LBP (LAND BANK OF THE PHILIPPINES) INSURANCE

BROKERAGE, INC.

RISK MANAGEMENT MANUAL

i

TABLE OF CONTENTS

PAGE NO. CHAPTER 1 OBJECTIVE

Risk Management Objectives A. Board of Directors thru Risk Management Committee

1. Role 2. Authority 3. Composition 4. Frequency of Meetings 5. Duties and Responsibilities

i. Core Duties and Responsibilities ii. Specific Duties and Responsibilities

B. Risk Management Officers 1. Duties and Responsibilities

C. Authorized Risk Takers 1. Duties and Responsibilities 2. Specific Duties and Responsibilities

i. Market Risk ii. Business Operations Risk

1.1

1.2

1.3

1.5

1.6

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CHAPTER 2 IDENTIFICATION OF RISK 1. Market Risk 2. Counterparty Credit Risk

a. Settlement Risk 3. Regulatory Risk 4. Operational Risk

a. Legal Risk

Contract b. Communication and Investor Relations

Employee Communication c. Delivery

Product Delivery & Support d. People Risk

Culture

Recruiting & Retention

People Development & Performance

Succession Planning e. Information Technology

IT Management

IT Confidentiality

IT Availability/Continuity

IT Integrity f. Business Interruption

Business Continuity Planning 5. Reputation Risk 6. Governance

a. Board Performance b. Tone at the Top

7. Planning and Resource Allocation a. Organizational Structure b. Strategic Planning c. Forecasting

8. Major Initiatives a. Vision & Direction b. Planning & Execution c. Measuring & Monitoring of Major Initiatives d. Technology Implementation

9. Accounting & Reporting a. Accounting, Reporting and Disclosure b. Internal Control

2.1

2.2

2.3

2.4

2.5

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CHAPTER 3 RISK MANAGEMENT PROCESS A. Strategic Level- Risk Policy Formulation and Approval B. Portfolio Level- Analysis, Control and Policy Review C. Transaction Level- Implementing Risk Policies

3.1

3.2 3.4

CHAPTER 4 MARKET RISK MANAGEMENT A. Foreign Currency Risk

1. Market Risk Limits a. Limits Type and Definition

i. VaR Limits ii. Factor Sensitivity Limits iii. Factor Sensitivity Limits for Foreign Exchange

b. Loss Alerts c. Stop Loss d. Limit Approval e. Counterparty Credit Risk Limits f. Settlement Limits

2. Computation of Mark-to-market as shown in ANNEX A B. Interest Rate Risk

1. Factor Sensitivity Limits for Interest Rates

4.1

4.2

4.3

4.4

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CHAPTER 5 OPERATIONS RISK MANAGEMENT A. Integrated Insurance Business System (IIBS)

1. Security & Control Capabilities a. Use of Password b. Filtering of Menu/Transaction Capabilities c. Internal Confirmation

2. Accounting Structure B. Foreign Exchange Process Flow

1. Manual Entry 2. Confirmation 3. Settlement

C. Reporting on Limit Excesses and Loss Alerts 1. Excesses of Limits 2. Risk Reporting 3. Daily Reporting and Limits Control

D. Trading Principles and Policies 1. Trading Principles

a. Honesty b. Integrity c. Confidentiality

2. Trading Room Policies a. Dealing at “Arms-Length” b. Market Basis c. Communication d. Trading Practice e. On-Premises Trading f. Personal Trading g. Compliance

E. Other Issues/Policies 1. Non-Standard Products 2. Periodic Verification 3. Responsibility

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5.2

5.3

5.4

5.5

5.6

5.7

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ANNEX A. Sample Computation Of Impairment Testing For Fixed Rate Treasury Notes & Retail Treasury Bond

B. Integration Insurance Brokerage System Application Modules

Annex A.1

Annex B.1 Annex B.2

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LBP (LAND BANK OF THE PHILIPPINES) INSURANCE BROKERAGE, INC. RISK MANAGEMENT MANUAL

Chapter 1

INTRODUCTION

I. OBJECTIVE

The objective of this Manual is to serve as basis and reference for consistent risk management that is applicable to all employees of LBP (Land Bank of the Philippines) Insurance Brokerage, Inc. (LIBI). It aims to create a culture of risk-awareness, not risk-aversion based on the prudential framework required by BSP Circulars and the Insurance Commission (IC). It provides a general set on risk principles delegated to each business unit through its reporting and approval procedures. Risk Management Objectives

1. Identify, measure and control risks inherent in LIBI’s activities 2. Disseminate Risk Management philosophy and policies 3. Assist risk-taking business units in understanding and measuring risk/return

profiles 4. Develop risk management and control infrastructure

LIBI’s involvement in risk process and their specific roles and responsibilities are described as follows:

A. Board of Directors thru Risk Management Committee

1. Role The Risk Management Committee (RISKCOM) shall be primarily responsible for the development and oversight of the risk management programs of LIBI which include the following: a. Oversight of management functions and approval of proposals

regarding LIBI’s policies, procedures and best practices relative to asset and liability management, credit, market and business operations risks ensuring that:

Insurance requirements of Landbank clients and their lending units are passed on to LIBI;

System of limits remain effective; and

Immediate corrective actions are taken whenever limits are breached or whenever necessary.

1.2

b. Be responsible for ensuring compliance to written policies and procedures relating to the management of risks throughout LIBI. This shall include:

Comprehensive risk management approach;

Detailed structure of limits, guidelines and other parameters used to govern risk-taking units;

Clear delineation of lines of responsibilities for managing risk;

Adequate system for measuring risk; and

Effective internal controls and a comprehensive risk reporting process.

