Risk Policy

8/7/2019 Risk Policy

1/38

Risk Management Policy

For Corporate Treasury


2/38

Contents

INTRODUCTION.........................................................................................................................................................3

OBJECTIVES...............................................................................................................................................................3

POLICY STATEMENT...............................................................................................................................................3

POLICY FRAMEWORK............................................................................................................................................4

IDENTIFICATION OF RISKS...................................................................................................................................5

EXCHANGE RATE RISK

..........................................................................................................................................................................................7

IDENTIFICATIONOF EXPOSURE.............................................................................................................................7MEASUREMENTOF EXPOSURE.............................................................................................................................7MANAGEMENTOF EXPOSURE..............................................................................................................................8

VALUATION................................................................................................................................................10

INTEREST RATE RISK............................................................................................................................................11

IDENTIFICATIONOF EXPOSURE...........................................................................................................................11MEASUREMENTOF EXPOSURE...........................................................................................................................11MANAGEMENTOF EXPOSURE............................................................................................................................15VALUATION................................................................................................................................................17

COMMODITIES PRICE RISK................................................................................................................................18

IDENTIFICATIONOF EXPOSURE...........................................................................................................................18MEASUREMENTOF EXPOSURE...........................................................................................................................18MANAGEMENTOF EXPOSURE............................................................................................................................18VALUATION................................................................................................................................................21

LIQUIDITY RISK .....................................................................................................................................................21IDENTIFICATIONOF EXPOSURE...........................................................................................................................21MEASUREMENTOF EXPOSURE...........................................................................................................................21MANAGEMENTOF EXPOSURE............................................................................................................................22VALUATION................................................................................................................................................24

CREDIT RISK............................................................................................................................................................26

IDENTIFICATIONOF EXPOSURE...........................................................................................................................26MEASUREMENTOF EXPOSURE...........................................................................................................................26MANAGEMENTOF EXPOSURE............................................................................................................................27

OPERATIONAL RISK..............................................................................................................................................28

MEASUREMENTOF EXPOSURE...........................................................................................................................28MANAGEMENTOF EXPOSURE............................................................................................................................29

STOP LOSS AND VALUE AT RISK.......................................................................................................................30

STOP LOSS LIMIT.........................................................................................................................................30LIMIT STRUCTURE.........................................................................................................................................31VALUEAT RISKLIMITS....................................................................................................................................33

SIMULATION APPROACHES................................................................................................................................34

REPORTING AND REVIEW...................................................................................................................................35

REPORTING................................................................................................................................................35

2


3/38

MONITORINGOF COMPLIANCE...........................................................................................................................36

ANNEXURE................................................................................................................................................................37

HEDGINGINSTRUMENTS..................................................................................................................................37

Introduction

Any business is open to a number of risks, amongst them: movements incompetitors' prices, raw material prices, competitors cost of capital, foreignexchange rates and interest rates are the most important.These Risk Management Guidelines set the principles and practices to managingrisks due to movements in foreign exchange rates, interest rates andcommodity prices. The Group/Company is expected to formulate its RiskManagement Policy that conforms to these guidelines and takes into accountUnit-specific issues and circumstances. The Company Board should approvesuch a Policy.

Objectives

The objective of the policy is to provide an overarching framework for managingthe risks associated with treasury functions. Specifically the policy aims to:

1. Identify, measure and effectively manage financial risk;2. On the operational side [cash flows arising from regular import andexport transactions and project related costs], minimize the impact ofadverse fluctuations in the foreign currency rates on the cash flowssubject to exchange risk exposure limits set;

3. On the financing side [cash flows associated with foreign currencydebt servicing obligations, i.e. principal and interest payments], avoidlosses while servicing loans taken in foreign currency, which may arisefrom adverse exchange rate movements away from the target exchangerate;4. Minimize the cost of gross debt (i.e. total borrowings), within prudentrisk parameters;5. Minimize the impact of adverse interest rate movements through theuse of interest rate management tools;6. Minimize price risk in commodity/raw material by hedging; and7. Ensure professional interaction with financial markets.

In essence, the objective is to reduce, if not eliminate, any losses due to forexand interest rate related transactions.

Policy Statement

The following principles underlie the Treasury Management Policy:

Centralised market interaction but decentralized strategic decisions;

3


4/38

Identification and effective management of financial risks;

Clear accountability;

Policy Framework

Establishing successful policy frameworks involves articulating objectives,strategies and tactics and defining how performance will be measured. Ageneric template is provided to ensure consistency in the application of thepolicy. However, the policies need to be formulated on a case-by-case basis withconsideration of the nature, size and complexity of financial market activities,particularly the quantitative limits.

In order to carry out its responsibilities, the Board of Directors in a Companyshould approve strategies and policies with respect to risk management and

ensure that senior management takes the steps necessary to monitor andcontrol these risks consistent with the approved strategies and policies. Theboard of directors should be informed regularly of the risk exposure of theCompany in order to assess the monitoring and controlling of such risk againstthe boards guidance on the levels of risk that are acceptable to the Company.

Senior management must ensure that the structure of the Company's businessand the level of risk it assumes are effectively managed, that appropriatepolicies and procedures are established to control and limit these risks, and thatresources are available for evaluating and controlling risk.

Companies should clearly define the individuals and/or committees responsible

for managing risk and should ensure that there is adequate separation of dutiesin key elements of the risk management process to avoid potential conflicts ofinterest. The Company should have risk measurement, monitoring, and controlfunctions with clearly defined duties that are sufficiently independent from thebusiness decision-making and position-taking functions of the company andwhich report risk exposures directly to senior management and the board ofdirectors. Larger Corporate should have a designated independent unitresponsible for the design and administration of the companys riskmeasurement, monitoring, and control functions.

The companys risk policy should be applied on consolidated basis and, asappropriate, at the level of individual affiliates, especially when recognizinglegal distinctions.

