return investment with a low-risk, lower-return investment. A simplerisk-adjusted return measure is dividing the portfolio’s annual return by its annualstandard deviation. This ratio gives an indication of the amount of return generated byeach risk unit. The higher the ratio, the better the risk-adjusted return.

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Risk-free rate: This is the theoretical rate of return of an investment with no risk offinancial loss. The risk-free rate represents the interest that an investor would expectfrom an absolutely risk-free investment over a given period of time. Risk-free assetsusually refer to short-dated government bonds. For United States dollar investments,usually United States Treasury bills are used; while a common choice for euroinvestments are German Government bills or the Euro Interbank Offered Rate (Euribor).

Sharpe ratio: This is a measure of risk-adjusted performance. It measures the relationbetween the portfolio’s average excess return (in excess of risk-free return) and itsstandard deviation. The higher the Sharpe ratio is, the better the reward for market risk.

Standard deviation: This is a measure of the volatility of a certain value around itsaverage. The higher the standard deviation, the more the value is dispersed around itsaverage. In the case of portfolio returns, the higher the standard deviation of returns,the more returns are expected to vary around the average expected return. Therefore, aportfolio with a high standard deviation is considered more risky than one with a lowerone, all else being equal.

Value-at-risk: This is the maximum potential loss an investment can incur over adefined time horizon within a specified confidence level. If an investment portfolio ofUS$100 million has a three-month VaR of 1.5 per cent with a confidence level of 95 percent, the maximum amount that could be lost over the next three-month period isUS$1.5 million; and this estimate can be trusted with 95 per cent certainty, meaningthat it is expected that the estimate is correct 19 times out of 20 (95 per cent of thetimes).

Volatility: This is a measure of the fluctuation in the market price of the underlyingsecurity. Mathematically, volatility is the annualized standard deviation of returns.