2. Authority The RISKCOM shall exercise authority over matters within the scope of its functions and responsibilities. It is empowered to: a. Approve the risk management program prepared by Risk

Management Officer (RMO). b. Exercise functional supervision over RMO. Administrative

supervision of RMO shall be under the President or in his absence the General Manager of LIBI.

c. Serve as direct channel of communication to the RMO.

3. Composition The RISKCOM shall be composed of at least three (3) members of the Board of Directors who shall possess a range of expertise as well as adequate knowledge of LIBI’s risk exposure to be able to develop appropriate strategies for preventing losses and minimizing the impact of losses when they occur.

4. Frequency of Meetings

The RISKCOM shall meet on a quarterly basis or as needed.

5. Duties and Responsibilities

a. Core Duties and Responsibilities

The RISKCOM shall perform the following core duties and responsibilities: 1) Notation of the risk reports as presented by the Authorized

Risk Takers (ARTs). The RISKCOM shall:

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Assess the probability of each risk becoming reality and shall estimate its possible effect and cost with priority on those risks that are most likely to occur and are costly when they happen.

2) Approval of the Risk Management Strategies and Plan.

b. Specific Duties and Responsibilities The RISKCOM shall perform the following specific duties and responsibilities: 1) Promote a risk culture that requires and encourages the

highest standards of ethical behavior by risk management overseers and authorized risk takers.

2) Meet with request the submission of and evaluate information from the Management Committee and other committees of the Bank; and perform/approve the necessary actions/proposals as it deems appropriate, regarding the scope of its work, significant findings, together with the actions and responses of management.

3) Oversee the management of future risks rather than risk in past transactions.

4) Recognize those risks and institute contingency plans to mitigate said risks.

5) Provide regular periodic reports to the Board of Directors pertaining to LIBI’s overall risk exposure and actions taken to reduce the risks.

6) Encourage the professional development and training of personnel engaged in both risk oversight and risk-taking activities.

7) Oversee the adequacy of this Manual on an annual basis and recommend any proposed changes to the Board of Directors for approval.

B. Risk Management Officers (RMO)

RMO are personnel which reports administratively to the President of LIBI and functionally to RISKCOM. The RMO shall be the Risk Focal Person for LANDBANK.

1. Duties and Responsibilities

The RMO shall perform the following core duties and responsibilities: 1) Consolidate RISKCOM reports submitted by the Authorized

Risk Takers (ARTs). The RMO shall:

1.4

Perform RISKCOM Secretariat function

Collaborate with the ARTs for the preparation of RISKCOM report

Consolidate report for RISKCOM

2) Develop Risk Management Strategies and Plan. The RMO shall:

Develop a written plan defining the strategies and plan for managing and controlling the major risks.

Identify practical strategies to reduce the chance of harm and failure or minimize losses if the risks become real.

Communicate the risk management plan and loss control procedures to affected parties.

Conduct regular discussions on LIBI’s current risk exposure based on regular management reports and direct concerned units or offices on how to reduce these risks.

3) Review and revise the Risk Management Plan, as needed. The RMO shall:

Review and evaluate the steps that management has taken to monitor and control risk exposures to ensure its continued relevance, comprehensiveness and effectiveness.

Revisit strategies, look for emerging or changing exposures and stay abreast of developments that might affect the likelihood of harm or loss.

Report regularly to the Board of Directors of LIBI’s over-all risk exposure, actions taken to reduce the risks, and recommend further action or plans as necessary.

1.5

C. Authorized Risk-Takers (ARTs) ARTs refer to all LIBI personnel who have been given authority to commit LIBI to insurance and forex transactions and inherently expose LIBI to market risks. ARTs, which operate within designated units and specified limits, are LIBI’s “front-line” in risk exposure management. They are responsible for identifying opportunities for return, taking commensurate risk positions and actively monitoring, evaluating and adjusting those positions.

1. Duties and Responsibilities

In view of considerable discretion inherent in their activities, ARTs have the responsibility to:

a. Identify and Evaluate Exposures.

Identify and document types of risks.

Identify and assess the external risks that may affect the business plans and directions of LIBI.

Assess the probability of each risk becoming reality and shall estimate its possible effect and cost with priority on those risks that are most likely to occur and are costly when they happen.

Conduct risk-taking activities within limits at all times.

Understand risk profile of managed position/portfolio and to scan and determine market opportunities within context of overall LIBI strategy and risk tolerance.

Submit quarterly (or as needed) risk reports to RISKCOM for notation

2. Specific Duties and Responsibilities a. Market Risk

1) Meet with, request/gather (or compel submission, in proper

cases), receive and evaluate information from management and appropriate sources and act or approve proposals, accordingly, on the following items relating to Market Risk:

Policies and procedures on market risk;

Market risk resulting from LIBI’s insurance brokering/forex trading;

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Information relating to compliance with both external and internal regulations regarding market risks.

b. Business Operations Risk 1) Meet with, request/gather (or compel submission, in proper

cases), Receive and evaluate information from management and appropriate sources and act or approve proposals, accordingly, on the following items relating to Business Operations Risk:

Policies and procedures on operational risk matters e.g. technology, legal, reputation and personnel risks;

Management reports relating to operational issues;

Awareness on proper risk culture and how risks should be addresses; and

Information relating to compliance with both external and internal regulations regarding operational risks.

2.1

Chapter 2

IDENTIFICATION OF RISK As of part of identification risk, the following are classified as major risks that LIBI manages in the course of its business.

1. Market Risk

It is defined as the risk to earnings or capital arising from changes in the value of traded portfolios of financial instruments. This risk arises from market-making, dealing, and position-taking in interest rate, foreign exchange, equity and commodities markets. (BSP Circular 510, Guidelines on Supervision by Risk) Market risk can be generally defined as risk of loss, immediate or over time, due to adverse fluctuations in price or market value of instruments, products and transactions in LIBI’s overall portfolio. Market risks are central focus of risk measurement methodologies and limits, as well as a gauge by which LIBI can determine returns it will require for its activities.

