Risk Policy

Risk Management Policy
For Corporate Treasury

Contents
INTRODUCTION.........................................................................................................................................................3 OBJECTIVES...............................................................................................................................................................3 POLICY STATEMENT...............................................................................................................................................3 POLICY FRAMEWORK............................................................................................................................................4 IDENTIFICATION OF RISKS...................................................................................................................................5 EXCHANGE RATE RISK ..........................................................................................................................................................................................7
IDENTIFICATION OF EXPOSURE.............................................................................................................................7 MEASUREMENT OF EXPOSURE.............................................................................................................................7 MANAGEMENT OF EXPOSURE..............................................................................................................................8 VALUATION................................................................................................................................................10

INTEREST RATE RISK............................................................................................................................................11
IDENTIFICATION OF EXPOSURE...........................................................................................................................11 MEASUREMENT OF EXPOSURE...........................................................................................................................11 MANAGEMENT OF EXPOSURE............................................................................................................................15 VALUATION................................................................................................................................................17

COMMODITIES PRICE RISK................................................................................................................................18
IDENTIFICATION OF EXPOSURE...........................................................................................................................18 MEASUREMENT OF EXPOSURE...........................................................................................................................18 MANAGEMENT OF EXPOSURE............................................................................................................................18 VALUATION................................................................................................................................................21

LIQUIDITY RISK .....................................................................................................................................................21
IDENTIFICATION OF EXPOSURE...........................................................................................................................21 MEASUREMENT OF EXPOSURE...........................................................................................................................21 MANAGEMENT OF EXPOSURE............................................................................................................................22 VALUATION................................................................................................................................................24

CREDIT RISK............................................................................................................................................................26
IDENTIFICATION OF EXPOSURE...........................................................................................................................26 MEASUREMENT OF EXPOSURE...........................................................................................................................26 MANAGEMENT OF EXPOSURE............................................................................................................................27

OPERATIONAL RISK..............................................................................................................................................28
MEASUREMENT OF EXPOSURE...........................................................................................................................28 MANAGEMENT OF EXPOSURE............................................................................................................................29

STOP LOSS AND VALUE AT RISK.......................................................................................................................30
STOP LOSS LIMIT.........................................................................................................................................30 LIMIT STRUCTURE.........................................................................................................................................31 VALUE AT RISK LIMITS....................................................................................................................................33

SIMULATION APPROACHES................................................................................................................................34 REPORTING AND REVIEW...................................................................................................................................35
REPORTING................................................................................................................................................35

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MONITORING

OF

COMPLIANCE...........................................................................................................................36

ANNEXURE................................................................................................................................................................37
HEDGING
INSTRUMENTS..................................................................................................................................37

Introduction
Any business is open to a number of risks, amongst them: movements in competitors' prices, raw material prices, competitors’ cost of capital, foreign exchange rates and interest rates are the most important. These Risk Management Guidelines set the principles and practices to managing risks due to movements in foreign exchange rates, interest rates and commodity prices. The Group/Company is expected to formulate its Risk Management Policy that conforms to these guidelines and takes into account Unit-specific issues and circumstances. The Company Board should approve such a Policy.

Objectives
The objective of the policy is to provide an overarching framework for managing the risks associated with treasury functions. Specifically the policy aims to: 1. Identify, measure and effectively manage financial risk; 2. On the ‘operational’ side [cash flows arising from regular import and export transactions and project related costs], minimize the impact of adverse fluctuations in the foreign currency rates on the cash flows subject to exchange risk exposure limits set; 3. On the ‘financing’ side [cash flows associated with foreign currency debt servicing obligations, i.e. principal and interest payments], avoid losses while servicing loans taken in foreign currency, which may arise from adverse exchange rate movements away from the target exchange rate; 4. Minimize the cost of gross debt (i.e. total borrowings), within prudent risk parameters; 5. Minimize the impact of adverse interest rate movements through the use of interest rate management tools; 6. Minimize price risk in commodity/raw material by hedging; and 7. Ensure professional interaction with financial markets. In essence, the objective is to reduce, if not eliminate, any losses due to forex and interest rate related transactions.

Policy Statement
The following principles underlie the Treasury Management Policy: • Centralised market interaction but decentralized strategic decisions;
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• •

Identification and effective management of financial risks; Clear accountability;

Policy Framework
Establishing successful policy frameworks involves articulating objectives, strategies and tactics and defining how performance will be measured. A generic template is provided to ensure consistency in the application of the policy. However, the policies need to be formulated on a case-by-case basis with consideration of the nature, size and complexity of financial market activities, particularly the quantitative limits. In order to carry out its responsibilities, the Board of Directors in a Company should approve strategies and policies with respect to risk management and ensure that senior management takes the steps necessary to monitor and control these risks consistent with the approved strategies and policies. The board of directors should be informed regularly of the risk exposure of the Company in order to assess the monitoring and controlling of such risk against the board’s guidance on the levels of risk that are acceptable to the Company. Senior management must ensure that the structure of the Company's business and the level of risk it assumes are effectively managed, that appropriate policies and procedures are established to control and limit these risks, and that resources are available for evaluating and controlling risk. Companies should clearly define the individuals and/or committees responsible for managing risk and should ensure that there is adequate separation of duties in key elements of the risk management process to avoid potential conflicts of interest. The Company should have risk measurement, monitoring, and control functions with clearly defined duties that are sufficiently independent from the business decision-making and position-taking functions of the company and which report risk exposures directly to senior management and the board of directors. Larger Corporate should have a designated independent unit responsible for the design and administration of the company’s risk measurement, monitoring, and control functions. The company’s risk policy should be applied on consolidated basis and, as appropriate, at the level of individual affiliates, especially when recognizing legal distinctions. Products and activities that are new to the Company should undergo a careful pre-acquisition review to ensure that the Company understands their risk characteristics and can incorporate them into its risk management process. Prior to introducing a new product, hedging, or position-taking strategy, management should ensure that adequate operational procedures and risk control systems are in place. The board or its appropriate delegated committee should also approve major hedging or risk management initiatives in advance of
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their implementation. Proposals to undertake new instruments or new strategies should contain these features: • • • • Description of the relevant product or strategy; Identification of the resources required to establish sound and effective risk management of the product or activity; Analysis of the reasonableness of the proposed activities in relation to the Company's overall financial condition and capital levels; and Procedures to measure, monitor, and control the risks of proposed product.

