Summary of accounting policies EC

General information

Dutch Fund for Climate and Development: Land Use Facility: In 2019, the Dutch Government awarded a tender to manage the Dutch Fund for Climate and Development (DFCD) to the consortium of FMO, Stichting SNV Nederlandse Ontwikkelingsorganisatie, Stichting Het Wereld Natuur Fonds-Nederland, and Coöperatief Climate Fund Managers U.A. (through Climate Investor Two). FMO is the lead partner in the DFCD consortium and responsible for the management of the DFCD’s Land Use Facility (LUF, the Program).

Under the EFSD+ program of the European Commission (EC), a proposal (“DFCD Aya”, or “Aya”) was positively advised by the EC Operational Board to top up the Program with a loan/ contribution from FMO (‘FMO-A’, total up to €240 million) on a commitment basis, of which €105 million is to be guaranteed under the EFSD+ program of the EC. The facility will be provided from FMO-A to LUF. The guarantee agreement was signed in the last quarter of 2024 and the loan disbursements under the 'Aya' program have since commenced.

These financial statements relate to the EC's participation in the Program.

Basis of preparation

The financial statements have been prepared in accordance with International Public Sector Accounting Standards (IPSAS) and paragraph 11 of the EFSD+ guarantee agreement. IPSAS 41: Financial Instruments is applied to account for the financial guarantees within the Program. The EC has prepared its own guidance on applying IPSAS 41 to financial guarantees under EFSD+ guarantee agreements, and this guidance has been applied in the preparation of the financial statements.

The EC’s exposure to the Program is not carried through a specific legal entity, although it has similar reporting obligations. As there is no reference to a specific legal entity in the financial statements, these financial statements relate only to the EC’s exposure to the Program. A separate technical assistance subsidy is provided by the EC for the Program, however this is not covered in the financial statements.

The EC is entitled to a guarantee fee for its participation in the program. In accordance with the EFSD+ agreement, the guarantee fee started accruing from October 18, 2024.

As the financial statements represent the EC's participation in the Program, no current or deferred tax implications are recognized for the financial guarantee or the guarantee fee.

The annual financial report is prepared on the 'going concern principle'. EC has committed to cover part of the losses of a part of the Program as contributor and has not given any indications that the Agreement of their participation should be terminated before the agreed term. EC's participation in the Program is not comparable to a legal entity in the sense that it would have an impact on the capital or liquidity position.

These financial statements have been prepared under the historical cost convention except for:

The initial measurement of financial guarantee liabilities which is based on fair value;
The determination of the ECL allowance for financial guarantee contracts.

All amounts stated in tables are in € x 1,000 unless stated otherwise.

Significant estimates and assumptions and judgements

In preparing the financial statements, management is required to make estimates and assumptions affecting reported income, expenses, assets, liabilities and disclosure of contingent assets and liabilities. Use of available information and application of judgment is inherent to the formation of estimates. Although these estimates are based on management’s best knowledge of current events and actions, actual results could differ from such estimates and the differences may be material to the financial statements. The most relevant estimates and assumptions relate to:

The valuation of financial assets / liabilities.
The determination of the ECL allowance for financial guarantee contracts.

Foreign currency translation

The euro is used as the unit for presenting the financial statements. All amounts are denominated in thousands of euros unless stated otherwise. Foreign currency transactions are translated to euro at the exchange rate prevailing on the date of the transaction. At the balance sheet date, monetary assets and liabilities are reported using the closing exchange rate. Non-monetary assets that are not measured at cost denominated in foreign currencies are reported using the exchange rate that existed when fair values were determined.

Offsetting financial instruments

Financial assets and liabilities are offset and the net amount is reported in the balance sheet when there is a legally enforceable right to offset the recognized amounts and there is an intention to settle on a net basis, or realize the asset and settle the liability simultaneously.