Markets Risks of LIBI can be further broken down into specific areas from which they originate:

Foreign Exchange Risk (FX)

Volatility of FX rates, Interest rates and equity

Interest Rate Risk (from single or multiple yield curves)

Foreign exchange, equity and commodity prices, and volatility levels have relatively straightforward, single-dimension movements (i.e. they move up or down).

Interest rate risk however, is multi-dimensional – involving movements of rates across yield curves (term structures) of one or more instruments.

2. Counterparty Credit Risk

Counterparty Credit risk is defined as a class of credit risk that occurs from transactions where reciprocal obligations are made between LIBI and counterparties or customers.

a. Settlement Risk (SR) – occurs from simultaneous exchange of value with a

customer or counterparty, where verification of payment from counterparty is not received until after LIBI’s own payment is already delivered. Should a non-delivery on the part of the counterparty occur, LIBI is exposed to direct credit risk. SR is set at 100% of value of all maturing

2.2

b. Contracts with a counterparty on any given date and may last from one to several days (depending on the length of time needed to verify settlement).

Settlement risk is noteworthy in that this may be controlled by using operational or transactional methods such as delaying payment until receipt of funds is confirmed from the counterparties.

3. Regulatory Risk – refers to financial loss arising from changes in legal, monetary, tax or other governmental regulations of a country. This risk is interrelated with legal risk and should be covered by legal and tax review. It is defined as the failure to comply with circulars, memoranda, advisories and other issuances of regulatory bodies as applicable to the brokerage industry, may result to loss of business, administrative/criminal penalties/sanctions, and loss to reputation.

4. Operational Risk – is defined as the current and prospective risk to earnings or capital arising from fraud, error, inadequacy of internal controls and the inability to deliver products or services, maintain a competitive position, and manage information. Risk is inherent in efforts to gain strategic advantage, and in the failure to keep pace with changes in the financial services marketplace. Operational risk is evident in each product and service offered. Operational risk encompasses: product development and delivery, operational processing, systems development, computing systems, complexity or products and services, and the internal environment. (BSP Circular 510, Guidelines on Supervision by Risk)

a. Legal Risk – risk of financial loss due to incomplete, incorrect and

unenforceable documentation used by LIBI to protect and enforce its rights under contracts and obligations. A legal review shall verify capacity and authority of counterparties and customers to enter into transactions; and especially for derivatives transactions – “suitability” of a corporate customer to that derivative transaction. LIBI use Risk Control Self-Assessment as Risk Management tool as shown in Annex A.

Contract Failure to assess the favorableness of the contracts the institution enters into and the failure to comply with and monitor contract terms might lead to financial losses.

2.3

b. Communications and Investor Relations

Employee Communication Failure to understand and respond to the communication needs of different employees may cause discontent in the workforce resulting in operational difficulty

c. Delivery

Product Delivery & Support Failure to deliver and support products and services to meet customer expectations might lead to lost business or affect the institution’s reputation.

d. People Risk – refers to potential loss due to inadequate training, inexperience or illegal activities of risk-taking personnel. It is likewise interrelated to internal control aspects of operation risk. It highlights human side of risk-taking, role and adequacy of institutional trading guidelines, codes of conduct, personnel policies and training and development programs in overall Risk Management.

Culture Inability to create and instill the accepted norms of behavior may inhibit the achievement of desired performance and the accomplishment of corporate goals

Recruiting & Retention Inability to attract and retain competent employees might lead to organizational dysfunction and low morale.

People Development & Performance Inability to develop and enhance employee skills and provide a sound employee performance management system may reduce employee motivation and may adversely impact the achievement of desired performance and conduct

Succession Planning Failure to create and implement a feasible continuance plan for key positions and employees might adversely affect the stability of organizational leadership and business continuity.

e. Information Technology

IT Management Failure to effectively prioritize IT initiatives and administer IT resources may lead to lost business and hinder the achievement of the goals and objectives.

2.4

IT Confidentiality Failure of information systems to adequately protect both IT data and IT infrastructure may lead to or allow unauthorized access, or leads to destruction of information and information systems.

IT Availability/Continuity Failure to ensure uninterrupted operations and immediate recovery from systems and implementation failures may lead to lost business and losses.

IT Integrity Failure of information system to provide accurate, reliable and timely financial and non-financial information when needed may lead to operational inefficiencies or lost business opportunities.

f. Business Interruption

Business Continuity Planning Failure to undertake the appropriate advanced planning related to critical business functions/processes may result in the inability to recover and maintain business operations in the event of a disruption due to natural events or terror and malicious acts.

5. Reputation Risk – refers to the current and prospective impact on earnings or

capital arising from negative public opinion. This affects the LIBI’s ability to establish new relationships or services or continue servicing existing relationships. This risk may expose LIBI to litigation, financial loss, or a decline in its customer base. Reputation risk exposure is present throughout the organization and requires the responsibility to exercise an abundance of caution in dealing with customers and the community.

6. Governance

a. Board Performance Inability of the Board of Directors to discharge their obligations and duties owed to the institution and its stakeholders in good faith may hinder effective strategy-setting and decision-making.

b. Tone at the Top

Inability of the Board and senior management to establish a culture of accountability, integrity, professionalism and competency may result in an unfavorable working environment and lack of integrity in the way the business is conducted.