Products and activities that are new to the Company should undergo a carefulpre-acquisition review to ensure that the Company understands their riskcharacteristics and can incorporate them into its risk management process.Prior to introducing a new product, hedging, or position-taking strategy,management should ensure that adequate operational procedures and riskcontrol systems are in place. The board or its appropriate delegated committeeshould also approve major hedging or risk management initiatives in advance of

4


5/38

their implementation. Proposals to undertake new instruments or new strategiesshould contain these features:

Description of the relevant product or strategy;

Identification of the resources required to establish sound and effectiverisk management of the product or activity;

Analysis of the reasonableness of the proposed activities in relation to theCompany's overall financial condition and capital levels; and

Procedures to measure, monitor, and control the risks of proposedproduct.

Identification of Risks

Interest Rate risk;

Exchange Rate risk;

Commodity Price risk;

Credit risk;

Liquidity risk; Operational risk

Interest rate risk

Interest rate risk arises as a result of fluctuations in interest rates and it isusually defined as the risk that a corporates funding costs (or company's netinterest earnings) may be adversely affected by changes in market interestrates. Interest rate risk is of very wide importance to an organisation as itconcerns the risk of overall financial performance being impaired as a result ofchanges in interest rates. The size of the interest rate position(s), the volatilityof interest rates and the time period of the risk govern the magnitude of interest

rate risk.

Exchange Rate Risk

Foreign exchange transaction risk is the risk that the companys cash flows willbe adversely affected by movements in exchange rates that will increase thevalue of foreign currency payables, or will diminish the value of foreign currencyreceivables.Foreign exchange translation risk relates to the effect of currency movementson the value of a companys assets and liabilities denominated in foreigncurrencies when those values are translated into the functional currency of thecompany for accounting purposes.

For the purpose of this policy, Foreign Currency is defined as any currency thatis not the Units functional currency. It is likely that in case of certain Units, thelocal currency will be treated as foreign currency for purposes of applying thispolicy.

Commodity Price Risk

5


6/38

Commodity price risk arises due to uncertainty associated with the future abilityof an organization to buy and sell the necessary materials and finished productsrespectively at a price within a range sustainable for the business model.

Credit Risk

Credit risk is defined as the risk of incurring a loss as a result of the default by acounterparty that has:

Issued, accepted or endorsed a security in which the company hasinvested;

Accepted a deposit from the company; and

Entered into a hedging transaction with the company related to themanagement of financial risks.

The purpose of establishing credit limits is to ensure that the company dealswith creditworthy counterparties and that counterparty concentration risk isaddressed.Liquidity Risk

Liquidity risk is the potential that an organization cannot fund its operations orconvert assets into cash to meet commitments. Liquidity risk management isassociated with ensuring that there are sufficient funds available to meet thecompanys financial commitments in a timely manner. It is also associated withplanning for unforeseen events, which may curtail cash flows and causepressure on liquidity. The possible causes of a liquidity crisis include:

Unplanned reduction in revenue

Business disruption

Unplanned capital expenditureIn case of treasury, liquidity risk would be the ability of the company to unwindexisting or proposed trades for treasury.

Operational Risk

Operational risk is the risk associated with employing inadequate internalcontrols, systems, people, processes and procedures or from external events. Itconstitutes the risk of financial loss due to mismanagement, error, fraud orunauthorised use of instruments.

6


7/38

Exchange Rate Risk

Identification of Exposure

Any Cash Flow involving foreign exchange should be reported to theindividuals and/or committees responsible for managing risk. Theconcerned person is expected to maintain a running account of all foreignexchange transactions on a daily basis.

It is the responsibility of the individuals and/or committees to compile therequisite information on exposures from all sections of the company.

Measurement of Exposure

Exposure

An Exposure can be defined as the condition, in relation to an incompletetransaction (i.e. a transaction that has been initiated, committed or physicallycompleted but has not been fully settled) where the ultimate financial outcomeof the transaction upon the completion or settlement could be different from theone currently prevalent, due to changes in certain external circumstances. ARisk is the possibility that such a difference in outcome could be negative. In thematter of forex, the exposure would involve inflow or outflow of funds in acurrency other than the functional currency. A Forex exposure would arisewhen the flow of such funds is likely to take place at a future time, and there is

uncertainty about the effective rate of exchange between the functionalcurrency and the transaction currency.

Net Exposure

As Exports and Imports provide a natural hedge, provided the timing of therelated cash flows is identical, the inflows and outflows have to be netted-off toarrive at the net exposure. For instance, if Exports are USD 10 Million andImports are USD 9 Million, then the net exposure to be considered is USD 1Million.

For purposes of calculating Net Exposure, inflows and outflows have to be

matched based upon the expected dates of such flows. As it is very difficult toestimate such exact dates of inflows and outflows, the said exercise of matchinginflows and outflows, should be done over a fortnight, assuming the foreignexchange rate fluctuations within a fortnight is not significant enough to createany serious risk on the companys operations. However, if the company feelsthat the fluctuations in the relevant exchange rate are significant even during afortnight, then the company needs to do such matching of exposures overshorter periods, i.e., over a week. A significant fluctuation in this case may be inthe range of +/- X% of the Base Exchange rate.

7


8/38

Management of Exposure

Instruments for Hedging

To limit the exposure to changes in foreign exchange rates,corporates/institutions employs techniques, commonly called hedging, whichinclude (Explained in Annexure):

Spot;

Forward;

Futures;

Option;

Swaps;

Combinations of the above;

Exposures Limits

This exercise aims to state where the company would like its exposures toreach. Net Exposure mechanism is ideal while hedging decision has to be taken,but based on market view, forecasts and the risk appetite of the company thetreasury manager can take a view on the gross exposure with appropriateapproval.

The exposures will be considered over a period of Z months, on a rolling basis.This would be a continuous exercise, and therefore, at any point of time, theexposure for the next Z months will be taken into consideration for hedging orotherwise, decision making processes.

