Investors’ Notebook – Managing risk on local market

By Elias Mugabe

This article is continued from last week. THE treasury and financial bills counterparty risk management on buy-back agreement involves the funding of an underlying asset with short-term funds

hence the existence of an unfavourable funding gap on the part of the primary holder/purchaser of the financial asset;

* Where treasury bills are not marked to market and the trading period is between zero-90 days a standard additional risk cover equivalent to interest generated over the tenure of the deal must be duly lodged with the fund/investor.

It is however prudent to ensure that the cost plus interest is adequately covered on all deals and to ensure that the treasury bills covering the investments as security are not longer than 91 days;

* Again caution should be taken when parting with value and the same principle for outright deals must apply for maturities;

* Where the fund gets bills as security and the maturity profile of the asset is in excess of 180 days, it is prudent for the securities to be marked to market, ie determine the present value of your security so that your financial positions are linked to market value of the underlying securities;

* Due to the Real Time Gross Settlement (RTGS) system the fund manager or financial institution must transfer bills into the fund/investor’s account before value is moved into the fund manager/counterparty’s trading account by the fund/investor.

For this strategy to be effective, the back office unit must always reconcile the trading account on a daily basis and produce a reconciliation report of the fund’s running deals;

* By the time security is exchanged the fund/investor must be given a statement or instructions signed by the fund manager/counterparty’s authorised signatories requesting its bankers to transfer value of the same amount in favour of the fund. This must be duly stamped by the counterparty’s bankers and a receipt issued to confirm that equivalent value has indeed been credited to the relevant account;

* Request for counterparty’s list ofauthorised signatories so that investment and disinvestment decisions are done by authorised personnel;

* Overall the back office unit must manage RTGS cautiously by ensuring that no value is parted with before treasury bills are transferred to the fund’s account and must authenticate signing arrangements before depositing maturities through RTGS; and

* If cost and interest is duly covered and the underlying asset falls below 90 days then no limit will be necessary. However, the maturity profiles of the treasury bills must be critically analysed to minimise default risk.

Government-guaranteed bills

Quasi-government institutions that are seeking working capital finance issue these bills in collaboration with a number of financial institutions. In Zimbabwe, examples of such bills are megawatt bills, agro bills, petrofin bills and grain bills which are issued on behalf of Zesa, Arda, Noczim and GMB respectively. These bills have been accorded liquid asset status, acceptable for overnight accommodation on the interbank market and are guaranteed by the government hence they are considered to be less risky.

They do have qualities of the conventional treasury and special treasury bills but the difference is that such bills are issued through nominated financial institutions and the funds utilised by the relevant quasi-government institution.

Unlike banker’s acceptances, these bills are earmarked for quasi-government institutions. However, the risk is not specific to that institution as they are fully guaranteed by the government;

* Since these assets are fully backed by the Reserve Bank of Zimbabwe and acceptable for interbank settlements, then the fund can trade on these assets without setting any limits with any counterparties provided the deals have been marked to market or done on an outright basis. If capital plus interest is adequately covered then the fund can purchase assets from any registered institution or fund manager. However, for investment periods above 90 days, deals must be marked to market;

* The current system involves delivery of actual scrip, therefore any deals must be against scrip delivery;

* Before exchanging value the back office unit must ensure that the bills have been duly lodged with the securities department and the serial numbers and amounts confirmed with the lead bank or primary issuer of the bills. Upon confirmation of the relevant details the back office unit can disburse the RTGS investment instruction to the counterparty/fund manager and

* However, when parting with value the critical steps in terms of verification procedures must be followed.

In conclusion the amount of information that is available to the investor is very limited and as such investors can make decisions that may be very risky. The existence of advisors such as asset management companies who possess knowledge of the risk attached to any investment tends to provide relief to the investor who can consult these institutions.

The above securities have risk attached to them but risk has to be matched to the return depending on investors’ risk preference. Riskier instruments tend to offer a higher return on investments while most risk-averse investors tend to take a neutral position and opt for lower-yielding securities.

* Elias Mugabe is the finance &risk director of Imperial AssetManagement Company and canbe contacted through emugabe@