Identification of Risks
• • • • • • Interest Rate risk; Exchange Rate risk; Commodity Price risk; Credit risk; Liquidity risk; Operational risk

Interest rate risk Interest rate risk arises as a result of fluctuations in interest rates and it is usually defined as the risk that a corporates funding costs (or company's net interest earnings) may be adversely affected by changes in market interest rates. Interest rate risk is of very wide importance to an organisation as it concerns the risk of overall financial performance being impaired as a result of changes in interest rates. The size of the interest rate position(s), the volatility of interest rates and the time period of the risk govern the magnitude of interest rate risk. Exchange Rate Risk Foreign exchange transaction risk is the risk that the company’s cash flows will be adversely affected by movements in exchange rates that will increase the value of foreign currency payables, or will diminish the value of foreign currency receivables. Foreign exchange translation risk relates to the effect of currency movements on the value of a company’s assets and liabilities denominated in foreign currencies when those values are translated into the functional currency of the company for accounting purposes. For the purpose of this policy, Foreign Currency is defined as any currency that is not the Unit’s functional currency. It is likely that in case of certain Units, the local currency will be treated as foreign currency for purposes of applying this policy. Commodity Price Risk

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Commodity price risk arises due to uncertainty associated with the future ability of an organization to buy and sell the necessary materials and finished products respectively at a price within a range sustainable for the business model. Credit Risk Credit risk is defined as the risk of incurring a loss as a result of the default by a counterparty that has: • Issued, accepted or endorsed a security in which the company has invested; • Accepted a deposit from the company; and • Entered into a hedging transaction with the company related to the management of financial risks. The purpose of establishing credit limits is to ensure that the company deals with creditworthy counterparties and that counterparty concentration risk is addressed. Liquidity Risk Liquidity risk is the potential that an organization cannot fund its operations or convert assets into cash to meet commitments. Liquidity risk management is associated with ensuring that there are sufficient funds available to meet the company’s financial commitments in a timely manner. It is also associated with planning for unforeseen events, which may curtail cash flows and cause pressure on liquidity. The possible causes of a liquidity crisis include: • Unplanned reduction in revenue • Business disruption • Unplanned capital expenditure In case of treasury, liquidity risk would be the ability of the company to unwind existing or proposed trades for treasury. Operational Risk Operational risk is the risk associated with employing inadequate internal controls, systems, people, processes and procedures or from external events. It constitutes the risk of financial loss due to mismanagement, error, fraud or unauthorised use of instruments.

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Exchange Rate Risk Identification of Exposure
• Any Cash Flow involving foreign exchange should be reported to the individuals and/or committees responsible for managing risk. The concerned person is expected to maintain a running account of all foreign exchange transactions on a daily basis. It is the responsibility of the individuals and/or committees to compile the requisite information on exposures from all sections of the company.

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Measurement of Exposure
Exposure An Exposure can be defined as the condition, in relation to an incomplete transaction (i.e. a transaction that has been initiated, committed or physically completed but has not been fully settled) where the ultimate financial outcome of the transaction upon the completion or settlement could be different from the one currently prevalent, due to changes in certain external circumstances. A Risk is the possibility that such a difference in outcome could be negative. In the matter of forex, the exposure would involve inflow or outflow of funds in a currency other than the functional currency. A Forex exposure would arise when the flow of such funds is likely to take place at a future time, and there is uncertainty about the effective rate of exchange between the functional currency and the transaction currency. Net Exposure As Exports and Imports provide a natural hedge, provided the timing of the related cash flows is identical, the inflows and outflows have to be netted-off to arrive at the ‘net’ exposure. For instance, if Exports are USD 10 Million and Imports are USD 9 Million, then the ‘net’ exposure to be considered is USD 1 Million. For purposes of calculating Net Exposure, inflows and outflows have to be matched based upon the expected dates of such flows. As it is very difficult to estimate such exact dates of inflows and outflows, the said exercise of matching inflows and outflows, should be done over a fortnight, assuming the foreign exchange rate fluctuations within a fortnight is not significant enough to create any serious risk on the company’s operations. However, if the company feels that the fluctuations in the relevant exchange rate are significant even during a fortnight, then the company needs to do such matching of exposures over shorter periods, i.e., over a week. A significant fluctuation in this case may be in the range of +/- X% of the Base Exchange rate.

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Management of Exposure
Instruments for Hedging To limit the exposure to changes in foreign exchange rates, corporates/institutions employs techniques, commonly called hedging, which include (Explained in Annexure): • • • • • • Spot; Forward; Futures; Option; Swaps; Combinations of the above;

Exposures Limits This exercise aims to state where the company would like its exposures to reach. Net Exposure mechanism is ideal while hedging decision has to be taken, but based on market view, forecasts and the risk appetite of the company the treasury manager can take a view on the gross exposure with appropriate approval. The exposures will be considered over a period of Z months, on a rolling basis. This would be a continuous exercise, and therefore, at any point of time, the exposure for the next Z months will be taken into consideration for hedging or otherwise, decision making processes. • • The overall target for the Company / Group is to have the net exposure limit of USD X Million or 100% of Net Exposure (whichever is lower); Exposure Limits can be increased to the levels mentioned below after taking approval from the respective authorities. Exposure limits 100% of Net Exposure (if it is greater than USD X mn) Y% of (Gross Exposure – Net Exposure) + NE Z% of (Gross Exposure – Net Exposure) + NE • Approving Authority Head of Group Any Whole-time Director BOD

Under no circumstances the absolute exposure can be more than USD million. Therefore no authority can approve exposure limits where the absolute amount exceeds USD million.