The overall target for the Company / Group is to have the net exposurelimit of USD X Million or 100% of Net Exposure (whichever is lower);

Exposure Limits can be increased to the levels mentioned below aftertaking approval from the respective authorities.

Exposure limits Approving Authority

100% of Net Exposure (if it is greater than USD Xmn)

Head of Group

Y% of (Gross Exposure Net Exposure) + NE Any Whole-timeDirector

Z% of (Gross Exposure Net Exposure) + NE BOD

Under no circumstances the absolute exposure can be more than USDmillion. Therefore no authority can approve exposure limits where theabsolute amount exceeds USD million.

8


9/38

Deal size limit

The following levels of executive/ officers are authorized severally to deal in thefollowing contracts by way of a single deal:

(Rs mn.)

Type DealersHead of the

deskHead of the

GroupWhole time

Director

Upto Spot

Forwards

Futures

Options

Swaps

Combinations

Deal done above the specified limit shall be approved by the next higherauthority having the requisite power to enter the deal of that size. In case thedeal size is beyond the limit permitted for the whole time director, the BOD shallapprove the same.

Portfolio Limit

The following levels of executive/ officers are authorized severally to take amaximum net position upto the following amounts at any point of time:

(Rs mn.)


deskHead of the

GroupWhole time

Director

Upto Spot

Forwards

Futures

Options

Swaps

9


10/38

Combinations

Bucket-wise Limit

The following percentage (of the portfolio limit) can be taken as net position (foreach executive/officers) in the time periods at any point of time:

(%)

TypeUpto 1

yr>1 - 2

yrs>2 - 3

yrs>3 - 4

yrs>4 - 5

yrs> 5 yrs

Forwards

Futures

Options

Swaps

Combinations

Valuation

Marking to market shall be done for any spot/ forward/ tom positions arising out

of the operations of the group.

Tom/Spot PositionsAny outstanding position arising out of tom/ spot transaction shall be consideredfor MTM purpose. These shall be valued using the tom/ spot rate (FEDAI rates)as quoted at the close of trading on the Reuters or any information service.

Forward PositionsThe outstanding forward positions shall be valued using the forward rates asquoted at the end of the day on the Reuters or any other information service. Incase the forward rates are not available for the exact maturity of the contract,the two adjacent forward rates shall be interpolated and the MTM positions shall

be calculated using the interpolated forward rates (FEDAI rates).

SwapBoth the legs of the swaps shall be valued using the market rates as quoted atthe end of the day on the Reuters or any other information service. (FEDAI rates)

Currency optionsOptions shall be valued based on the strike price, volatility, residual tenor, spotrate, and interest rates.

10


11/38

Interest Rate Risk


Any Cash Flow involving interest rate payable/receivable should bereported to the individuals and/or committees responsible for managingrisk. The concerned person is expected to maintain a running account ofall interest rate transactions on a daily basis.

It is the responsibility of the individuals and/or committees to compile therequisite information on exposures from all sections of the company.


Exposure

A Company's interest rate risk measurement system should address all materialsources of interest rate risk including repricing, yield curve and basis riskexposures. A number of techniques are available for measuring the interest raterisk exposure of both earnings and economic value. Their complexity rangesfrom simple calculations to static simulations using current holdings to highlysophisticated dynamic modeling techniques that reflect potential futurebusiness activities.

If the company has positions denominated in different currencies it wouldexpose it to interest rate risk in each of these currencies. Since yield curves varyfrom currency to currency, the company would generally need to assessexposures in each. If the multi-currency exposures are substantial, the riskmeasurement process should include methods to aggregate the exposures indifferent currencies using assumptions about the correlation between interestrates in different currencies. The correlation assumptions to aggregate the riskexposures should be periodically reviewed so as to ascertain their stability andaccuracy. The company should also evaluate what its potential risk exposurewould be in the event that such correlations break down.

Repricing schedules

The simplest techniques for measuring a Company's interest rate risk exposurebegin with a maturity/repricing schedule that distributes interest-sensitiveassets, liabilities, and Off Balance-Sheet positions into a certain number ofpredefined time bands according to their maturity (if fixed-rate) or timeremaining to their next repricing (if floating-rate). These schedules can be usedto generate simple indicators of the interest rate risk sensitivity of both earningsand economic value to changing interest rates.

11


12/38

Gap analysis:Simple maturity/repricing schedules can be used to assess the interest rate riskof current earnings, and is typically referred to as gap analysis. To evaluateearnings exposure, interest rate-sensitive liabilities in each time band aresubtracted from the corresponding interest rate-sensitive assets to produce a

repricing gap for that time band. This gap can be multiplied by an assumedchange in interest rates to yield an approximation of the change in net interestexpense/income that would result from such an interest rate movement. Thesize of the interest rate movement used in the analysis can be based on avariety of factors, including historical experience, simulation of potential futureinterest rate movements, and the judgement of companys management.

These simple gap calculations can be augmented by information on the averagecoupon on assets and liabilities in each time band. This information can be usedto place the results of the gap calculations in context. For instance, informationon the average coupon rate could be used to calculate estimates of the level ofnet interest expense/income arising from positions maturing or repricing within

a given time band, which would then provide a scale to assess the changes inexpense/income implied by the gap analysis.

Duration:A maturity/repricing schedule can also be used to evaluate the effects ofchanging interest rates on a companys economic value by applying sensitivityweights to each time band. Typically, such weights are based on estimates ofthe duration of the assets and liabilities that fall into each time band. Duration isa measure of the percentage change in the economic value of a position thatwill occur given a small change in the level of interest rates. It reflects thetiming and size of cash flows that occur before the instrument's contractualmaturity. Generally, the longer the maturity or next repricing date of the

instrument and the smaller the payments that occur before maturity (e.g.coupon payments), the higher the duration (in absolute value). Higher durationimplies that a given change in the level of interest rates will have a largerimpact on economic value.

