Approach to Risk
The CEFC Board is ultimately responsible for overall business performance, including oversight of risk management, assisted by the Board Audit and Risk Committee.
At the executive level, the CEO has established an Executive Risk Committee, Executive Investment Committee, Joint Investment Committee for the Clean Energy Innovation Fund (with ARENA) and an Asset Management Committee. Each contribute to effective risk management.
The CEFC has established an enterprise-wide Risk Management Framework to monitor and manage all material risks, including strategic, investment and financial risks, operational risks, and regulatory and compliance risks. Consistent with section 68(c) of the CEFC Act, the Risk Management Framework sets out the manner in which risk is managed for the CEFC’s investments and for the CEFC itself.
The Risk Management Framework, along with the CEFC Investment Policies, embeds the active identification, management and mitigation of risks into all areas of the CEFC’s investment functions, portfolio management and broader business operations.
The CEFC’s primary activity is its investment function, and therefore our central focus is on managing all types of investment risk and associated decision-making processes.
An investment strategy that is too risk-averse would prevent the CEFC from fulfilling its public policy purpose, while an approach that is too risk-tolerant could lead to excessive capital losses. Balancing risk return and public policy outcomes are factors that are considered as part of each investment decision and ongoing management of the portfolio.
The CEFC Investment Risk team reviews and assesses credit and other risks associated with each proposed investment, independent of the investment origination team. Post-investment, the Portfolio Management team manages and reviews the performance of investments, with prompt remedial action taken where necessary.
Analysing and Mitigating Investment Risk
The CEFC has established processes for screening, reviewing and approving investments to ensure that there are appropriate controls and ‘checkpoints’ for risk, before a given investment proposal is approved and documented. This is further underpinned by a thorough process of due diligence:
- Investment proposals must be commercially viable, with an acceptable risk/return profile.
- Standard techniques are employed in risk identification, analysis and mitigation, as part of any investment analysis.
- Where unfamiliar or unique risks are identified, the progression of the investment may be paused while additional due diligence or market-specific research is undertaken.
- The CEFC typically seeks the lowest possible risk position in the capital structure, particularly where the investment itself involves heightened levels of risk, as a protection of the CEFC investment against underperformance.
- If the CEFC lends to projects that sell power on an uncontracted or ‘merchant’ basis, the loans are sized and structured in a prudent manner. Overall merchant risk exposure is also capped at the portfolio level.
- The CEFC applies a range of conditions to an investment to mitigate an identified risk, including accelerated repayments of capital in certain events.
- The CEFC has a strong preference for investing alongside private sector capital providers, enabling investment risks to be shared.
- For debt investments, the CEFC typically holds first ranking security against the borrowing entity, the project, or the equipment finance.
- The CEFC spends considerable effort analysing the creditworthiness of borrowers, the technology, the business case of the proposal, the security on offer, and the CEFC’s potential exposure in the event that an investment may not achieve expectations.
- The CEFC seeks portfolio diversification to avoid excessive exposure and concentration of risk, including: specific technologies; higher risk financing structures; single entities; merchant energy price risk; individual markets and geographical areas.
- The CEFC has a portfolio management function, with systems and process to ensure continuous monitoring of investments and early detection of underperformance and enable remedial action.
- Inevitably a proportion of investments will underperform and the CEFC will experience a loss. For example, in a debt default situation, the level of loss incurred by the CEFC will be determined by a number of factors, including the level of seniority that the CEFC holds in the capital structure and the value of the underlying security.