2.5

7. Planning and Resource Allocation a. Organizational Structure

Lack of a responsive organizational structure may prevent the achievement of the strategic goals and objectives in an efficient manner.

b. Strategic Planning

Failure to develop, implement and monitor institutional strategies and direction may threaten the overall viability and growth prospects.

c. Forecasting Inability to foresee macroeconomic and market trends, opportunities and threats will threaten the competitiveness in the long run and may result in inappropriate business strategies and missed business opportunities.

8. Major Initiatives a. Vision & Direction

Failure to establish, align and communicate a vision and direction for the institution and its major initiatives, including services, products and programs, may hamper the achievement of the objectives and strategies.

b. Planning & Execution Failure to plan and execute programs and initiatives effectively may lead to operational inefficiencies, financial losses and project failure.

c. Measuring & Monitoring of Major Initiatives Failure to identify appropriate performance metrics and standards to monitor attainment of objectives and targets may prevent the achievement of desired output and performance.

d. Technology Implementation Failure to adopt and implement the appropriate system and technology to support business processes or major initiatives may lead to costly investments and work inefficiencies, and may compromise product or service delivery.

9. Accounting and Reporting a. Accounting, Reporting and Disclosure

Inaccurate recording and reporting of material financial transactions in accordance with existing standards may result to regulatory sanctions for the Bank, and may also lead to misinformed business decisions by Bank management and other stakeholders.

2.6

b. Internal Control Failure to establish and maintain adequate internal controls that align with stakeholder and regulatory expectations may result in errors or omissions in financial reporting, control breakdowns or fraud.

3.1

CHAPTER 3

RISK MANAGEMENT PROCESS LIBI realizes that risks are inevitable, losses optional in its trading operations. LIBI-Forex Division is an area where clearly defined set of market risk limits are essential and strong control procedures are built into dealing activities. Total Risk Management process will identify measure, manage and oversee risks in all its form. Risk Management Process (RMP) is not a simple concept and as such, it can only be defined by describing its total process. RMP traces out a complete and coherent risk management plan that is performed at three difference levels: 1) strategic level; 2) transactional level; and 3) portfolio level. All three levels form critical and integral components of the entire RMP. RMP as envisioned requires a top-down process – from Board of Directors represented by the Risk Management Committee, Top Management as represented by Insurance and Forex and down to individual ARTs. Within these three levels there exists a feedback mechanism not only to ensure that policies, limits, procedures, etc. are complied with by all units but also to guide top management in drawing up and reviewing LIBI’s management strategies and policies.

A. Strategic Level– Risk Policy Formulation and Approval 1. The strategic level provides macro perspective, policy formulation and approval

segment of RMP. It starts with top management considering its basic reward/risk trade-off in formulating LIBI’s annual business or budget plan. In business plan, management balances amount of risks to be taken with desired revenue goals. It makes sure that risk approval process is congruent with budget approval process. The more aggressive LIBI wants to be (i.e., the bigger revenue targets), the greater the risk it is willing to take and capital it is willing to provide. Accordingly, approved limit structure set up for business units must be in line with their targeted trading and interest revenues.

2. The next step does not originate from metrics and models but defines LIBI’s

philosophy on risk – creation of a culture that accepts RISK as a financial variable. Much of the responsibility in creating risk philosophy and risk awareness lies at the hands of Board of Directors and top management. They will define culture and risk management organization and incorporate RMP as an essential part of corporate strategic plan.

3. Top Management shall establish actively in planning, approving, reviewing and assessing various risks involved in derivative activities.

4. As part of risk awareness propagation, (i.e to guarantee that RMP are understood and responsibilities that come from risk taking activities are adequately met from traders to key officers) relevant trainings shall be provided continuously.

5. LIBI Organizational Structure

3.2

B. Portfolio Level – Analysis, Control and Policy Review

1. After a risk is assumed, attendant processes of reporting, controlling, reviewing of performance and portfolio management are initiated.

2. Accounting shall take lead in capturing and revaluing through mark-to-market

aggregate position taken by individual ARTs. This process will also include reconciliation of records between those of front and back office.

3. Shall likewise ascertain validity of mark-to-market valuations including independent checking of prices and yields used in process. Shall monitor if open positions or portfolios and their mark-to-market values are within prescribed limits.

4. The next step shall be generation of reports. Management reports should be generated to provide senior management a snapshot of overall risk positions of LIBI and financial risk/reward exposures were to be realized at prevailing or at simulated market rates.

5. With these financial tools and reports, top management can evaluate performance from a risk-adjusted perspective and make adjustments to overall business strategy if needed. Performance is thereby measured relative to risk-free or “with-risk” benchmarks and/or target hurdles of return.

6. Controlling Risks

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a. Responsibilities of implementing risk controls are given to Insurance and Forex. They shall monitor day-to-day compliance of ARTs to approved risk policies and procedures. Ensure that limits are followed by ARTs and management is immediately apprised of implications on non-compliance of risk policies and procedures.

b. Audit Group ensures that controls are actually complied with required

infrastructure are in place. Audit Group shall perform a post-audit of entire treasury operations at least once a year.

c. Exception reports, if possible, shall include corrective measures to lessen probable impact of infractions on LIBI’s capital.

d. Corrective measures to be effected shall depend on gravity of non-compliance. For instance, corrective measure for breach on potential loss amount (VaR limit) will depend on how large is accumulated realized and mark-to-market losses. If losses within the period exceed loss alert amount (i.e., early warning signal for management), concerned ART must consult top management whether to unwind his position or continue trading. If trader continues to accumulate losses beyond stop-loss limit (maximum allowable realized and M-T-M losses), he should stop trading and unwind all his positions.

e. Duration of these corrective measures shall depend on frequency of occurrence and limits set for a given period of time (e.g., daily, monthly, quarterly and yearly). In general, if trader’s losses have exceeded his VaR limit for a given period of time, say for 1 month, he must not be allowed to continue for the remaining days of that month.