Duration-based weights can be used in combination with a maturity/repricingschedule to provide a rough approximation of the change in a companyseconomic value that would occur given a particular change in the level ofmarket interest rates. Specifically, an average duration is assumed for thepositions that fall into each time band. The average durations are thenmultiplied by an assumed change in interest rates to construct a weight for eachtime band. In some cases, different weights can be used for different positions

that fall within a time band, reflecting broad differences in the coupon rates andmaturities (for instance, one weight for assets, and another for liabilities). Inaddition, different interest rate changes can be sometimes used for differenttime bands, generally to reflect differences in the volatility of interest ratesalong the yield curve. The weighted gaps are aggregated across time bands toproduce an estimate of the change in economic value of the company thatwould result from the assumed changes in interest rates.

12


13/38

Alternatively, an institution could estimate the effect of changing market ratesby calculating the precise duration of each asset, liability, and Off Balance-Sheetposition and then deriving the net position for the company, rather than byapplying an estimated average duration weight to all positions in a given timeband. This would eliminate potential errors occurring when aggregatingpositions/cash flows. As another variation, risk weights could also be designed

for each time band on the basis of actual percentage changes in market valuesof hypothetical instruments that would result from a specific scenario ofchanging market rates. That approach - which is sometimes referred to aseffective duration - would better capture the non-linearity of price movementsarising from significant changes in market interest rates and, thereby, wouldavoid an important limitation of duration.

Standardized Framework: Example

This annex contains an example setting out the methodology and calculationprocess in one version of a standardized framework. Other methodologies andcalculation processes could be equally applicable in this context, depending onthe circumstances of the company concerned.

Methodology: Positions on the companys balance sheet would be slotted intothe maturity approach according to the following principles:

All assets and liabilities and all Off Balance Sheet items that are sensitiveto changes in interest rates (including all interest rate derivatives) areslotted into a maturity ladder comprising a number of time bands largeenough to capture the nature of interest rate risk. Separate maturityladders are to be used for each currency accounting for more than 5% ofeither assets or liabilities.

On-balance-sheet items are treated at book value. Fixed-rate instruments are allocated according to the residual term to

maturity and floating-rate instruments according to the residual term tothe next repricing date.

Core deposits are slotted according to an assumed maturity of no longerthan five years.

Derivatives are converted into positions in the relevant underlying. Theamounts considered are the principal amount of the underlying or of thenotional underlying. Futures and forward contracts, including forward rateagreements (FRA), are treated as a combination of a long and a shortposition. The maturity of a future or a FRA will be the period until deliveryor exercise of the contract, plus - where applicable - the life of the

underlying instrument. For example, a long position in a June three monthinterest rate future (taken in April) is to be reported as a long positionwith a maturity of five months and a short position with a maturity of twomonths.

Swaps are treated as two notional positions with relevant maturities. Forexample, an interest rate swap under which a company is receivingfloating-rate interest and paying fixed-rate interest will be treated as along floating-rate position of maturity equivalent to the period until thenext interest fixing and a short fixed-rate position of maturity equivalent

13


14/38

to the residual life of the swap. The separate legs of cross-currency swapsare to be treated in the relevant maturity ladders for the currenciesconcerned.

Options are considered according to the delta equivalent amount of theunderlying or of the notional underlying.

Calculation process: The calculation process consists of five steps.

The first step is to offset the longs and shorts in each time band, resultingin a single short or long position in each time band.

The second step is to weight these resulting short and long positions by afactor that is designed to reflect the sensitivity of the positions in thedifferent time bands to an assumed change in interest rates. The set ofweighting factors for each time band is set out in Table 1 below. Thesefactors are based on an assumed parallel shift of 200 basis pointsthroughout the time spectrum, and on a proxy of modified duration ofpositions situated at the middle of each time band and yielding 5%.

The third step is to sum these resulting weighted positions, offsettinglongs and shorts, leading to the net short- or long-weighted position in thegiven currency.

The fourth step is to calculate the weighted position of the wholecompany by summing the net short- and long-weighted positionscalculated for different currencies.

The fifth step is to relate the weighted position to the limit exposure.

Table 1Weighting factors per time band (second step in the calculation process)

Time band

Middle of time

band

Proxy of

modifiedduration

Assumed

change inyield

Weighting

factor

Up to 1month

0.5 months 0.04 years 200 bp 0.08%

1 to 3 months 2 months 0.16 years 200 bp 0.32%3 to 6 months 4.5 months 0.36 years 200 bp 0.72%

6 to 12months

9 months 0.71 years 200 bp 1.43%

1 to 2 years 1.5 years 1.38 years 200 bp 2.77%2 to 3 years 2.5 years 2.25 years 200 bp 4.49%3 to 4 years 3.5 years 3.07 years 200 bp 6.14%4 to 5 years 4.5 years 3.85 years 200 bp 7.71%

5 to 7 years 6 years 5.08 years 200 bp 10.15%7 to 10 years 8.5 years 6.63 years 200 bp 13.26%

10 to 15years

12.5 years 8.92 years 200 bp 17.84%

15 to 20years

17.5 years 11.21 years 200 bp 22.43%

Over 20 years 22.5 years 13.01 years 200 bp 26.03%

14


15/38


16/38

Limits

Notional Deal size limit for derivative instruments

The following levels of officials are authorised severally to transact by way of asingle deal (based on notional value of the transaction) in the followingderivative instruments:

(Rs. mn)

Type DealersHead of

deskHead ofgroup

Wholetime

Director

Forward Rate Agreements

Interest Rate Futures

Interest Rate Options

Interest Rate Swaps

Combinations

Deals to be done above the specified limits shall be approved by the next higher

authority having the requisite power to enter the deal of that size. In case thedeal size is beyond the limit permitted for the whole time director, the BOD shallapprove the same.