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Deal size limit The following levels of executive/ officers are authorized severally to deal in the following contracts by way of a single deal: (Rs mn.) Type Upto Spot Forwards Futures Options Swaps Combinations Deal done above the specified limit shall be approved by the next higher authority having the requisite power to enter the deal of that size. In case the deal size is beyond the limit permitted for the whole time director, the BOD shall approve the same. Portfolio Limit The following levels of executive/ officers are authorized severally to take a maximum net position upto the following amounts at any point of time: (Rs mn.) Type Upto Spot Forwards Futures Options Swaps Dealers Head of the desk Head of the Group Whole time Director Dealers Head of the desk Head of the Group Whole time Director

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Combinations

Bucket-wise Limit The following percentage (of the portfolio limit) can be taken as net position (for each executive/officers) in the time periods at any point of time: (%) Type Forwards Futures Options Swaps Combination s Upto 1 yr >1 - 2 yrs >2 - 3 yrs >3 - 4 yrs >4 - 5 yrs > 5 yrs

Valuation
Marking to market shall be done for any spot/ forward/ tom positions arising out of the operations of the group. Tom/Spot Positions Any outstanding position arising out of tom/ spot transaction shall be considered for MTM purpose. These shall be valued using the tom/ spot rate (FEDAI rates) as quoted at the close of trading on the Reuters or any information service. Forward Positions The outstanding forward positions shall be valued using the forward rates as quoted at the end of the day on the Reuters or any other information service. In case the forward rates are not available for the exact maturity of the contract, the two adjacent forward rates shall be interpolated and the MTM positions shall be calculated using the interpolated forward rates (FEDAI rates). Swap Both the legs of the swaps shall be valued using the market rates as quoted at the end of the day on the Reuters or any other information service. (FEDAI rates) Currency options Options shall be valued based on the strike price, volatility, residual tenor, spot rate, and interest rates.
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Interest Rate Risk Identification of Exposure
• Any Cash Flow involving interest rate payable/receivable should be reported to the individuals and/or committees responsible for managing risk. The concerned person is expected to maintain a running account of all interest rate transactions on a daily basis. It is the responsibility of the individuals and/or committees to compile the requisite information on exposures from all sections of the company.

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Measurement of Exposure
Exposure A Company's interest rate risk measurement system should address all material sources of interest rate risk including repricing, yield curve and basis risk exposures. A number of techniques are available for measuring the interest rate risk exposure of both earnings and economic value. Their complexity ranges from simple calculations to static simulations using current holdings to highly sophisticated dynamic modeling techniques that reflect potential future business activities. If the company has positions denominated in different currencies it would expose it to interest rate risk in each of these currencies. Since yield curves vary from currency to currency, the company would generally need to assess exposures in each. If the multi-currency exposures are substantial, the risk measurement process should include methods to aggregate the exposures in different currencies using assumptions about the correlation between interest rates in different currencies. The correlation assumptions to aggregate the risk exposures should be periodically reviewed so as to ascertain their stability and accuracy. The company should also evaluate what its potential risk exposure would be in the event that such correlations break down. Repricing schedules The simplest techniques for measuring a Company's interest rate risk exposure begin with a maturity/repricing schedule that distributes interest-sensitive assets, liabilities, and Off Balance-Sheet positions into a certain number of predefined “time bands” according to their maturity (if fixed-rate) or time remaining to their next repricing (if floating-rate). These schedules can be used to generate simple indicators of the interest rate risk sensitivity of both earnings and economic value to changing interest rates.

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Gap analysis: Simple maturity/repricing schedules can be used to assess the interest rate risk of current earnings, and is typically referred to as gap analysis. To evaluate earnings exposure, interest rate-sensitive liabilities in each time band are subtracted from the corresponding interest rate-sensitive assets to produce a repricing “gap” for that time band. This gap can be multiplied by an assumed change in interest rates to yield an approximation of the change in net interest expense/income that would result from such an interest rate movement. The size of the interest rate movement used in the analysis can be based on a variety of factors, including historical experience, simulation of potential future interest rate movements, and the judgement of company’s management. These simple gap calculations can be augmented by information on the average coupon on assets and liabilities in each time band. This information can be used to place the results of the gap calculations in context. For instance, information on the average coupon rate could be used to calculate estimates of the level of net interest expense/income arising from positions maturing or repricing within a given time band, which would then provide a “scale” to assess the changes in expense/income implied by the gap analysis. Duration: A maturity/repricing schedule can also be used to evaluate the effects of changing interest rates on a company’s economic value by applying sensitivity weights to each time band. Typically, such weights are based on estimates of the duration of the assets and liabilities that fall into each time band. Duration is a measure of the percentage change in the economic value of a position that will occur given a small change in the level of interest rates. It reflects the timing and size of cash flows that occur before the instrument's contractual maturity. Generally, the longer the maturity or next repricing date of the instrument and the smaller the payments that occur before maturity (e.g. coupon payments), the higher the duration (in absolute value). Higher duration implies that a given change in the level of interest rates will have a larger impact on economic value. Duration-based weights can be used in combination with a maturity/repricing schedule to provide a rough approximation of the change in a company’s economic value that would occur given a particular change in the level of market interest rates. Specifically, an “average” duration is assumed for the positions that fall into each time band. The average durations are then multiplied by an assumed change in interest rates to construct a weight for each time band. In some cases, different weights can be used for different positions that fall within a time band, reflecting broad differences in the coupon rates and maturities (for instance, one weight for assets, and another for liabilities). In addition, different interest rate changes can be sometimes used for different time bands, generally to reflect differences in the volatility of interest rates along the yield curve. The weighted gaps are aggregated across time bands to produce an estimate of the change in economic value of the company that would result from the assumed changes in interest rates.