7. Policy Review

a. Analysis of portfolios, generation of management reports shall be used as inputs by top management for Risk Management Policy Review to be undertaken at least once a year not only for effective management of risks but also as rational basis for future business plans.

b. As previously mentioned, Risk Management Policy Review shall be done in

line with LIBI’s annual preparation of business or budget plan. Proposals for income, expenses, assets and liabilities requirements shall be consolidated. Other considerations like new taxes, BSP circulars and regulatory laws, which might affect LIBI’s bottom-line are also factored in. End-result of exercise is a preliminary projected profit and loss figure.

c. Budget plan will be deliberated by Management Committee (MANCOM) to further fine-tune targets and ultimately, get commitment and consensus of Insurance and Forex.

3.4

d. Business plan shall be presented in the Bank-wide Planning Conference usually held in November to define responsibilities of business units and support units in achieving these targets.

e. Budget plan shall then be presented to Board of Directors for approval.

C. Transactional Level – Implementing Risk Policies 1. In contrast, transactional level involves specifics of day-to-day risk taking

activities as performed by ARTs. All transactions of ARTs should conform with designated products and within specified limits.

2. ARTs start day-to-day Risk Management Process by determining financial

opportunities such as yield enhancement, hedging of trade positions, alternative source of funding or liquidity, cost reduction, etc.

3. Once opportunities are determined, ARTs identify types of risks associated as spelled out in Risk Taxonomy to realize these opportunities.

4. ARTs quantify and evaluate identified risks vis-à-vis market and liquidity risk limits delegated to them or its potential effect on a position or portfolio of LIBI. It also includes assessment of existing system capability to support risk-taking activities.

5. To measure and effectively manage impact of risk on position or portfolio, specific tools and techniques, ARTs use trading tools, analytical models, statistical methodologies, historical studies and market analysis. Proper use of tools and techniques as well as strict compliance in policies and procedures are requisites of a coherent risk management system.

6. Culmination of transactional level is when an ART takes a position. This act would further entail active monitoring, evaluating and if necessary, adjusting position to attain Risk Management twin objectives of pursuing best possible return for LIBI and managing associated risk.

3.5

7. Work Flow of Insurance and Forex

a. Processing of New Insurance

PROCESSING OF RENEWAL OF INSURANCE

3.6

b. Insert Work Flow of Forex

4.1

Chapter 4

MARKET RISK MANAGEMENT Market risk is the risk to earnings or capital arising from changes in the value of traded portfolios of financial instruments. This risk arises from market-making, dealing, and position-taking in interest rate, foreign exchange, equity and commodities markets. (BSP Circular 510, Guidelines on Supervision by Risk) A. Foreign Currency Risk

Inability to appropriately plan for and manage fluctuations in foreign exchange rates may lead to unfavorable changes in the values and cash flows relating to the foreign-currency denominated assets and liabilities. 1. Market Risk Limits

An appropriately designed structure of market risk limits will provide ART an understanding of nature of risks to be taken and loss tolerance levels in order to have the same interpretation on the given set of limits. All risk-taking activities are subject to limits. Market risks are bounded by a measure of VaR for mark-to-market portfolios for which a maximum exposure for LIBI. In addition, actual operating results are compared to designated levels of accumulated mark-to-market losses (“loss alerts”). If losses within a period exceed loss alert amount, ART must consult the unit head of LIBI-Forex regarding current risks and their subsequent management. a) Limits Type and Definition

Since limit setting is designed to communicate degree of risk taking, market risk limits should be expressed using measurements that quantify exposures to market risk factors. The following measures are used as market risk limits. i. VaR Limits

VaR is a measurement of likely earnings volatility of a portfolio of end-of-day positions. For trading portfolios or positions subject to only one market risk factor. For portfolios with multiple market factors, VaR depends on factor sensitivities, signs (plus or minus), volatilities and correlations between market factors. VaR calculations are LIBI’s measures of risk in its positions. Daily VaR calculations are to be compared against VaR limits. VaR limits are effectively the monetary amount of risk deemed tolerable by LIBI Management. VaR

4.2

limit is a general limit that incorporates a wide array of risks, but reduces quantification of these risks to a single number. As such, a VaR limit is not sufficient as a standalone limit. Other limits and sub-limits are also established to provide more concrete bounds on risk taking. VaR limits are to be requested or renewed by ARTs annually. It is based on a percentage of budgeted profits for the year in order to relate risks to expected returns and overall earnings of LIBI.

ii. Factor Sensitivity Limits Factor Sensitivity Limits are next layers of limits that define amount of exposure for each market factor that LIBI can tolerate.

iii. Factor Sensitivity Limits for Foreign Exchange

Limit for foreign exchange is on factor sensitivity to a one percent (1.0%) change in exchange rate against the other currency in pair. This sensitivity limit then determines a nominal position limit which may not be exceeded. There may be different limits for overbought and oversold positions, but nominal FX limits will foremost conform to regulatory definition of and be in line with Bangko Sentral ng Pilipinas (BSP) limits.

b) Loss Alerts

Loss Alert (LA) is an amount of cumulative mark-to-market losses within a specified time period (normally monthly, quarterly and yearly), that defines LIBI Management’s tolerance market-related losses for that period. A loss alert is activated whenever losses during that period equal or exceed specified LA amount. When that happens, the Head of LIBI-Forex immediately consults with the President in order to agree on appropriate course of action. In this way, LIBI is assured to receive direct prompt information about market conditions and adverse impacts to the LIBI’s portfolios each time there are heightened risks to earnings.