Portfolio Limit

The following levels of executive/ officers are authorized severally to take amaximum gap position upto the following amounts at any point of time:

(Rs. mn)

Type DealersHead of

desk

Head of

group

Wholetime

DirectorForward Rate Agreements



Interest Rate Swaps

Combinations

16


17/38

Bucket-wise Limit

The following percentage (of the portfolio limit) can be taken as net position (foreach executive/officers) in the time periods at any point of time: (%)

Type

Upto 1

yr

>1 - 2

yrs

>2 - 3

yrs

>3 - 4

yrs

>4 - 5

yrs > 5 yrsForward RateAgreements



Interest Rate Swaps

Combinations

Valuation

The marked to market value of the Company's portfolio can be arrived at, byusing market values of individual products on real time basis.

Forward Rate Agreements

Forward Rate Agreements should be valued using the market rates asquoted at the end of the day on the Reuters or any other informationservice.


Interest Rate Futures shall be valued using the market rates as quoted atthe end of the day on the Reuters or any other information service.


Interest Rate Options shall be valued using the market rates as quoted atthe end of the day on the Reuters or any other information service.

Interest rate swaps

The marked to market is the net value of both the legs of the swap basedon the prices quoted on Reuters and other services or quotes obtained

from market participants and brokers.

17


18/38

Commodities Price Risk


Any Cash Flow involving commodity price payable/receivable should bereported to the Exposure Manager. Thus the Exposure Manager isexpected to maintain a running account of all commodity transactions ona daily basis.

It is the responsibility of the Exposure Manager to ensure that he receivesthe requisite information on exposures from all sections of the company.


Exposure

An Exposure can be defined as the condition, in relation to procurement/sale ofthe commodity in the open market where the ultimate financial outcome of thetransaction is dependent upon the price movement of the commodity, due tochanges in certain external circumstances. A Risk is the possibility that such adifference in outcome could be negative. In the matter of commodity, theexposure would involve purchase or sale of a commodity. A Commodityexposure would arise when the amount payable or receivable on purchase andsale respectively is likely to take place at a future time, and there is uncertaintyabout the effective market rate.


Instruments for Hedging

18


19/38

To limit the exposure to changes in commodity prices, corporates/institutionsemploys techniques, commonly called hedging, which include (Explained inAnnexure):

Spot

Forwards

Futures,

Options,

Swaps and

Combinations of the above

Limits

The limits for dealing in different commodities are set as under:

Asset type Limit

Commodity 1

Commodity 2

Commodity 3

Commodity 4

Commodity 5

Deal Size Limits

The following levels of executive/ officers are authorized severally to deal in thefollowing commodity contracts (applicable to each commodity asset separately)by way of a single deal:

(Rs mn.)


desk

Head of the

Group

Wholetime

Director

Spot

Forwards

Futures

Options

19


20/38


21/38


22/38

liquidity will typically be managed under normal circumstances, the companymust be prepared to manage liquidity under abnormal conditions.


Investment Limit

The investment limits (based on book value of investment) of the company indifferent markets is as follows:

(Rs.mn)

Instrument Limit

Equity Market

Money Market InstrumentsDebt Market Instruments

Mutual Funds

Bank Deposit/Cash

Deal size limit

The following levels of officials are authorised, severally, to invest in the undermentioned instruments by way of a single deal

(Rs.Mn)

Instrument DealersHead of

deskHead ofgroup

Whole timeDirector

Equity MarketMoney MarketInstrumentsDebt Market InstrumentsMutual FundsBank Deposit/Cash

Portfolio Limit

22


23/38

The following levels of executive/ officers are authorized severally to take amaximum net position upto the following amounts at any point of time:

(Rs.Mn)

Instrument Dealers

Head of

desk

Head of

group

Whole time

DirectorEquity MarketMoney MarketInstrumentsDebt Market InstrumentsMutual FundsBank Deposit/Cash

Deals to be done above the specified limit shall be approved by the next higherauthority having the requisite power to enter the deal of that size. In case thedeal size is beyond the limit permitted for the whole time director, BOD shallapprove the same.

Maturity wise limit

The cumulative investment in Debt Market Instruments across maturities shallnot exceed the following limits.(Rs. mn)

Maturity

1 - 3 yrs>3 - 5 yrs>5 - 10 yrs

>10 yrs

Rating wise investment limit

Investment in Money/Debt Market Instruments other than central and stategovernment guaranteed bonds, of a single issue shall not exceed any of thefollowing limits:

(Rs.mn)

Rating* Issue wise Limit Cumulative for ratingcategory

AAA/ AA+AA, AA-A+, A

A-, BBB+, BBB, BBB-* Rating limit includes structured obligation (SO) instruments alsoThe rating from CRISIL, ICRA, CARE and Fitch are to be considered for theabove.

23


24/38

Industry wise limit

In order to maintain exposure to industries at prudent levels and to diversifyrisks involved, Companys total exposure to a particular industry / sector wouldbe limited to a maximum of 15% of total exposure per industry / sector.

Valuation

In an ideal situation, the marked to market value of the Company's portfolio can

be arrived at, by using market values of individual securities on real time basis.The absence of market data on some of the instruments precludes the use ofthis methodology. Considering the constraints in terms of data availability,different methods are proposed for different set of securities.

Commercial Paper (CP)

Commercial Paper shall be valued at carrying cost. The carrying cost shallinclude the acquisition cost and the discount accrued on it from the dateof purchase.

GOI Securities, State Government Securities and Treasury Bills

GOI Securities shall be valued on daily basis at FIMMDA prices.

In case the rates are not available for State Government securities, theseshall be valued applying the YTM method by marking it up by 25 basispoints or as may be stipulated by RBI, above the yields of GOI Secs ofequivalent maturity published by FIMMDA periodically.