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Alternatively, an institution could estimate the effect of changing market rates by calculating the precise duration of each asset, liability, and Off Balance-Sheet position and then deriving the net position for the company, rather than by applying an estimated average duration weight to all positions in a given time band. This would eliminate potential errors occurring when aggregating positions/cash flows. As another variation, risk weights could also be designed for each time band on the basis of actual percentage changes in market values of hypothetical instruments that would result from a specific scenario of changing market rates. That approach - which is sometimes referred to as effective duration - would better capture the non-linearity of price movements arising from significant changes in market interest rates and, thereby, would avoid an important limitation of duration. Standardized Framework: Example This annex contains an example setting out the methodology and calculation process in one version of a standardized framework. Other methodologies and calculation processes could be equally applicable in this context, depending on the circumstances of the company concerned. Methodology: Positions on the company’s balance sheet would be slotted into the maturity approach according to the following principles: • All assets and liabilities and all Off Balance Sheet items that are sensitive to changes in interest rates (including all interest rate derivatives) are slotted into a maturity ladder comprising a number of time bands large enough to capture the nature of interest rate risk. Separate maturity ladders are to be used for each currency accounting for more than 5% of either assets or liabilities. On-balance-sheet items are treated at book value. Fixed-rate instruments are allocated according to the residual term to maturity and floating-rate instruments according to the residual term to the next repricing date. Core deposits are slotted according to an assumed maturity of no longer than five years. Derivatives are converted into positions in the relevant underlying. The amounts considered are the principal amount of the underlying or of the notional underlying. Futures and forward contracts, including forward rate agreements (FRA), are treated as a combination of a long and a short position. The maturity of a future or a FRA will be the period until delivery or exercise of the contract, plus - where applicable - the life of the underlying instrument. For example, a long position in a June three month interest rate future (taken in April) is to be reported as a long position with a maturity of five months and a short position with a maturity of two months. Swaps are treated as two notional positions with relevant maturities. For example, an interest rate swap under which a company is receiving floating-rate interest and paying fixed-rate interest will be treated as a long floating-rate position of maturity equivalent to the period until the next interest fixing and a short fixed-rate position of maturity equivalent
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• • • •

•

to the residual life of the swap. The separate legs of cross-currency swaps are to be treated in the relevant maturity ladders for the currencies concerned. • Options are considered according to the delta equivalent amount of the underlying or of the notional underlying. Calculation process: The calculation process consists of five steps. • • The first step is to offset the longs and shorts in each time band, resulting in a single short or long position in each time band. The second step is to weight these resulting short and long positions by a factor that is designed to reflect the sensitivity of the positions in the different time bands to an assumed change in interest rates. The set of weighting factors for each time band is set out in Table 1 below. These factors are based on an assumed parallel shift of 200 basis points throughout the time spectrum, and on a proxy of modified duration of positions situated at the middle of each time band and yielding 5%. The third step is to sum these resulting weighted positions, offsetting longs and shorts, leading to the net short- or long-weighted position in the given currency. The fourth step is to calculate the weighted position of the whole company by summing the net short- and long-weighted positions calculated for different currencies. The fifth step is to relate the weighted position to the limit exposure.

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Table 1 Weighting factors per time band (second step in the calculation process) Time band Up to 1 month 1 to 3 months 3 to 6 months 6 to 12 months 1 to 2 years 2 to 3 years 3 to 4 years 4 to 5 years 5 to 7 years 7 to 10 years 10 to 15 years 15 to 20 years Over 20 years Middle of time band 0.5 months 2 months 4.5 months 9 months 1.5 years 2.5 years 3.5 years 4.5 years 6 years 8.5 years 12.5 years 17.5 years 22.5 years Proxy of modified duration 0.04 years 0.16 years 0.36 years 0.71 years 1.38 2.25 3.07 3.85 5.08 6.63 years years years years years years Assumed change in yield 200 bp 200 bp 200 bp 200 bp 200 200 200 200 200 200 bp bp bp bp bp bp Weighting factor 0.08% 0.32% 0.72% 1.43% 2.77% 4.49% 6.14% 7.71% 10.15% 13.26% 17.84% 22.43% 26.03%

8.92 years 11.21 years 13.01 years

200 bp 200 bp 200 bp

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Management of Exposure
Instruments for Hedging To limit the exposure to changes in interest rates, corporates/institutions employs techniques, commonly called hedging, which include (Explained in Annexure): • • • • • Forward Rate Agreement Interest rate futures, Interest rate options, Interest rate swaps Combinations of the above

Exposures Limits This exercise aims to state where the company would like its exposures to reach. Gap/Duration based approach is ideal while hedging decision has to be taken, but based on market view, forecasts and the risk appetite of the company the treasury manager can take a view on the gross exposure with appropriate approval. • • The overall target for the Company / Group is to have the Gap limit of USD X Million or 100% of Net Exposure (whichever is lower); Exposure Limits can be increased to the levels mentioned below after taking approval from the respective authorities. Exposure limits 100% of Gap (if it is greater than USD X mn) Y% of (Gross Exposure – Gap) + Gap Z% of (Gross Exposure – Gap) + Gap • Approving Authority Head of Group Any Whole-time Director BOD

Under no circumstances the Gap can be more than USD million. Therefore no authority can approve Gap limits where the absolute amount exceeds USD million.

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Limits Notional Deal size limit for derivative instruments The following levels of officials are authorised severally to transact by way of a single deal (based on notional value of the transaction) in the following derivative instruments: (Rs. mn) Whole Head of Head of Type Dealers time desk group Director Forward Rate Agreements Interest Rate Futures Interest Rate Options Interest Rate Swaps Combinations Deals to be done above the specified limits shall be approved by the next higher authority having the requisite power to enter the deal of that size. In case the deal size is beyond the limit permitted for the whole time director, the BOD shall approve the same. Portfolio Limit The following levels of executive/ officers are authorized severally to take a maximum gap position upto the following amounts at any point of time: (Rs. mn) Type Forward Rate Agreements Interest Rate Futures Interest Rate Options Interest Rate Swaps Combinations Dealers Head of desk Head of group Whole time Director

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Bucket-wise Limit The following percentage (of the portfolio limit) can be taken as net position (for each executive/officers) in the time periods at any point of time: (%) Upto 1 >1 - 2 >2 - 3 >3 - 4 >4 - 5 Type > 5 yrs yr yrs yrs yrs yrs Forward Rate Agreements Interest Rate Futures Interest Rate Options Interest Rate Swaps Combinations

Valuation
The marked to market value of the Company's portfolio can be arrived at, by using market values of individual products on real time basis. Forward Rate Agreements • Forward Rate Agreements should be valued using the market rates as quoted at the end of the day on the Reuters or any other information service.

Interest Rate Futures • Interest Rate Futures shall be valued using the market rates as quoted at the end of the day on the Reuters or any other information service.

Interest Rate Options • Interest Rate Options shall be valued using the market rates as quoted at the end of the day on the Reuters or any other information service.

Interest rate swaps • The marked to market is the net value of both the legs of the swap based on the prices quoted on Reuters and other services or quotes obtained from market participants and brokers.

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Commodities Price Risk Identification of Exposure
• Any Cash Flow involving commodity price payable/receivable should be reported to the Exposure Manager. Thus the Exposure Manager is expected to maintain a running account of all commodity transactions on a daily basis. It is the responsibility of the Exposure Manager to ensure that he receives the requisite information on exposures from all sections of the company.

