Archived - Departmental Response to the Risk Management Evaluation
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The Department of Finance and the Bank of Canada are responsible for the management of the Government of Canada's financial assets and liabilities. The management of risks, associated with funds management activities, is assessed on an ongoing basis to ensure that financial, operational and legal risks are appropriately identified, measured, mitigated and reported following best risk practices.
In order to codify the risk management practices pertaining to the Government's borrowing and investing programs, the Bank of Canada and the Department of Finance established in February 1998, a Memorandum of Understanding (MOU) on Risk Management. The purpose of the MoU was to set out a policy framework for the management of treasury risks and to agree on the roles and responsibilities of the Bank and Finance with respect to the implementation of the framework. In 2003, the Treasury Management Governance Framework was created, in part, to enhance the integration of risk management in policy development and market operations. The Financial Risk Office (FRO) of the Bank of Canada was created to ensure the provision of information and advice on financial and operational risk is carried out in an independent manner, apart from front office activities. This framework was updated in 2006 to further clarify the roles and responsibility of FRO and the Risk Committee that oversees treasury risk management. Also in 2006, the Treasury Risk Management Framework (TRMF) was created to document, in a transparent manner, the risk guidelines and exposure limits that apply to funds management activities. Since 2006, work has been ongoing to improve risk policies, measures and reporting.
Professor Glen Donaldson, Finning Ltd. Professor in Finance at the University of British Columbia, was engaged in February 2007 under the Department of Finance's Treasury Evaluation Program to conduct a review of the risk management frameworks and processes regarding the Government's debt and liquid assets, including the Exchange Fund Account (EFA), relative to objectives and best practices of other comparable entities. The review period included an assessment of the impact of the period of credit market disruption experienced starting in August 2007.
Response to Recommendations
The Department is pleased to note that the report concludes that the risk management framework and processes within the Department and the Bank of Canada are generally appropriate, taking into account industry best practices and those of comparable international institutions. Mr. Donaldson's report highlights that the Government's risk framework is working well and that most areas do not need to be adjusted.
The Department notes that Mr. Donaldson has made some recommendations to enhance current treasury risk processes, a few of which he recommends be addressed as soon as possible and others which could be monitored for possible changes in the future.
Following are the main recommendations to the Government and the Department's initial response:
- Elements that should be addressed as soon as possible
- Color-code risk reports, using yellow or red to highlight information and statistics of particular interest, in an effort to enhance readability
- Determine and set clear Market Risk limits at which sub-portfolios within the Exchange Fund Account must be rebalanced, or at least a balancing discussion must occur, leveraging statistics such as VaR, gap (currency/duration), etc., similar to what is done with counterparty limits on the Credit Risk side
- Consider appointing an independent member to the Risk Committee – ideally an individual with expertise in risk management, familiarity with the Bank and Finance, and no conflicts of interest – in part to gain ready and ongoing access to knowledge of ongoing developments in risk management best practices and issues, and to provide added assurance in oversight
- Re-evaluate whether Finance has the information and power necessary to perform risk oversight of the Crowns to the degree of robustness desired, and take appropriate actions, if this is not the case
- The recommendation to enhance the readability of risk reports by introducing color-coding has been implemented by the Financial Risk Office at the Bank of Canada.
- Work on developing enhanced market risk limits is being undertaken with a view to adopting an enhanced suite of market risk VaR metrics for the reserves portfolio.
- The Department will seek to appoint an external member to the Risk Committee.
- With respect to the risk oversight of Crown corporations, it must be recognized that the Board of Directors of each Crown is responsible for ensuring that treasury risk is prudently managed, consistent with the Treasury Risk Guidelines for Crown Corporations of the Minister of Finance. The related information needs and roles and responsibilities of the Department of Finance will be examined in 2008 with the review of the Treasury Risk Guidelines announced in Budget 2008.
- Elements that should be monitored for possible change in the future
- Consider adding enhanced models and metrics of Liquidity Risk and Credit Risk as they become available and practical.
- Finance to consider enhancing plans and documents to permit easier coverage of tasks in the event of employee departure or absenteeism – for example, along the lines of what the Bank has implemented
- Finance and the Bank should re-evaluate their models and systems, so as to avoid Model and Spreadsheet Risk, in the event the portfolios become more complex; this is in addition to the regular periodic evaluations that are undertaken to ensure the ongoing appropriateness of models, systems, risk measures, scenarios, tests, procedures, etc., for the current instruments employed.
- The Department of Finance and the Bank of Canada seek to continually improve risk models and metrics to measure, report and manage liquidity and credit risks, in keeping with evolving best practice of peer institutions and the needs of the portfolios for which they are used. For example, new indicators have been introduced during the past two years to measure credit VaR, days of liquidity and operational risk events.
- Departmental practices and documentation will be enhanced to support the transfer of corporate knowledge and reduce potential operational risks related to employee turnover.
- Current risk models, systems, measures and procedures are regularly checked for appropriateness and are refined as circumstances warrant. There are no plans to add more complex securities to the EFA portfolio at this time.