Treasury Bills shall be valued at carrying cost. The carrying cost shallinclude the acquisition cost and the discount accrued on it from the dateof purchase.

24


25/38


26/38

ascertained from the companys latest balance sheet (which should notbe more than one year or eighteen months (in case of companies withaccounting year ending other than March 31) prior to the date ofvaluation). In case the latest balance sheet is not available the shares areto be valued at Re.1 per company. In case of shares with a lock in period,valuation shall be based on current market price/break up value. Equity

shares, which are not traded in the last thirty days, shall be unquoted forthe above purposes.

Mutual Funds

In case of listed units, quoted market price shall be used for valuationpurpose.

In case of unlisted units, Net Asset Value (NAV)/ repurchase price shall beused for valuation purpose.

Units of mutual funds with a lock-in period for which repurchase price/market quote is not available will be valued at carrying cost.

CREDIT RISK


The basis for an effective credit risk management process is the identificationand analysis of existing and potential risks inherent in any product or activity.Consequently, it is important that the company identify all credit risk inherent inthe products they enter and the activities in which they engage. Suchidentification stems from a careful review of the existing and potential credit riskcharacteristics of the product or activity.


An effective credit monitoring system will include measures to:

Ensure that the company understands current financial condition of thecounterparty;

Monitor compliance with existing covenants;

Identify contractual payment delinquencies and classify potential problemcredits on a timely basis; and

Direct promptly problems for remedial management.

26


27/38

The Company should have methodologies that enable them to quantify the riskinvolved in exposures to individual counterparties. Company should also be ableto analyse credit risk at the product and portfolio level in order to identify anyparticular sensitivities or concentrations. The measurement of credit risk shouldtake account of

The specific nature of the credit and its contractual and financialconditions (maturity, reference rate, etc.);

The exposure profile until maturity in relation to potential marketmovements;

The potential for default based on the credit rating.


Aggregate Counterparty Exposure Limits

Counter Party Tenor Limit Amount

Counter Party 1Upto 3 yrs>3 - 5 yrs

>5 - 10 yrs>10 yrs

Counter Party 2

Upto 3 yrs>3 - 5 yrs

>5 - 10 yrs>10 yrs

Counter Party 3

Upto 3 yrs>3 - 5 yrs

>5 - 10 yrs

>10 yrs

27


28/38

Operational Risk


Risk identification is paramount for the subsequent development of a viable

operational risk monitoring and control system. Effective risk identificationconsiders both internal factors (such as the companys structure, the nature ofthe companys activities, the quality of the companys human resources,organizational changes and employee turnover) and external factors (such aschanges in the industry and technological advances) that could adversely affectthe achievement of the companys objectives.


Amongst the possible tools which can used by the company for identifying andassessing operational risk are:

Self- or Risk Assessment

A company assesses its operations and activities against a menu of potentialoperational risk vulnerabilities. This process is internally driven and oftenincorporates checklists and/or workshops to identify the strengths andweaknesses of the operational risk environment. Scorecards, for example,provide a means of translating qualitative assessments into quantitative metricsthat give a relative ranking of different types of operational risk exposures.Scores may address inherent risks, as well as the controls to mitigate them. Inaddition, scorecards may be used by the company to allocate economic capitalto treasury in relation to performance in managing and controlling various

aspects of operational risk.

Risk Mapping

In this process treasury functions or process flows are mapped by risk type. Thisexercise can reveal areas of weakness and help prioritize subsequentmanagement action.

Risk Indicators

Risk indicators are statistics and/or metrics, often financial, which can provideinsight into a companys risk position. These indicators tend to be reviewed on a

periodic basis (such as monthly or quarterly) to alert the company to changesthat may be indicative of risk concerns. Such indicators may include the numberof failed trades, staff turnover rates and the frequency and/or severity of errorsand omissions.

Measurement

Firms can also quantify their exposure to operational risk using a variety ofapproaches. For example, data on the companys historical loss experience

28


29/38

could provide meaningful information for assessing the treasurys exposure tooperational risk and developing a policy to mitigate/control the risk. An effectiveway of making good use of this information is to establish a framework forsystematically tracking and recording the frequency, severity and other relevantinformation on individual loss events. Firms can also combine internal loss datawith external loss data, scenario analyses, and risk assessment factors.


The company should ensure that internal practices are in place as appropriateto control operational risk. Examples of these include:

Close monitoring of adherence to assigned risk limits or thresholds;

Maintaining safeguards for access to, and use of, companys assets andrecords;

Ensuring that staffs have appropriate expertise and training;

Identifying products where returns appear to be out of line with

reasonable expectations (e.g., where a supposedly low risk, low margintrading activity generates high returns that could call into questionwhether such returns have been achieved as a result of an internalcontrol breach);

Regular verification and reconciliation of transactions and accounts; and

Use of Voice Recording System while finalizing deals with counterparties.

29


30/38

Stop Loss and Value at Risk

Stop Loss Limit

Stop Loss limits are risk control mechanisms. A Stop Loss is the maximum

permissible loss that can be incurred on a position or a portfolio of positions. It isthat point at which either approval of a superior authority is required to continuewith the position or the trader has to square off the position and book the loss.

Need for Stop Loss

The company is exposed to price risk arising out of interest rate movements,foreign currency movements and credit risk on account of investments/positions. Since the value of the positions undergoes a change on account of thechanges in the interest rates, exchange rates or the credit rating, the marketvalue of the position undergoes change, even though the position has not beenliquidated.

In order to limit the amount of loss, which can arise out of the adverse marketrate movements, stop loss limits are stipulated for treasury operations. It alsoenables an efficient risk monitoring mechanism by which information can bepassed on to the management before a certain threshold level of stop loss limithas been reached. The management shall then be able to take corrective action,if necessary, before the actual stop loss limit is reached. The Head of Groupsand the Country Head, in case of overseas/ offshore offices, shall be informed byemail when the stop loss exceeds 75% of the limit prescribed in this policy.