•

Measurement of Exposure
Exposure An Exposure can be defined as the condition, in relation to procurement/sale of the commodity in the open market where the ultimate financial outcome of the transaction is dependent upon the price movement of the commodity, due to changes in certain external circumstances. A Risk is the possibility that such a difference in outcome could be negative. In the matter of commodity, the exposure would involve purchase or sale of a commodity. A Commodity exposure would arise when the amount payable or receivable on purchase and sale respectively is likely to take place at a future time, and there is uncertainty about the effective market rate.

Management of Exposure
Instruments for Hedging

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To limit the exposure to changes in commodity prices, corporates/institutions employs techniques, commonly called hedging, which include (Explained in Annexure): • • • • • • Spot Forwards Futures, Options, Swaps and Combinations of the above

Limits The limits for dealing in different commodities are set as under:
Asset type Limit

Commodity 1 Commodity 2 Commodity 3 Commodity 4 Commodity 5 Deal Size Limits The following levels of executive/ officers are authorized severally to deal in the following commodity contracts (applicable to each commodity asset separately) by way of a single deal: (Rs mn.) Type Spot Forwards Futures Options
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Dealers

Head of the desk

Head of the Group

Wholetime Director

Swaps Combinations Deal done above the specified limit shall be approved by the next higher authority having the requisite power to enter the deal of that size. In case the deal size is beyond the limit permitted for the whole time director, the BOD shall approve the same.

Portfolio Limit The following levels of executive/ officers are authorized severally to take a maximum net position (applicable to each commodity asset separately) upto the following amounts at any point of time: (Rs mn.) Type Spot Forwards Futures Options Swaps Combinations Bucket-wise Limit The following percentage (of the portfolio limit) can be taken as net position (for each executive/officers) in the different time periods at any point of time: (%) Type Forwards Upto 1 yr >1 - 2 yrs >2 - 3 yrs >3 - 4 yrs >4 - 5 yrs > 5 yrs Dealers Head of the desk Head of the Group Whole time Director

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Futures Options Swaps Combinations

Valuation
The marked to market value of the Company's portfolio shall be arrived at, by using market values of individual commodities on real time basis.

LIQUIDITY RISK Identification of Exposure
Liquidity, or the ability to fund increases in assets and meet obligations as they come due, is crucial to the ongoing viability of any organization. Sound liquidity management can reduce the probability of serious problems. For this reason, the analysis of liquidity requires management not only to measure the liquidity position of the company on an ongoing basis but also to examine how funding requirements are likely to evolve under various scenarios, including adverse conditions.

Measurement of Exposure
An effective liquidity measurement process involves assessing all of a company’s cash inflows against its outflows to identify the potential for any net shortfalls going forward. This includes funding requirements for off-balance sheet commitments. A number of techniques can be used for measuring liquidity risk, ranging from simple calculations and static simulations based on current holdings to highly sophisticated modeling techniques. As all companies are affected by changes in the economic climate and market conditions, the monitoring of economic and market trends is key to liquidity risk management. Whether a company is sufficiently liquid depends in large measure on the behaviour of cash flows under different conditions. Analyzing liquidity thus entails laying out a variety of "what if" scenarios. Under each scenario, a company should try to account for any significant positive or negative liquidity swings that could occur. These scenarios should take into account factors that are both internal (company-specific) and external (market-related). While

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liquidity will typically be managed under “normal” circumstances, the company must be prepared to manage liquidity under abnormal conditions.

Management of Exposure
Investment Limit The investment limits (based on book value of investment) of the company in different markets is as follows: (Rs. mn) Instrument Limit Equity Market Money Market Instruments Debt Market Instruments Mutual Funds Bank Deposit/Cash Deal size limit The following levels of officials are authorised, severally, to invest in the under mentioned instruments by way of a single deal (Rs. Mn) Head of Head of Whole time Instrument Dealers desk group Director Equity Market Money Market Instruments Debt Market Instruments Mutual Funds Bank Deposit/Cash Portfolio Limit
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The following levels of executive/ officers are authorized severally to take a maximum net position upto the following amounts at any point of time: (Rs. Mn) Head of Head of Whole time Instrument Dealers desk group Director Equity Market Money Market Instruments Debt Market Instruments Mutual Funds Bank Deposit/Cash Deals to be done above the specified limit shall be approved by the next higher authority having the requisite power to enter the deal of that size. In case the deal size is beyond the limit permitted for the whole time director, BOD shall approve the same.

Maturity wise limit The cumulative investment in Debt Market Instruments across maturities shall not exceed the following limits. (Rs. mn) Maturity 1 - 3 yrs >3 - 5 yrs >5 - 10 yrs >10 yrs Rating wise investment limit Investment in Money/Debt Market Instruments other than central and state government guaranteed bonds, of a single issue shall not exceed any of the following limits: (Rs. mn) Cumulative for rating Rating* Issue wise Limit category AAA/ AA+ AA, AAA+, A A-, BBB+, BBB, BBB* Rating limit includes structured obligation (SO) instruments also The rating from CRISIL, ICRA, CARE and Fitch are to be considered for the above.
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Industry wise limit In order to maintain exposure to industries at prudent levels and to diversify risks involved, Company’s total exposure to a particular industry / sector would be limited to a maximum of 15% of total exposure per industry / sector.

Valuation
In an ideal situation, the marked to market value of the Company's portfolio can be arrived at, by using market values of individual securities on real time basis. The absence of market data on some of the instruments precludes the use of this methodology. Considering the constraints in terms of data availability, different methods are proposed for different set of securities. Commercial Paper (CP) • Commercial Paper shall be valued at carrying cost. The carrying cost shall include the acquisition cost and the discount accrued on it from the date of purchase.

