Financial Management of Trust Funds Currency and Commitment Risks CFP Financial Management (CFPFM)

1. Basis of Commitment for Trust Funds Programs 2. Foreign Exchange Risk in Trust Fund Programs 2 Roadmap

The typical life cycle of TF contributions, payments, allocations, commitments and disbursements: 1.Donors agree to contribute to a TF, through a contribution agreement 2.Funds are either paid in shortly after signing of agreement, or according to an agreed schedule of (multi-year) installment payments 3.The TF program manager allocates the TF resources to specific projects or activities, in accordance with the contribution agreement 4.Funding is committed to final recipients through grant agreements Commitments represent obligations to pay subject to availability of donor funds 5.Funds are disbursed over time as projects are implemented Risks arise when TFs make commitments based on future donor funds yet to be received Life cycle of TF contributions 3

There are two “bases for commitment” for TFs: 1.Liquid assets (cash received and invested) = USD18 billion (March 2010) 2.Donor contribution receivables (including promissory notes held and not yet encashed) = USD10 billion (March 2010) Entering into grant commitments based on future donor receivables entails risk for final recipients, should donors not contribute as agreed (donor credit risk). In addition, there is currency exposure. Donor contribution agreements and governing documents do not generally indicate the basis of commitment Exception: Larger TFs and FIFs, such as GEF and Global Fund, often have explicit guidelines for commitments, set by their governing bodies For new TFs, there is evidence of an increasing degree of commitment against donor contribution receivables, rather than cash Different TF Bases of Commitment create risks 4

TF grant commitments have doubled over the past years 5.. and in recent years, signing grant agreements based on future donor receivables has become more prevalent Note that this data excludes FIFs, IFC, MIGA and ICSID commitments

Measures being taken to manage Basis of Commitment risk 1.Strengthening legal agreements and enhancing disclosure to donors and grant recipients 2.Strengthening internal controls, including enhanced data recording 3.Aligning financial reporting of TFs with their basis of commitment (i.e. non- cash TFs to report on an “accrual” basis) 4.Enhancing training and certification for task managers of TFs whose basis of commitment includes donor receivables 5.Exercising targeted IT system controls based on the actual basis of commitment for each TF 6.Establishing the ability for TFs to draw on the Donor Balance Account (DBA) in case of a funding shortfall 7.Adjusting commitment authority available to TFs based on specific risk factors 6

1. Basis of Commitment for Trust Funds Programs 2. Foreign Exchange Risk in Trust Fund Programs 7 Roadmap

Trust Funds have grown substantially, in size and complexity TF disbursements of $6.9 billion in fiscal year 2009 were equivalent to 70% of annual IDA disbursements, or 20% of total World Bank (IBRD, IDA and Trust Funds) disbursements There are now 245 TF donors, from 77 countries, providing funding in some 30 different currencies Most TFs provide grants to final recipients in US dollars. However, the majority of donor contributions is in currencies other than the US dollar, thus creating a currency mismatch With the recent strengthening of the US dollar against major currencies, the US dollar value of donors’ non-US dollar contributions decreases, lowering the funding available for grant recipients Growth in TF volume and currency exposure 8

Currency risk exists until donor receivables have been paid in cash and converted into the target currency (“holding currency”) for a TF Currency risk in TFs arises in 4 main ways: 1.The national currency of donors differs from the agreed currency of contribution 2.The agreed currency of donor contribution differs from the holding currency for a TF (=> this is the main source of currency risk for TFs) 3.The holding currency for a TF differs from the currencies of grant agreements 4.The TF grant agreement currency differs from the national currency/ the primary procurement currency of final grant recipients 9 Sources of currency risk

TF contribution & disbursement currencies 87% of TF donor contributions are in non-USD currencies 10 88% of TF grant disbursements are in USD Note: These are aggregate portfolio amounts; individual trust fund contribution/ disbursement profiles may differ.

Resulting TF currency exposure The mismatch between contribution and disbursement currencies results in some USD 4 billion of currency exposure 11 Note: These are aggregate portfolio amounts; individual trust fund contribution/ disbursement profiles may differ.

US dollar appreciation against donor contribution currencies since mid-2007 is a particular issue for TFs The US dollar has strengthened during the financial crisis 12 Currency composition in the basket: EUR, GBP, JPY, SEK, NOK, CHF, NZD, CAD, AUD, and SDR

As the US dollar value of donor receivables falls, less total funding will be available for project expenditures in US dollars for a given TF: Overall, a given TF program will have less funding available in US dollars, adversely impacting programming ability Individual grant recipients may also be at risk if grant commitments are based on donor receivables (and are not limited to cash received from donors) Example: A TF commits EUR10 million to a recipient, equivalent to USD14 million at the time of commitment (EUR1 = USD1.40). The recipient then purchases goods or services based on this commitment. If the EUR depreciated to parity (EUR1 = USD 1.00) against the USD by the time the EUR is contributed to the World Bank, there would only be USD10 million available to pay to the recipient. Example of TF currency exposure 13

Risk mitigating measures that can be deployed at the individual TF level include the following: 1.Limiting grant commitments to available TF cash balances only – the most conservative risk management approach 2.Establishing a “reserve” that acts as a valuation buffer for future donor receivables (Examples: GEF currency reserve; limiting grant commitments against non-USD donor receivables to xx% of their USD equivalent value) 3.Donors can decide to contribute to TFs in the grant commitment currency, thus taking on the currency exposure at the donor level 14 Possible approaches for managing the risk

15 The US dollar value of donor receivables could be locked in, using currency hedges from the capital markets. In the case of IDA15, IBRD was able to intermediate such hedges for donor receivables. For trust funds, however, specific challenges include: 1.Some 850 active TFs, with different currency exposures 2.Conditional and qualified donor commitments, which could not be hedged 3.Lack of legal status of TFs, with resulting credit issues for markets/ for IBRD As a result, setting up a currency hedging framework for TFs would be complex and costly Possible approaches for managing the risk continued

16 If using currency hedges, possible methods would include: 1.Hedging exact currency flows for individual TFs within an overall “pool” structure 2.Hedging donor contributions “at the source”, i.e. directly with the donors 3.Creating a rolling macro foreign exchange position that TFs could buy into as a partial hedge of their currency risk The World Bank will explore these and other options, provided there is sufficient demand from TF donors and recipients Possible approaches for managing the risk continued

Thank you 17