The stop loss for foreign currency exposure of the company would be monitoredon a real time basis and the Head of Groups would be informed by emailimmediately when the stop loss exceeds 75% of the limit prescribed in thispolicy at any time during the day. However, in case the stop loss does notexceed the aforesaid limit the Head of Groups would be informed the same byend of day by the Daily Treasury Report. This process is applicable to breach ofdaily as well as cumulative stop loss limits.

30


31/38

Limit Structure

Daily stop loss limits and Cumulative loss limits are stipulated for the portfolio asa whole.

Daily Portfolio stop loss limit are set as under: Rs. mnProducts Limits

Fixed Income (FI)Foreign ExchangeDerivativesCommoditiesTotal

P&L due to foreign currency risk in derivatives shall form part of foreignexchange limits. There is no limit for interest rate risk in derivatives.

Derivatives limit is included in FI and Fx limits. The limits shall be fungibleacross product categories.

The total limit for currency option across all groups shall be Rs mn.Notes: The upfront incentive income received on any security shall beconsidered as part of profit for the purpose of the calculation of the stop losslimit.

Cumulative Loss Limits shall be for a financial year.Rs. mn

Products LimitsFixed Income (FI)Foreign ExchangeDerivativesCommoditiesTotal

P&L due to foreign currency risk in derivatives shall form part of foreignexchange limits. There is no limit for interest rate risk in derivatives.

Derivatives limit is included in FI and Fx limits. The limits shall be fungibleacross product categories.

The total limit for currency option across all groups shall be Rs mn.

Calculation of profit/ loss for monitoring of Stop Loss Limit

Profit/ loss on market exposures for the purpose of monitoring of daily stop lossof the portfolio shall be computed as follows:

Unrealised gain/ loss as on the date of the computation

Less: Unrealised gain/ loss as at the end of the last trading day

Add: Realised gain/ loss during the day

In case the underlying is hedged with a derivative the profit/ loss shall beconsidered after taking into account the profit/ loss on the derivative.

31


32/38

Profit/ loss for the purpose of monitoring of cumulative loss limits shall be asfollows:

Unrealised gain/ loss as on the date of computation

Less: Unrealised gain/ loss as at the end of the last accounting year

Add: Realised gain/ loss from beginning of the financial year till date ofcomputation.

Authorization Structure

In case a stop loss limit, as laid down by this policy, is breached, the positionshall be liquidated. However, if the position is intended to be continued further,specific approval shall be obtained from the following authorities:

Stop loss limits Approving AuthorityPortfolio-wise daily Any Whole-time DirectorCumulative yearly BOD

Chief Financial Officer & Treasurer and will jointly allocate the stop loss andinvestment limits, product-wise, to various overseas/ offshore branches.

Stop loss limits breaches, if any, should be reported to BOD.

32


33/38

Value at Risk limits

Value-at-Risk (VaR) is a risk control mechanism and is the potential loss that canbe incurred on a portfolio under normal market conditions at a pre-determinedconfidence level (99%) over a one-day holding period.

VaR for each portfolio is calculated by taking into account the factor sensitivitiesand the volatilities of risk factors. For this purpose, factor sensitivities are usedto monitor the price risks of portfolios. Factor sensitivity measures the changesin portfolio value for a defined change in risk factors (e.g., interest rates,exchange rates, exchange rate volatility, etc.). These factor sensitivities wouldbe back tested to take into account the changes in the same at least once in ayear and the required revisions, if any would be made in the factor sensitivities.

Daily Value at Risk (VaR) limit

The Product wise VaR limits shall be as under:

Rs. mnProducts Limits

Fixed Income (FI)Foreign ExchangeDerivativesCommodities

For breach of VaR Limits, approval shall be obtained from any whole timedirector.

33


34/38

Simulation approaches

Many companies (especially those using complex financial instruments orotherwise having complex risk profiles) employ more sophisticated riskmeasurement systems than those based on simple maturity/repricing schedules.

These simulation techniques typically involve detailed assessments of thepotential effects of changes in interest rates, foreign exchange rate andcommodity prices on earnings by simulating the future path of the rates andtheir impact on cash flows.

Simulation approaches typically involve a more detailed breakdown of variouscategories of on- and off balance-sheet positions, so that specific assumptionsabout the interest and principal payments and currency transaction arising fromeach type of position can be incorporated. In addition, simulation techniques canincorporate more varied and refined changes in the rates environment, rangingfrom changes in the slope and shape of the yield curve to interest rate scenariosderived from Monte Carlo simulations and similar scenarios can be created for

currency rates.

Static simulation

In static simulations, the cash flows arising solely from the companys currenton- and off-balance-sheet positions are assessed. For assessing the exposure ofearnings, simulations estimating the cash flows and resulting earnings streamsover a specific period are conducted based on one or more assumed ratescenarios. Typically, although not always, these simulations entail relativelystraightforward shifts or tilts of the yield curve, or changes of spreads betweendifferent interest rates or movement in currency rate. When the resulting cashflows are simulated over a specified period and discounted back to their present

values, an estimate of the change in the companys profit/loss can becalculated.

Dynamic simulation

In a dynamic simulation approach, the simulation builds in more detailedassumptions about the future course of currency rates, interest rates and theexpected changes in a companys business activity over that time. For instance,the simulation could involve assumptions about a companys strategy forchanging administered interest rates and/or about the future stream of businessthat the company will encounter. Such simulations use these assumptions aboutfuture activities and reinvestment strategies to project expected cash flows and

estimate dynamic earnings. These more sophisticated techniques allow fordynamic interaction of currency rates, commodity prices and interest rates.