GOI Securities, State Government Securities and Treasury Bills • • GOI Securities shall be valued on daily basis at FIMMDA prices. In case the rates are not available for State Government securities, these shall be valued applying the YTM method by marking it up by 25 basis points or as may be stipulated by RBI, above the yields of GOI Secs of equivalent maturity published by FIMMDA periodically. Treasury Bills shall be valued at carrying cost. The carrying cost shall include the acquisition cost and the discount accrued on it from the date of purchase.
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•

Debentures/ Bonds •
•

•

•

•

•

All quoted debentures/ bonds shall be valued at prices as available from the trades/ quotes on the stock exchanges. Where traded prices/ quotes are not available, rated and unrated debentures/ bonds shall be valued based on appropriate mark-up over the YTM rates for GOI Securities as published by FIMMDA. Where a particular structured issue (with (SO) rating) has been rated by any one credit rating agency, appropriate mark-up as per the said rating shall be considered for valuation purpose. Where more than one credit rating agencies have rated such an issue, appropriate mark-up as per the lowest of the ratings shall be considered for valuation purpose. For all other issues, lowest of the available ratings among all the credit rating agencies for comparable issues shall be considered for valuation purpose. Where the bonds have simultaneous call and put options (on the same day) and there are several such call and put options in the life of the bond, the nearest date shall be taken as maturity date for price/ YTM calculation. Where interest/ principal on the debenture/ bonds is in arrears, the provision would be made for the debentures as in the case of debentures/ bonds treated as advances. The depreciation/ provision requirement towards debentures where the interest is in arrears or principal is not paid as per due date, shall not be allowed to be set-off against appreciation against other debentures/ bonds. Where the debenture/ bonds is quoted and there have been transactions within 15 days prior to the valuation date, the value adopted should not be higher than the rate at which the transaction is recorded on the stock exchange.

Certificate of Deposits (CDs) • CDs shall be valued at carrying cost. The carrying cost shall include the acquisition cost and the discount accrued on it from the date of purchase.

Securitised Paper • • All quoted instruments shall be valued at prices as available from the trades/ quotes on stock exchanges. Where traded prices/ quotes are not available, valuation shall be done by discounting the future cash flows at an yield based on appropriate markup over the ZC rates for GOI Secs as published by FIMMDA.

Equity • • In case of equity shares ex-dividend, ex-bonus and ex-rights prices shall be considered. Equity shares for which current quotations are not available or where the shares are not quoted on the stock exchanges, should be valued at breakup value (without considering ‘revaluation reserves’, if any) which is to be
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ascertained from the company’s latest balance sheet (which should not be more than one year or eighteen months (in case of companies with accounting year ending other than March 31) prior to the date of valuation). In case the latest balance sheet is not available the shares are to be valued at Re.1 per company. In case of shares with a lock in period, valuation shall be based on current market price/break up value. Equity shares, which are not traded in the last thirty days, shall be unquoted for the above purposes. Mutual Funds • • • In case of listed units, quoted market price shall be used for valuation purpose. In case of unlisted units, Net Asset Value (NAV)/ repurchase price shall be used for valuation purpose. Units of mutual funds with a lock-in period for which repurchase price/ market quote is not available will be valued at carrying cost.

CREDIT RISK Identification of Exposure
The basis for an effective credit risk management process is the identification and analysis of existing and potential risks inherent in any product or activity. Consequently, it is important that the company identify all credit risk inherent in the products they enter and the activities in which they engage. Such identification stems from a careful review of the existing and potential credit risk characteristics of the product or activity.

Measurement of Exposure
An effective credit monitoring system will include measures to: • Ensure that the company understands current financial condition of the counterparty; • Monitor compliance with existing covenants; • Identify contractual payment delinquencies and classify potential problem credits on a timely basis; and • Direct promptly problems for remedial management.

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The Company should have methodologies that enable them to quantify the risk involved in exposures to individual counterparties. Company should also be able to analyse credit risk at the product and portfolio level in order to identify any particular sensitivities or concentrations. The measurement of credit risk should take account of • • • The specific nature of the credit and its contractual and financial conditions (maturity, reference rate, etc.); The exposure profile until maturity in relation to potential market movements; The potential for default based on the credit rating.

Management of Exposure
Aggregate Counterparty Exposure Limits Counter Party Counter Party 1 Tenor Upto 3 yrs >3 - 5 yrs >5 - 10 yrs >10 yrs Upto 3 yrs >3 - 5 yrs >5 - 10 yrs >10 yrs Upto 3 yrs >3 - 5 yrs >5 - 10 yrs >10 yrs Limit Amount

Counter Party 2

Counter Party 3

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Operational Risk Identification of Exposure
Risk identification is paramount for the subsequent development of a viable operational risk monitoring and control system. Effective risk identification considers both internal factors (such as the company’s structure, the nature of the company’s activities, the quality of the company’s human resources, organizational changes and employee turnover) and external factors (such as changes in the industry and technological advances) that could adversely affect the achievement of the company’s objectives.

Measurement of Exposure
Amongst the possible tools which can used by the company for identifying and assessing operational risk are: Self- or Risk Assessment A company assesses its operations and activities against a menu of potential operational risk vulnerabilities. This process is internally driven and often incorporates checklists and/or workshops to identify the strengths and weaknesses of the operational risk environment. Scorecards, for example, provide a means of translating qualitative assessments into quantitative metrics that give a relative ranking of different types of operational risk exposures. Scores may address inherent risks, as well as the controls to mitigate them. In addition, scorecards may be used by the company to allocate economic capital to treasury in relation to performance in managing and controlling various aspects of operational risk. Risk Mapping In this process treasury functions or process flows are mapped by risk type. This exercise can reveal areas of weakness and help prioritize subsequent management action. Risk Indicators Risk indicators are statistics and/or metrics, often financial, which can provide insight into a company’s risk position. These indicators tend to be reviewed on a periodic basis (such as monthly or quarterly) to alert the company to changes that may be indicative of risk concerns. Such indicators may include the number of failed trades, staff turnover rates and the frequency and/or severity of errors and omissions. Measurement Firms can also quantify their exposure to operational risk using a variety of approaches. For example, data on the company’s historical loss experience

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could provide meaningful information for assessing the treasury’s exposure to operational risk and developing a policy to mitigate/control the risk. An effective way of making good use of this information is to establish a framework for systematically tracking and recording the frequency, severity and other relevant information on individual loss events. Firms can also combine internal loss data with external loss data, scenario analyses, and risk assessment factors.