LA is set for month-to-date mark-to-market results. LIBI-Forex Head

will have loss alerts approved for each portfolio category. Whenever a loss alert is activated, authorized risk taker consults with LIBI-Forex Head in order to decide on a course of action for positions involved. At the same time, the LIBI-Forex Head may establish a new trigger to remain in effect for balance of that month. LA should revert to previous levels at the beginning of each month.

Head of LIBI-Forex may lower a loss alert at any time to monitor more

volatile market environments. It is good practice to reset Loss alerts based on percentage of year-to-date results already recorded (whether it be a net profit or a net loss), as a way of preserving gains for the year. Likewise, initial Loss

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Alert is related to unit’s VaR Limit (or sub-limit), to make it an effective “early warning device” for management.

c) Stop Loss

Stop Loss limit is maximum monetary amount for market-related losses for a specified time period (monthly, quarterly and yearly). If Stop Loss limit is reached or exceeded, all risk-taking activities of unit cease, VaR Limit serves as a natural stop loss limit, although stop loss limit can be set higher. Like VaR limits, sub-limits of overall Treasury Stop Loss can be set according to unit, portfolio, instrument or trader. Both VaR and Stop Loss Limits (if different) shall not be reached without triggering of Loss Alerts and appropriate forewarning to Management. Business Unit and specific ART stop loss sub-limits and VaR limits are related to that unit’s or ART’s annual and monthly budgets in consonance with linking of all risk to expected return. As good practice, ARTs are expected to set stop loss levels on a per trade basis based on a ratio of expected profit or target return from trade. In this way, stop loss sub-limit act as a notional amount of “risk capital” allocated to ART who is then tasked to manage it throughout the year.

d) Limit Approval

It is the responsibility of ART to request or renew market risk limits. Strategic Risk Exposure Limits are then summarized in a Risk Approval Form.

e) Counterparty Credit Risk Limits

Credit Risk Limits are discussed in this Manual because they principally occur

from transactions where reciprocal obligations are made between LIBI and counterparties or customers, essentially market transactions, and for Pre-Settlement Limits especially, measurement and management are closely related to that of market risk.

f) Settlement Limits

As defined in earlier sections, Settlement Risk (SR) occurs from simultaneous exchange of value with a customer or counterparty, where verification of payment from counterparty is not received until after LIBI’s own payment is already delivered. Non-delivery of payment by counterparty exposes LIBI to direct credit risk of 100% of value of all maturing contracts on settlement date plus a verification period.

4.4

This settlement date plus verification period defines settlement period. This settlement period defines a time limit which transactions must meet or else fall under a different credit limit (i.e., for direct credit risk). Settlement Limits is set to control these risks for each customer or counterparty of LIBI. For definition, settlement period for verification is end of business hour after actual value date set to receive counter payment. Transactions not meeting these criteria are treated as normal extensions of credit. Settlement is applied for and approved daily.

SR may be controlled, offset or significantly reduced using operational or transactional methods (e.g. delaying payment until receipt of funds is confirmed from counterparties; or using payment versus payment agreements) and these should be taken into consideration by ARTs in their product programs.

2. Computation of Mark-to-market as shown in ANNEX B

B. Interest Rate Risk

Inability to appropriately plan for and react to fluctuation in interest rates may lead to market value losses on investment securities or cash flow shortfalls. 1. Factor Sensitivity Limits for Interest Rates

Interest rate sensitivity can only be applied in those countries that have a defined government yield curve. Where yield curve is not defined, limits should be expressed in terms of market values.

Diversification. It is the policy of LIBI to invest excess funds in government securities (GS)

where the servicing and repayments are fully guaranteed by the government. The

investment in GS may be placed with the Land Bank Treasury and Investment Banking

Group or Land Bank Trust Banking Group. LIBI’s Investment Committee observes

diversified GS portfolio, varied maturity spectrum and optimum yields in deciding the type

and term of investment. When yields of GS are expected to go down, LIBI buys long-term

GS in order to lock-in on high yielding GS. Conversely, when yields are expected to go up,

it buys short-term GS to stay liquid and be able to switch to high yielding GS when rates

start to pick up.

5.1

Chapter 5

OPERATIONS RISK MANAGEMENT Operational controls are the key component of LIBI’s risk management process, helping management to detect and resolve problems before they lead to severe financial loss. The guiding principle remains, i.e. separation of functions between ARTs who execute trades and operations and backroom personnel who confirm and settle trades and report financial performance.

A. Integrated Insurance Business System (IIBS)

Integrated Insurance Business System (IIBS) – The Integrated Insurance

Brokerage System combines ease of use with rich and practical software features powered by Oracle Technology. It is the solution-of-choice of insurance and reinsurance brokers to deliver quick insurance coverage, renewal, collections, remittance, claims processing and online financial reports. The IIBS provides an efficient single point of data entry while allowing secured access to information by multiple authorized users across the Local/Wide Area Network and/or the Internet.

Functions of IIBS (SEE ANNEX C)

1. Security & Control Capabilities

a. Use of Password Users are allowed access to Infinity System through use of password. Each user has its own distinct password. Password has an expiry date to ensure that if ever an unauthorized person is able to gain hold of user’s password, he can only use this for a limited period of time.

b. Filtering of Menu/Transaction Capabilities Another security feature existing in Infinity is the ability to segregate

duties of users on system by menu item/transaction/instrument. Only menus/transaction types/product types defined for user can be accessed by that specific user. Thus, traders cannot access confirmation nor settlement screen of operations people since it is not in their menu capabilities.

c. Internal Confirmation

This security level provides supervisor to check on inputted deals by

the ARTs before same are forwarded to backroom for confirmation and

5.2

settlement with counterparty. Internal confirmation capability follows “checker-maker” principle of control.