As with other approaches, the usefulness of simulation-based risk measurementtechniques depends on the validity of the underlying assumptions and theaccuracy of the basic methodology. The output of sophisticated simulationsmust be assessed largely in the light of the validity of the simulation'sassumptions about future rates and the behaviour of the company. One of the

34


35/38

primary concerns that arise is that such simulations do not become blackboxes that lead to false confidence in the precision of the estimates.

Reporting and Review

Reporting

The Reporting would consist of the following two aspects:

Historical Information - Information on actual inflows and outflows for thepast period, i.e., historical information. This would involve maintaining ofa log of all foreign exchange transactions indicating for each transaction,the date and time of the transaction, the counter party and all relevantparticulars of the transaction.

Estimates for future - Information on estimated future inflows andoutflows to be prepared based on transactions that are to be entered intoin the next 3 months;

Exposure Reports

The treasury of the company should prepare the following reports.

Management Information reports:The following Management Information report should be sent to the undermentioned as per the schedule given below.

Sr.No.

Name of the ReportPeriodicit

yTo be submitted

within/bySubmitted to

1Daily Treasury Report(DTR)

Daily By next working daySeniorManagement

2Investment Review oftreasury transactions

QuarterlyIn the BOD meetingpost finalization ofaccounts

BOD

3Review of ForeignExchangeTransactions

QuarterlyWithin fortnight ofclosure of accounts

BOD

4Downward creditmigration

Monthly Within fortnight BOD

Money Market reports:The Money Market Reports should be submitted to the CFO of the company asper the schedule given below

Sr.No.

Name of the Report PeriodicityTo be submitted

within/by

1Daily Return onCall/Notice/Term Money/RepoTransactions

DailyBefore 6 pm on thesame day

2 IRS Return FortnightlyBy the end of the nextfortnight

35


36/38

3Status of Interest RateFutures

MonthlyBy 10th of the followingmonth

Foreign Exchange & Derivatives reports:The Foreign Exchange & Derivatives Reports should be submitted to the CFO ofthe company as per the schedule given below

Sr.No.

Name of the Report PeriodicityTo be submitted

within/by

1Long Term Foreign CurrencyRupee Swap

Weekly By end of next week

2 Weekly Position Weekly By end of next week

3Statement on balances heldabroad (BAL)

Fortnightly Within next 7 days

4 Maturity and Position (MAP)Last Friday ofMonth Within next 21 days

5 Outstanding Export CreditsLast Friday ofMonth

Within next 10 days

6 Cross Currency derivatives Half-yearly No statutory deadline

7 Rupee Dollar Option MonthlyBy the followingMonday

8Outstanding overseasforeign currency borrowings

Monthly Within 10 days

9Review of Foreign ExchangeTransactions

MonthlyWithin week of closureof accounts

Monitoring of Compliance

The Internal Assurance department should monitor compliance of the policy aspart of their audit plan. The company should have in place adequate internalaudit coverage to verify that policies and procedures have been implementedeffectively. The company should ensure that the scope and frequency of theaudit programme is appropriate to the risk exposures. Audit should periodicallyvalidate that the firms treasury risk management framework is beingimplemented effectively across the firm.

36


37/38

Annexure

Hedging instruments

Forward Contracts

A forward contract is an agreement to buy or sell an asset at a certain time inthe future for a certain price (the delivery price). It can be contrasted with a spotcontract, which is an agreement to buy or sell immediately. The contract is anagreement between two financial institutions or between a financial institution

and one of its clients. No money changes hands when contract is first negotiatedand it is settled at maturity. The forward price for a contract is the delivery pricethat would be applicable to the contract if it were negotiated today (i.e., it is thedelivery price that would make the contract worth exactly zero). The forwardprice may be different for contracts of different maturities.

Options

There are two basic types of options. A call option gives the holder the right tobuy the underlying asset by a certain date for a certain price (the strike price). Aput option gives the holder the right to sell a certain asset by a certain date fora certain price (the strike price). American options can be exercised at any time

up to the expiration date. European options can be exercised only on theexpiration date itself. In India only European options are permitted.

Swaps

A swap is an agreement to exchange cash flows at specified future timesaccording to certain specified rules. Converting a liability or investment from fixed rate to floating rate or floating rate to fixed rate. A swap can be regardedas a convenient way of packaging forward contracts. The value of the swap isthe sum of the values of the forward contracts underlying the swap.

Forward Rate Agreement

A Forward Rate agreement is an agreement between the company and acounter party which effectively fixes an interest rate for a deposit / loan whichwill arise at a future date. The FRA is based on a notional principal amount.


An interest rate futures contract is based on an Interbank deposit rate or anunderlying debt security. The price of futures is inversely related to movements

37


38/38

in interest rates. Therefore, if it is believed that interest rates will decline,hedging of underlying position can be achieved by buying futures contracts nowto benefit from the price rise.

Interest Rate Cap

An interest rate cap is an option that affords the company protection against anupward movement of rates while still allowing the company to exploit thebenefit of falling interest rates. This is achieved by setting an upper limit (orcap) on the floating interest rate. If that limit is exceeded, the company will befully compensated by the bank. The company pays a cash premium for the capup front. The closer the cap levels to the current interest rate, the moreexpensive the option.

Interest Rate Collar

An interest rate collar is an option that affords the company protection against adownward movement of rates while still allowing the company to exploit thebenefit of increasing interest rates.The collar is used when a company does not want to pay the full premium for acap. The company can negate some of the cost by selling the bank an interestrate floor, which can totally or partially offset the cost of the cap. The companybenefits from falling interest rates until the floor level is reached. The companyis still protected from an adverse rise in rates above the cap level. Therefore arange or 'collar' is created and the company will never pay a lesser interest rate

than the floor rate nor a greater interest rate than the cap rate.

Interest Rate Swap

This product allows you to swap the interest rate basis of an asset or liabilityfrom a floating rate to a fixed rate or vice versa. This is an off-balance sheetinstrument involving no exchange of principal amounts at any stage.

Risk Policy

Documents

Transcript of Risk Policy