Management of Exposure
The company should ensure that internal practices are in place as appropriate to control operational risk. Examples of these include: • • • • Close monitoring of adherence to assigned risk limits or thresholds; Maintaining safeguards for access to, and use of, company’s assets and records; Ensuring that staffs have appropriate expertise and training; Identifying products where returns appear to be out of line with reasonable expectations (e.g., where a supposedly low risk, low margin trading activity generates high returns that could call into question whether such returns have been achieved as a result of an internal control breach); Regular verification and reconciliation of transactions and accounts; and Use of Voice Recording System while finalizing deals with counterparties.

• •

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Stop Loss and Value at Risk Stop Loss Limit
Stop Loss limits are risk control mechanisms. A Stop Loss is the maximum permissible loss that can be incurred on a position or a portfolio of positions. It is that point at which either approval of a superior authority is required to continue with the position or the trader has to square off the position and book the loss.

Need for Stop Loss
The company is exposed to price risk arising out of interest rate movements, foreign currency movements and credit risk on account of investments/ positions. Since the value of the positions undergoes a change on account of the changes in the interest rates, exchange rates or the credit rating, the market value of the position undergoes change, even though the position has not been liquidated. In order to limit the amount of loss, which can arise out of the adverse market rate movements, stop loss limits are stipulated for treasury operations. It also enables an efficient risk monitoring mechanism by which information can be passed on to the management before a certain threshold level of stop loss limit has been reached. The management shall then be able to take corrective action, if necessary, before the actual stop loss limit is reached. The Head of Groups and the Country Head, in case of overseas/ offshore offices, shall be informed by email when the stop loss exceeds 75% of the limit prescribed in this policy. The stop loss for foreign currency exposure of the company would be monitored on a real time basis and the Head of Groups would be informed by email immediately when the stop loss exceeds 75% of the limit prescribed in this policy at any time during the day. However, in case the stop loss does not exceed the aforesaid limit the Head of Groups would be informed the same by end of day by the Daily Treasury Report. This process is applicable to breach of daily as well as cumulative stop loss limits.

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Limit Structure
Daily stop loss limits and Cumulative loss limits are stipulated for the portfolio as a whole. Daily Portfolio stop loss limit are set as under: Rs. mn Products Limits Fixed Income (FI) Foreign Exchange Derivatives Commodities Total • P&L due to foreign currency risk in derivatives shall form part of foreign exchange limits. There is no limit for interest rate risk in derivatives. • Derivatives limit is included in FI and Fx limits. The limits shall be fungible across product categories. • The total limit for currency option across all groups shall be Rs mn. Notes: The upfront incentive income received on any security shall be considered as part of profit for the purpose of the calculation of the stop loss limit. Cumulative Loss Limits shall be for a financial year. Rs. mn Products Limits Fixed Income (FI) Foreign Exchange Derivatives Commodities Total • P&L due to foreign currency risk in derivatives shall form part of foreign exchange limits. There is no limit for interest rate risk in derivatives. • Derivatives limit is included in FI and Fx limits. The limits shall be fungible across product categories. • The total limit for currency option across all groups shall be Rs mn. Calculation of profit/ loss for monitoring of Stop Loss Limit Profit/ loss on market exposures for the purpose of monitoring of daily stop loss of the portfolio shall be computed as follows: • • • Unrealised gain/ loss as on the date of the computation Less: Unrealised gain/ loss as at the end of the last trading day Add: Realised gain/ loss during the day

In case the underlying is hedged with a derivative the profit/ loss shall be considered after taking into account the profit/ loss on the derivative.

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Profit/ loss for the purpose of monitoring of cumulative loss limits shall be as follows: • • • Unrealised gain/ loss as on the date of computation Less: Unrealised gain/ loss as at the end of the last accounting year Add: Realised gain/ loss from beginning of the financial year till date of computation.

Authorization Structure In case a stop loss limit, as laid down by this policy, is breached, the position shall be liquidated. However, if the position is intended to be continued further, specific approval shall be obtained from the following authorities: Stop loss limits Portfolio-wise – daily Cumulative – yearly Approving Authority Any Whole-time Director BOD

Chief Financial Officer & Treasurer and will jointly allocate the stop loss and investment limits, product-wise, to various overseas/ offshore branches. Stop loss limits breaches, if any, should be reported to BOD.

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Value at Risk limits
Value-at-Risk (VaR) is a risk control mechanism and is the potential loss that can be incurred on a portfolio under normal market conditions at a pre-determined confidence level (99%) over a one-day holding period. VaR for each portfolio is calculated by taking into account the factor sensitivities and the volatilities of risk factors. For this purpose, factor sensitivities are used to monitor the price risks of portfolios. Factor sensitivity measures the changes in portfolio value for a defined change in risk factors (e.g., interest rates, exchange rates, exchange rate volatility, etc.). These factor sensitivities would be back tested to take into account the changes in the same at least once in a year and the required revisions, if any would be made in the factor sensitivities. Daily Value at Risk (VaR) limit The Product wise VaR limits shall be as under: Rs. mn Products Fixed Income (FI) Foreign Exchange Derivatives Commodities Limits

For breach of VaR Limits, approval shall be obtained from any whole time director.

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Simulation approaches
Many companies (especially those using complex financial instruments or otherwise having complex risk profiles) employ more sophisticated risk measurement systems than those based on simple maturity/repricing schedules. These simulation techniques typically involve detailed assessments of the potential effects of changes in interest rates, foreign exchange rate and commodity prices on earnings by simulating the future path of the rates and their impact on cash flows. Simulation approaches typically involve a more detailed breakdown of various categories of on- and off balance-sheet positions, so that specific assumptions about the interest and principal payments and currency transaction arising from each type of position can be incorporated. In addition, simulation techniques can incorporate more varied and refined changes in the rates environment, ranging from changes in the slope and shape of the yield curve to interest rate scenarios derived from Monte Carlo simulations and similar scenarios can be created for currency rates. Static simulation In static simulations, the cash flows arising solely from the company’s current on- and off-balance-sheet positions are assessed. For assessing the exposure of earnings, simulations estimating the cash flows and resulting earnings streams over a specific period are conducted based on one or more assumed rate scenarios. Typically, although not always, these simulations entail relatively straightforward shifts or tilts of the yield curve, or changes of spreads between different interest rates or movement in currency rate. When the resulting cash flows are simulated over a specified period and discounted back to their present values, an estimate of the change in the company’s profit/loss can be calculated. Dynamic simulation In a dynamic simulation approach, the simulation builds in more detailed assumptions about the future course of currency rates, interest rates and the expected changes in a company’s business activity over that time. For instance, the simulation could involve assumptions about a company’s strategy for changing administered interest rates and/or about the future stream of business that the company will encounter. Such simulations use these assumptions about future activities and reinvestment strategies to project expected cash flows and estimate dynamic earnings. These more sophisticated techniques allow for dynamic interaction of currency rates, commodity prices and interest rates. As with other approaches, the usefulness of simulation-based risk measurement techniques depends on the validity of the underlying assumptions and the accuracy of the basic methodology. The output of sophisticated simulations must be assessed largely in the light of the validity of the simulation's assumptions about future rates and the behaviour of the company. One of the

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primary concerns that arise is that such simulations do not become “black boxes” that lead to false confidence in the precision of the estimates.

