SFIL Annual financial report 2018

Management report I 1 27 Annual Financial Report 2018 SFIL Management report Report on corporate governance Consolidated financial statements in accordance with IFRS Annual financial statements in accordance with French GAAP Shareholders’ Meeting of May 29, 2019 General information people and systems or from external events, and includ‑ ing legal risk”. Operational risk includes, in particular, risks related to events with a low probability of occurrence but a high impact, the internal and external fraud risks defined in article 324 of the above-mentioned Regulation (EU) No. 575/2013, and model risks. Management procedures for operational risks apply to all SFIL’s divisions, activities and processes. 2.4.2. Organization and governance SFIL has implemented an organization, procedures and a management system for monitoring and controlling its operational risks. The Operational Risks and Permanent Control division, within the Risks division, draws up the management policy to be used for operational risks, excluding compliance risk, as well as the methods employed to identify and control them. It implements the operational risk management sys‑ tem and relies on a network of designated correspondents in each operating division. The correspondents’ role is to collect operating incident data, assess risks and measure key risk indicators with the help of the staff of the Opera‑ tional Risks and Permanent Control division. The involvement of operating division managers strength‑ ens the system’s effectiveness, of which they are the pri‑ mary guarantors. The Operational Risks and Permanent Control Commit‑ tee, chaired by the Deputy Chief Executive Officer, brings together all members of the Executive Committee every quarter. It validates the operational risk management policy and methods (excluding compliance), examines operating incidents that have occurred in the quarter and monitors risk prevention and system improvement proposals (per‑ manent control, operational risk management, IT security, business continuity, etc.). It also examines the operational risks identified and key risk indicators that have exceeded their alert threshold. It decides whether or not they are acceptable and, where appropriate, what corrective meas‑ ures should be taken. A summary of significant operational risk developments is presented quarterly to SFIL's Risks and Internal Control Committee and to the Supervisory Board of the Caisse Française de Financement Local, through the quarterly risk review. Moreover, a detailed presentation of action points, areas for improvement and corrective measures proposed or already implemented to limit operational risk is also given annually at a specific Internal Control Committee meeting. The presentation for 2018 was made to the Risks and Inter‑ nal Control Committee on January 24, 2019. The Compliance division is responsible for the policy and supervision of the compliance and reputation risk manage‑ ment system (see overall internal control system). 2.4.3. SFIL operational risk policy (excluding compliance risk) SFIL has opted for the standard method of calculating its regulatory capital for operational risk. SFIL’s policy for measuring and managing operational risks consists of regularly identifying and assessing its risk expo‑ sure and the existing mitigation and control systems to check whether the level of residual risk is acceptable. The policy applied involves three main processes: the collec‑ tion and reporting of operational incidents, the mapping of operational risks and the monitoring of key operational risk indicators. This system is rounded out by an IT security pol‑ These indicators are calculated from a static viewpoint. The main risks identified and associated with a low interest rate environment are: •  exposure to a rapid normalization of rates; •  an increase in early repayments not offset by early repay‑ ment penalties; • margin reduction. The SFIL Group has little exposure to interest rate changes and therefore to a rapid normalization of rates: each entity uses interest rate risk management indicators to manage and monitor exposure to the risks of both parallel and non-par‑ allel shifts in the yield curve, including exposure to the risk associated with a sudden normalization of interest rates. The Group also has little exposure to early repayment risk as almost all of its loan agreements contain early repayment penalty clauses. Lastly, the SFIL Group's business model, which is based on the financing of the local public sector and the refinancing of large export credits, is relatively insensitive to the low interest rate environment. In particular, because the Group does not take sight deposits, it is unaffected by the issue of transformation margin reduction in a low interest rate environment. 2.3.4. Foreign exchange risk Foreign exchange risk is defined as the risk of loss, observed or unrealized, linked to changes in the exchange rate of foreign currencies against a reference currency. The SFIL Group’s reference currency is the euro; foreign exchange risk thus reflects any change in the value of assets and liabilities denominated in a currency other than the euro resulting from that currency’s fluctuation against the euro. Issues and assets denominated in foreign currencies give rise, at the latest when they are recognized on the balance sheet and until their final maturity, to a cross-currency swap against the euro, thereby ensuring perfect currency hedging of these balance sheet items’ nominal and interest rates. The adjustable rate exposures resulting from this management are covered by interest rate risk management. For opera‑ tional reasons, SFIL continues to incur marginal foreign exchange risk affecting the share of margin of USD-denom‑ inated export credit transactions not paid on to CAFFIL. Certain loans to refinance large export credits denominated in USD may also result in very limited foreign exchange risk during their drawing phase. This residual risk is managed by setting a very low sensitivity limit. Foreign exchange risk is monitored using the net foreign exchange position in each currency, calculated on all for‑ eign currency balance sheet receivables, commitments and accrued interest not yet due. The net position per currency must be zero, with the exception of that in USD, for which a marginal position is tolerated for operational reasons. 2.4 – OPERATIONAL RISK 2.4.1. Definition In accordance with section 1 of article 4 of the above-men‑ tioned Regulation (EU) No. 575/2013, the arrêté of Novem‑ ber 3, 2014 defines operational risk as “the risk of loss resulting from inadequate or failed internal processes,