PRESENTATION FOR September 2017 Bank of Botswana 6/21/2019 PRESENTATION FOR MEFMI SERMINAR ON MARKET RISK September 2017

RISK MANAGEMENT FRAMEWORK Board Investment Committee (Chaired by Governor) Financial Markets Department (I.C Sub) Risk Management Unit (within FMD)

INVESTMENT POLICY AND OBJECTIVES SAFETY Maintenance of purchasing power of foreign exchange reserves LIQUIDITY Timely availability of funds that can be accessed to meet payment obligations RETURN Subject to liquidity and risk constraints, reasonable earnings are generated.

INVESTMENT POLICY AND OBJECTIVES LIQUIDITY PORTFOLIO 100 percent short maturity bonds and bank deposits Lower but stable expected return PULA FUND 35 percent equities 65 percent long maturity bonds Higher expected return over the long term

INVESTMENT POLICY AND OBJECTIVES (Cont’d) PULA FUND Fund for future generations (quasi SWF) LIQUIDITY PORTFOLIO Short-term portfolio to cover six months of import cover Safety Liquidity Return Safety Return Liquidity

RESERVES STRUCTURE AGGREGATE PORTFOLIO IMF ( (6-months import cover) LIQUIDITY PORTFOLIO TRANSACTION BALANCE TRANCHE LIQUIDITY INVESTMENT TRANCHE PULA FUND GLOBAL FIXED INCOME EQUITIES GLOBAL MANDATE REGIONAL MANDATES (USA, Europe, Japan, UK) The portfolio structure is shown in more detail in this this slide, with values for the main components as at December 2016: LP, cash, money market and short fixed income PF: both fi an equities with the latter broken down ….and equities (i.e., shares traded on major stock markets, with a global mandate supplemented by regional mandates focussed on those markets

PORTFOLIO MANAGERS Pula Fund (65 percent ) (35 percent) Bonds (65 percent ) Bank of Botswana External Mangers Equities (35 percent) External managers

Market Risk/Systematic risk Negative returns due to market factors. Accept risk is inherent in portfolio Identify and manage the risk

Managing Currency Risk Invest in well developed financial markets Currency must be convertible Minimum rating Aa/AA Currency Exposure Limits (+/- 5 or 10% vs Benchmark) Non benchmark currencies max 5 percent Hedging- forwards and derivatives. Derivatives allowed only for hedging or portfolio rebalancing

Managing Interest Risk Adverse movements in interest rates Duration- most widely used measure BoB uses modified duration Duration buckets Duration decision taken by I.C Local market duration Total portfolio duration limit +/-1.5 years Internal portfolio managers +/- 0.2 years Correct deviation within two business days

Tracking Risk Difference between portfolio return and benchmark return TE = Return (p) – Return (BM) But model uses standard deviation of differences in portfolio and benchmark returns 3-year rolling tracking error target. Weekly Tracking error for Sub-I.C Quarterly Tracking Error – Custodian Reports

Value at Risk An estimate of what the portfolio could lose Set time period – normally 3-months Certain level of confidence (95%)

Bank Risk Deposit Takers Based on credit ratings Monthly setting of exposure limits Daily monitoring of exposures

Fund Manager Monitoring Daily compliance monitoring Compliance Radar Email alerts Weekly fund manager reports Monthly reports.

RISK ASSOCIATED WITH QUASI SWF Reserves are in the balance sheet of BoB Not independent Unplanned withdrawal for fiscal expenditure

CONCLUSION A robust risk management framework is important Manage risk, do not avoid it Have a risk budget KNOW YOUR PORTFOLIO CHARATERITICS !!!!!