Reporting and Review Reporting
The Reporting would consist of the following two aspects: • Historical Information - Information on ‘actual’ inflows and outflows for the past period, i.e., historical information. This would involve maintaining of a log of all foreign exchange transactions indicating for each transaction, the date and time of the transaction, the counter party and all relevant particulars of the transaction. • Estimates for future - Information on ‘estimated’ future inflows and outflows to be prepared based on transactions that are to be entered into in the next 3 months; Exposure Reports The treasury of the company should prepare the following reports. Management Information reports: The following Management Information report should be sent to the under mentioned as per the schedule given below. Sr. No. 1 Name of the Report Periodicit y To be submitted within/by By next working day Submitted to Senior Management BOD BOD BOD

Daily Treasury Report Daily (DTR)

In the BOD meeting Investment Review of 2 Quarterly post finalization of treasury transactions accounts Review of Foreign Within fortnight of 3 Exchange Quarterly closure of accounts Transactions Downward credit 4 Monthly Within fortnight migration

Money Market reports: The Money Market Reports should be submitted to the CFO of the company as per the schedule given below Sr. No. Name of the Report Periodicity To be submitted within/by Before 6 pm on the same day By the end of the next fortnight

Daily Return on 1 Call/Notice/Term Money/Repo Daily Transactions 2 IRS Return Fortnightly

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3

Status of Interest Rate Futures

Monthly

By 10th of the following month

Foreign Exchange & Derivatives reports: The Foreign Exchange & Derivatives Reports should be submitted to the CFO of the company as per the schedule given below Sr. No. 1 Name of the Report Periodicity Weekly Weekly Fortnightly Last Friday of Month Last Friday of Month Half-yearly Monthly Monthly Monthly To be submitted within/by By end of next week By end of next week Within next 7 days Within next 21 days Within next 10 days No statutory deadline By the following Monday Within 10 days Within week of closure of accounts

Long Term Foreign Currency Rupee Swap 2 Weekly Position Statement on balances held 3 abroad (BAL) 4 Maturity and Position (MAP) 5 Outstanding Export Credits 6 Cross Currency derivatives 7 Rupee Dollar Option Outstanding overseas foreign currency borrowings Review of Foreign Exchange 9 Transactions 8

Monitoring of Compliance
The Internal Assurance department should monitor compliance of the policy as part of their audit plan. The company should have in place adequate internal audit coverage to verify that policies and procedures have been implemented effectively. The company should ensure that the scope and frequency of the audit programme is appropriate to the risk exposures. Audit should periodically validate that the firm’s treasury risk management framework is being implemented effectively across the firm.

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Annexure Hedging instruments
Forward Contracts A forward contract is an agreement to buy or sell an asset at a certain time in the future for a certain price (the delivery price). It can be contrasted with a spot contract, which is an agreement to buy or sell immediately. The contract is an agreement between two financial institutions or between a financial institution and one of its clients. No money changes hands when contract is first negotiated and it is settled at maturity. The forward price for a contract is the delivery price that would be applicable to the contract if it were negotiated today (i.e., it is the delivery price that would make the contract worth exactly zero). The forward price may be different for contracts of different maturities. Options There are two basic types of options. A call option gives the holder the right to buy the underlying asset by a certain date for a certain price (the strike price). A put option gives the holder the right to sell a certain asset by a certain date for a certain price (the strike price). American options can be exercised at any time up to the expiration date. European options can be exercised only on the expiration date itself. In India only European options are permitted. Swaps A swap is an agreement to exchange cash flows at specified future times according to certain specified rules. Converting a liability or investment from – fixed rate to floating rate or –floating rate to fixed rate. A swap can be regarded as a convenient way of packaging forward contracts. The value of the swap is the sum of the values of the forward contracts underlying the swap. Forward Rate Agreement A Forward Rate agreement is an agreement between the company and a counter party which effectively fixes an interest rate for a deposit / loan which will arise at a future date. The FRA is based on a notional principal amount. Interest Rate Futures An interest rate futures contract is based on an Interbank deposit rate or an underlying debt security. The price of futures is inversely related to movements

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in interest rates. Therefore, if it is believed that interest rates will decline, hedging of underlying position can be achieved by buying futures contracts now to benefit from the price rise.

Interest Rate Cap An interest rate cap is an option that affords the company protection against an upward movement of rates while still allowing the company to exploit the benefit of falling interest rates. This is achieved by setting an upper limit (or cap) on the floating interest rate. If that limit is exceeded, the company will be fully compensated by the bank. The company pays a cash premium for the cap up front. The closer the cap levels to the current interest rate, the more expensive the option. Interest Rate Collar An interest rate collar is an option that affords the company protection against a downward movement of rates while still allowing the company to exploit the benefit of increasing interest rates. The collar is used when a company does not want to pay the full premium for a cap. The company can negate some of the cost by selling the bank an interest rate floor, which can totally or partially offset the cost of the cap. The company benefits from falling interest rates until the floor level is reached. The company is still protected from an adverse rise in rates above the cap level. Therefore a range or 'collar' is created and the company will never pay a lesser interest rate than the floor rate nor a greater interest rate than the cap rate. Interest Rate Swap This product allows you to swap the interest rate basis of an asset or liability from a floating rate to a fixed rate or vice versa. This is an off-balance sheet instrument involving no exchange of principal amounts at any stage.

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