Fair value of financial instruments

Fair value is the price that would be received when selling an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date. When available, the fair value of an instrument is measured by using the quoted price in an active market for that instrument. If there is no quoted price in an active market, valuation techniques are used that maximize the use of relevant observable inputs and minimize the use of unobservable inputs.

Amortized cost and gross carrying amount

The amortized cost ("AC") of a financial asset or financial liability is the amount at which the financial asset or financial liability is measured on initial recognition minus the principal repayments, plus or minus the cumulative amortization using the effective interest method of any difference between that initial amount and the maturity amount and adjusted for any expected credit loss allowance. The gross carrying amount of a financial instrument is the AC of a financial instrument before adjusting for any expected credit loss allowance.

Financial guarantee contract - Receivable leg

The receivable legs of financial guarantee contracts relate to guarantee fees to be received over the life of the financial guarantee contracts, recognised in conjunction with the financial liabilities relating to financial guarantee contracts (see section below). Future guarantee fee receipts are discounted at a rate based on the cost of funding of FMO, as the guaranteed party.

The impact of discounting the projected guarantee fees is unwound on each reporting date with the corresponding adjustments being recorded in "Unwind of time value of money" in the statement of financial performance. The value of the receivable leg derived from financial guarantee contracts denominated in foreign currencies is measured based on the exchange rates on the date of initial recognition.

Financial guarantee contract - Payable leg

Initial recognition and measurement

A financial liability is recognized to reflect the estimated obligations arising from the guarantee contracts issued by the Program, specifically for the EC's tranche. Initial recognition occurs once the financial guarantee contract becomes effective. Each financial guarantee liability is initially recognised at fair value.

The guarantee fees earned by the EC contain a concessional element and as such are not representative of an arm's length fee from which to derive an initial fair value. In accordance with IPSAS 41 and the EC's accounting guidance, a proxy guarantee fee is to be applied in estimating an arm's length initial fair value. For this purpose, the gross guarantee before accounting for the fee reduction between the EC and FMO is considered a reasonable proxy for an arm's length guarantee fee.

The guarantee fees arising out of the guarantee contracts are not paid upfront but in arrears. In accordance with the EC's accounting guidance, the projected future guarantee fees are present valued in order to derive an estimate of the total guarantee fee on day 1. Due to uncertainty in forecasting the long-term deployment of the guarantee over the life of the Program, forecasted fees are based on covered contracts in place at the reporting date and projected covered instruments beyond the reporting date. The discount rate applied is based on the FMO cost of funding plus a base rate (SOFR), as the guaranteed party.

Financial guarantee liabilities derived from financial guarantee contracts denominated in foreign currencies are measured based on the exchange rates on the date of initial recognition.

Subsequent measurement

The initial value of each financial guarantee liability is amortised over the life of the financial guarantee contract using the straight-line method. Amortisation is recognised in profit and loss in the period to which it relates, and is recorded as other revenue from financial guarantee contracts in the statement of financial performance. In addition, the carrying value of the financial guarantee liability is measured as the higher of:

The initial fair value of the financial guarantee liability less accumulated amortisation, and
The expected credit loss associated with the financial guarantee.

Financial guarantee contracts - Expected credit loss

As a part of the higher-of assessment for subsequent measurement, the Program estimates expected credit losses on financial guarantee contracts in accordance with the impairment requirements of EAR 11. ECL estimates for the guarantee are obtained by looking through to the ECL associated with the underlying covered instruments, and adjusting for first loss buffers available to the Program.