2. Accounting Structure

Accounting structure of Infinity revolves around States, Books, Deal

Types and their interrelationships. These concepts are the ones defining the kind of Chart of Accounts set up in Infinity.

Infinity’s accounting is analyzed through movements in general

ledger. It is not a cumulative general ledger but rather a record of postings to chart of accounts during a period of time. Transaction by Chart of Accounts report shows all debits and credits posted to general ledger accounts. Postings include revaluations, interest accruals, premium or discount amortization as computed by Infinity.

A general ledger interface function likewise allows Infinity to generate

posting files to be passed to LIBI’s General Ledger System. Such capability limits errors associated to manual posting.

B. Foreign Exchange Process Flow

o Capture deals o Inquire upon unsettled as well as done transactions o Check and approve transactions o Confirm and settle transactions o Revalue outstanding positions and portfolios o Monitor exposures o Generate accounting postings and interface with General Ledger o Provide audit trail o Generate standard management and statutory reports o Foreign Exchange recording and monitoring of transactions are done

manually on a daily basis.

Fill-up application to Purchase

Foreign Exchange Form and Customer

Information Sheet

Inform the client on the

prevailing Exchange

Rate

Examine the authentication

and verification of

data, Identification

cards and signature of

clients

Verification of the

authenticity/genuineness

and completeness of all foreign

and local currencies

presented by clients prior to

payment

Review and Check the

completeness of documents

Confirmation of purchase and sale of regular

transactions and accomplishment

of FX Deal Slip

END

5.3

1. Manual Entry

All transactions must be entered into activity sheet daily.

2. Confirmation

Confirmation procedure requires that all foreign exchange transactions be confirmed. It is standard market practice to confirm foreign exchange transactions with counterparty to its contract. Confirmation is done to validate the done deals transactions valid and correct. Transactions must be confirmed prior to settlement. Confirmation of done transactions will be performed at the same date.

3. Settlement

Done transactions are settled within the day.

C. Reporting on Limit Excesses and Loss Alerts

ARTs shall report a daily and quarterly exposure to the RISKCOM. This report

should be both in management terms and accounting terms.

1. Excesses of Limits It is the responsibility of ARTs to investigate and resolve each reported excess in market risk limit, as defined and approved by the Board of Directors. If the ART determines that risk limit is insufficient or is in excess, ART and RMO must recommend increase or decrease in risk limit.

2. Risk Reporting

Daily and quarterly reporting must always include a complete and clear display of previous day’s closing risks vs. limits, as prepared and verified by the ART.

3. Daily Reporting and Limits Control

In Securities Portfolios, all long positions and short positions are

reported on a trade date basis, by instrument and by settlement date. Positions refer solely to ownership positions and reported value is mark-to-market value. Risk of each position must be calculated in accordance with appropriate approved procedures.

5.4

In general, net risk of long positions, short positions and of combined positions is reported and controlled with reference to approved limits. Calculation of VaR is a complementary control that highlights changes in potential earnings volatility of positions, both to changes in experienced volatility in market prices plus changes in trading liquidity available in markets.

Positions in securities are also reported on a net basis (trade date

values) for each issue, issuer, industry, rating category and country of issuer. These positions are compared to approve limits. Positions in exchange-traded futures contracts are reported for comparison to total open interest in each contract. Potential margin exposure to each exchange is calculated and reported according to approved procedures.

In portfolios that contain only future cash flows (viz.swaps and FX

forwards) net cash flows in each currency per instrument are reported for each value date. Risk is calculated in accordance with appropriate approved procedures.

D. Trading Principles and Policies

All ARTs are expected to know and fully observe Bankers Association of the

Philippines (BAP) Code of Conduct and Market Practices for Treasury Activities in the Philippines.

The Head of LIBI Forex shall maintain list of traders, including their respective

and specific risk-taking authorizations (e.g. instruments allowed, individual position sub-limits, and trading time authority). Names of traders without internal or confidential details may be disseminated to counterparties and customers.

As much as possible, lists of authorized traders of LIBI’s professional

counterparties shall be sought and kept up to date, in accordance with “know your counterparty” principle. Furthermore, no trades should be done with counterparties (or brokers) who have not gone through proper screening and credit processes.

The following principles, policies and practices apart from reinforcing that

Code, further define central characteristics and values of LIBI as represented by its ARTs and its operating standards:

1. Trading Principles

a. Honesty

ARTs of LIBI do not resort to lies or deceptions; do not spread rumors; and shall always deal in a legal and ethical manner with customers, counterparties and brokers.

5.5

b. Integrity ARTs of LIBI stand by their word in all dealings. Furthermore, all contracts and deals are to be done in strict adherence to letter and spirit of laws on insider trading (i.e. no transactions to be entered into on basis of material non-public information). All situations of conflict of interest for both institution and its traders and whether in fact or appearance must be avoided.

c. Confidentiality

ARTs shall never reveal or discuss information on client account relationships maintained by LIBI or business transactions with counterparties and clients in market, except to parties involved in those transactions.

2. Trading Room Policies

a. Dealing at “Arms-Length”

All trading transactions will be done on an “arms-length” basis, that is,

in a manner which conforms to all applicable legal, tax, regulatory and accounting standards and provisions in the Philippines as well as LIBI’s internal standards. Deals with all customers and counterparties shall represent actual economic market transactions.

b. Market Basis

Transactions by ARTs shall, unless prior approval is granted, always be

done at market rates prevailing at the time of transaction and not at contrived rates prevailing earlier in the day.

Prior to setting up of electronic system, deal tickers will be time-

stamped and promptly submitted to operations and accounting sections for processing.