ECL allowance reflects unbiased, probability-weighted estimates based on loss expectations resulting from default events over either a maximum 12-month period from the reporting date or the remaining life of a financial instrument. The method used to calculate the ECL allowances for Stage 1 and Stage 2 assets are based on the following parameters:

PD: the Probability of Default is an estimate of the likelihood of default over a given time horizon. The Program uses an scorecard model based on quantitative and qualitative indicators to assess current and future clients and determine PDs. The output of the scorecard model is mapped to the Moody’s PD master scale based on idealized default rates. For IFRS 9 a point in time adjustment is made to these PDs using a z-factor approach to account for the business cycle;
EAD: the Exposure at Default is an estimate of the exposure at a future default date, taking into account expected changes in the exposure after the reporting date, including repayments of principal and interest, scheduled by contract or otherwise, expected draw downs and accrued interest from missed payments;
LGD: the Loss Given Default is an estimate of the Program's loss arising in the case of a default at a given time. It is based on the difference between the contractual cash flows due and any future cashflows that the Program would expect to receive;
Z-factor: the Z-factor is a correction factor to adjust the client PDs for current and expected future conditions. The Z-factor adjusts the current PD and PD two years into the future. GDP growth rates per country from the IMF, both current and forecasted, are used as the macro-economic driver to determine where each country is in the business cycle. Client PDs are subsequently adjusted upward or downward based on the country where they are operating.

Macro-economic information

In addition to the country-specific Z-factor adjustments to PD, the Program applies probability-weighed scenarios to calculate final PD estimates in the ECL model. The scenarios are applied globally, and are based on the vulnerability of emerging markets to prolonged economic downturn. The scenarios and their impact are based on IMF data and research along with historical default data in emerging markets.

The three scenarios applied are:

Positive scenario: Reduced vulnerability to an emerging market economic downturn;
Base scenario: Vulnerability and accompanying losses based on the Program's best estimate from risk models;
Downturn scenario: Elevated vulnerability to an emerging market economic downturn.

Guarantee-specific impairments

In some circumstances, such as significant increases in credit risk, guarantee-specific impairments can provide a better estimate in the Program's portfolio. The following steps are taken which serve as input for the Financial Risk Committee (FRC) to decide about the specific impairment level:

Calculate probability weighted expected loss based on multiple scenarios
Based on these probability weights, a discount curve is generated and the discounted cashflow (DCF) model is used to determine the percentage to be applied on the outstanding amount of a guarantee.

Staging criteria and triggers

No material significant increase in credit risk since origination

All guarantees which have not had a significant increase in credit risk since contract origination are allocated to Stage 1 with an ECL allowance recognized equal to the expected credit loss over the next 12 months.

Significant increase in credit risk

For these guarantees, a loss allowance needs to be recognized based on their lifetime ECL. The Program considers whether there has been a significant increase in credit risk of an asset by comparing the lifetime probability of default upon initial recognition of the contract against the risk of a default occurring on the asset as at the end of each reporting period. This assessment is based on the following items:

The fact that an early warning signal has triggered financial difficulty following a transfer to the watchlist;
The fact that the financial asset is 30 days past due or more on any material obligation to the Program, including fees and excluding on charge expenses (unless reasonable information and supportable information is available demonstrating that the client can service its debt).

Definition of default

A guarantee is considered in default when the following occurs:

Based on a credit risk deterioration from financial distress in the portfolio or any other material adverse development, the FRC decides on a specific impairment on an individual basis;

Guarantee calls

Calls made by the entrusted entity under the financial guarantee contract will be recognised as an expense in the period they occur. They do not reduce the value of the financial guarantee liability.

Contributor's resources

Accumulated surplus / deficit

The accumulated surplus / deficit consist of the part of the annual results that the Program accumulates over the life of the Program.

Revenues returned to EC

Revenues returned to EC represent guarantee fees paid towards the EC. The payments represent returns of the EC's economic interest in the program and are reflected as a deduction in contributor's resources.

Financial guarantee contract fee subsidy

"Financial guarantee contract fee subsidy" represents the estimate of the concessional amount underlying each financial guarantee contract and is based on the difference between the initial fair value of the financial guarantee liability and the initial value of the guarantee fee receivable from the entrusted entity. The expense is recognised directly in profit and loss at the point of initial recognition of each financial guarantee contract.