Trades are not to be done at off-market rates or historical rates. Valuation of all positions and measurement of profit and loss will be

done using market rates, and use of contrived rates to hold back a profit or conceal a loss is strictly forbidden.

c. Communication

ARTs from different trading units must make it a point to

communicate with each other and with their superiors. Supervisors must be aware of the size and nature of risk exposure positions of their traders

5.6

and be promptly informed of problem situations. Different trading desks should communicate with each other daily, with goal of being pro-active and anticipating cross-market events rather than being reactive to these events.

d. Trading Practice

In general, ARTs should understand the position of trust and

responsibility placed on them by LIBI. Management must ensure that personnel are properly trained in LIBI policy requirements, practices and workings of the market and obligations of traders before they are entrusted with risk-taking authority. ARTs must:

Never renege on a transaction because of an adverse price change

and always stand by their word.

Enter into deals and transactions they have judged to be prudent under prevailing market conditions.

Comply with LIBI’s policies and limitations and conform to all external

legal and administrative constraints.

Conduct all business in financial markets in accordance with established procedures both as to definitive practice and intent.

Rectify obvious misquotes or erroneous prices by any counterparty.

Discourage improper conduct in marketplace by other counterparties.

Report suspected irregularities by others to management.

e. On-Premises Trading

It is LIBI’s general policy to trade on-premises, i.e. all deals are to be

done within dealing room and captured on proper voice recording

systems

f. Personal Trading

In no instance shall personal trading be allowed to ARTS.

g. Compliance

Management is responsible for maintaining and publicizing to all relevant employees a set of clearly stated rules derived from legal and regulatory statues and directives. In particular, “inside information”

5.7

defined as information which if generally known will have significant price impact on a company’s securities, must be monitored. LIBI or its ARTs cannot directly or directly benefit from improper use of this kind of information.

E. Other Issues/Policies

1. Non-Standard Products

A non-standard transaction is any transaction which is not booked routinely in back office systems. This includes all transactions of type not booked previously and any transaction with non-standard terms of conditions. Non-standard transactions require special care at time of execution and booking and may require periodic review to ensure that they continue to be valued in line with the market. One-of-a kind transactions can be approved by Head of LIBI-Forex after receiving concurrence of designated Risk Officer. Special care has to be taken in pricing and booking of non-standard transactions. If existing models and systems are used to book transaction, validity of models to handle transaction must be carefully examined and verified. The following factors should be considered when verifying entry of a non-standard transaction:

Verify that all terms and conditions, including all explicit and implicit options, have been properly booked, priced and accounted for.

Verify that all cash flows, including conditional cash flows, are correctly generated and that appropriate discount factors are used.

Verify that models used to price various components of transactions are used correctly.

Examine validity of explicit and implicit assumptions, including assumptions about price and volatility distributions, used in booking and pricing transaction.

Verify that the revaluation and sensitivity results are in line with those obtained by the corresponding front-office systems, and also that they are consistent with market prices for identical or for similar instruments.

Check that all necessary, legal and tax implications have been considered and that all necessary approvals are in place.

5.8

2. Periodic Verification When possible, pricing information should be verified by obtaining a number of independent quotations and comparing them to price obtained using revaluation models. This should be done before deal is closed to ensure that deal is being priced correctly by front office systems and after it has been booked to verify that it has been booked correctly. This procedure should be repeated at least quarterly for all non-standard, one-of-a-kind transactions to ensure that revaluation models used to book transaction and market factors used to price transaction continue to value it in line with the market.

3. Responsibility

It is the responsibility of the Head of LIBI-Forex entering into transaction to verify that all back office systems required to book, value and to measure exposure of transaction are either in place or can be developed in a timely manner. All models and systems must be in place and al new models must be independently validated before a significant volume of transactions is booked. ART entering into a non-standard transaction must also ensure that all accounting, tax, regulatory and legal implications of transactions have been carefully considered and resolved before transaction is closed. It is the responsibility of the Head of LIBI-Forex to ensure that transaction is booked correctly, that it is independently reviewed and approved and that resulting revaluation results are compared to market prices and any significant discrepancies are accounted for. It is a joint responsibility of front and back office to identify non-standard transactions that are already booked which might require periodic verification.

ANNEX A

0

ANNEX A.1

ANNEX A.2

ANNEX A.3

SAMPLE COMPUTATION OF IMPAIRMENT TESTING ANNEX B

FOR FXTN & RTB (computation supplemented by LANDBANK) 10/28/2016 FACE AMOUNT 110,000,000.00 COST 03/20/2014 ISSUE DATE 03/20/2016 2014 1 09/20/2014 1 MAT DATE 03/20/2021 2015 1 03/20/2015 1 1 09/20/2015 1

2016 1 03/20/2015 1 NO. OF COUPON PAYMENT 14 1 09/20/2016 1 NO. OF ELAPSED INTEREST PAYMENT 5 5 5 NO. OF REMAINING COUPON PAYMENT 9 QUARTER 180 ELAPSE DAYS FROM LAST REPRISING 101 REMAINING DAYS TO NEXT REPRISING 79 DAYS TO MATURITY 1520 MARKET RATE 3.17500%

=110,000,000.00

0.4388889

= 1.0127000

=110,000,000.00

1.11237681

MV = 98,887,349.99 COUPON RATE 3.500% MARKET RATE 2.5400% INTEREST/YEAR 3,080,000.00 per semi-annual 7,540,000.00 REMAINING DAYS TO NEXT REPRISING 79 SEMI 180 1 1.012700 0.843888884 1.005554 13,111,882.80 MV OF INTREST 13,111,882.80 MV OF COST 98,887,349.99 ACCRUAL (864,111.11) MARKET VALUE 112,863,343.90

ANNEX B.1

ANNEX C

ANNEX C.1

ANNEX C.2