ANALYSIS OF CASH AND CASH EQUIVALENTS

2019 2018

Cash at banks and call deposits and balances with

custodians 837.2 566.4

TOTAL 837.2 566.4

Reconciliation with the balance sheet:

Amounts shown in the balance sheet

Cash at banks 249.4 196.9

Deposits with banks and other financial

institutions 12,528.0 12,496.7

12,777.4 12,693.6 Less: Amounts with original maturities beyond

three months (11,940.2) (12,127.2)

Cash and cash equivalents in the statement of

cash flows 837.2 566.4

43 -18. FINANCIAL RISK MANAGEMENT

(a) Investment management and control

The day-to-day management of the Fund is the responsibility of the Treasurer who is appointed by the Director of Accounting Services under Fund Rule 5(4). The investment functions are the responsibility of the Board of Control which formulates the investment strategies of the Fund within the investment framework approved by the Financial Secretary. All sums considered by the Board to be surplus to the normal cash requirements of the Fund may at the direction of the Board be invested by the Treasurer as well as external investment managers who are appointed by the Board with the approval of the Financial Secretary.

The Fund’s investment objective is to maximise the recurrent and capital returns on the Fund assets and at the same time observe the principle of prudence.

Each year the Board approves an annual investment plan consistent with the Fund’s investment objective. The investment performance of the Fund is then monitored through the Investment Sub-committee which meets on a quarterly basis to review investment reports prepared by the Treasurer and to interview the Fund’s external investment managers.

The investment management and control of the Fund are set out in a documented risk management and investment strategy and reviewed on a regular basis by the Board.

(b) Market risk

Market risk is the risk that changes in market variables such as equity prices, interest rates and currency exchange rates may affect the fair value or cash flows of a financial instrument.

(i) Equity price risk

Equity price risk is the risk of loss arising from changes in equity prices. The Fund’s investments in equity securities are subject to the equity price risk inherent in all equity securities i.e. the value of holdings may fall as well as rise.

As at 31 August 2019, the equity securities were included in securities as shown in note 4. The risk is primarily addressed through diversification of investment portfolio in accordance with a documented risk management and investment strategy, and the Fund monitors the risk on a continuous basis.

It was estimated that, as at 31 August 2019, a 10% increase/decrease in the market bid prices of the equity securities, with all other variables held constant, would decrease/increase the net realised and revaluation losses recognised in the reserve fund for the year by HK$5,088.2 million (2018: increase/decrease the net realised and revaluation gains by HK$5,162.1 million).

(ii) Interest rate risk

Interest rate risk refers to the risk of loss arising from changes in market interest rates. This can be further classified into fair value interest rate risk and cash flow interest rate risk.

Fair value interest rate risk is the risk that the fair value of a financial instrument will fluctuate because of changes in market interest rates. Since a substantial portion of the Fund’s debt securities and all of its deposits with banks and other financial institutions bear interest at fixed rates, their fair values will fall when market interest rates increase. Investments in debt securities are made in accordance with a documented risk management and investment strategy, and the Fund monitors the fair value interest rate risk on a continuous basis.

It was estimated that, as at 31 August 2019, a 100 basis points increase/decrease in interest rates, with all other variables held constant, would increase/decrease the net realised and revaluation losses recognised in the reserve fund for the year by HK$1,276.9 million (2018: decrease/increase the net realised and revaluation gains by HK$1,341.5 million). As regards deposits with banks and other financial institutions, since they are all stated at amortised cost, their carrying amounts will not be affected by changes in market interest rates.

Cash flow interest rate risk is the risk that future cash flows of a financial instrument will fluctuate because of changes in market interest rates. The Fund does not have a significant exposure to cash flow interest rate risk because only a small portion of its debt securities bear interest at rates determined by reference to market interest rates.

(iii) Currency risk

Currency risk is the risk that the fair value or future cash flows of a financial instrument will fluctuate due to changes in currency exchange rates. The Fund’s investments denominated in foreign currencies are exposed to currency risk. The Fund only makes investments denominated in Hong Kong dollar, US dollar, Renminbi and currencies of countries whose foreign currency long-term debt has a high credit rating. The Fund’s exposure to currency risk is handled in accordance with a documented risk management and investment strategy, and the Fund monitors the risk on a continuous basis.

45

-The net exposure to each currency at the reporting date arising from recognised assets and liabilities after taking into account the effect of forward currency contracts is shown below:

2019 2018

Hong Kong dollar 39,663.0 40,521.3

US dollar 29,298.9 28,307.5

Euro 6,315.0 5,925.6

Renminbi 3,958.3 3,910.7

Japanese yen 3,890.3 4,334.7

Pound sterling 2,339.4 2,522.2

Others 4,795.6 3,800.9

90,260.5 89,322.9

It was estimated that, as at 31 August 2019, with all other variables held constant:

 a 0.5% increase/decrease in the exchange rate of US dollar against Hong Kong dollar would decrease/increase the net realised and revaluation losses recognised in the reserve fund for the year by HK$146.5 million (2018: increase/decrease the net realised and revaluation gains by HK$141.5 million);

 a 10% increase/decrease in the exchange rate of Pound sterling against Hong Kong dollar would decrease/increase the net realised and revaluation losses recognised in the reserve fund for the year by HK$233.9 million (2018: increase/decrease the net realised and revaluation gains by HK$126.1 million based on a 5% increase/decrease in the exchange rate. The change in assumption used in the sensitivity analysis was due to higher fluctuation of this currency against Hong Kong dollar after 31 August 2019); and

 a 5% increase/decrease in the exchange rates of other currencies against Hong Kong dollar would decrease/increase the net realised and revaluation losses recognised in the reserve fund for the year by HK$948.0 million (2018: increase/decrease the net realised and revaluation gains by HK$898.6 million).

(c) Credit risk

Credit risk is the risk that an issuer or a counterparty will cause a financial loss to the Fund by failing to discharge an obligation. Cash at banks, deposits with banks and other financial institutions, debt securities, derivative financial instruments, and receivables and other assets are potentially subject to credit risk. The Fund selects issuer or counterparty with good credit standing, strong financial strength and sizeable capital. The Fund also limits the individual exposure, in accordance with a documented risk management and investment strategy, and monitors credit risk on a continuous basis. Hence, the Fund does not have significant exposures to or concentration of credit risk, and the credit risk of these financial assets is considered to be low.

While the financial assets measured at amortised cost are subject to the impairment requirements, the Fund has estimated that their expected credit losses are immaterial and considers that no loss allowance is required.

The maximum exposure to credit risk at the reporting date without taking account of collateral held or other credit enhancements, if any, is shown below:

2019 2018

Cash at banks 249.4 196.9

Deposits with banks and other

financial institutions 12,528.0 12,496.7

Debt securities 26,467.4 24,633.1

Derivative financial instruments 61.3 45.3

Receivables and other assets 558.5 738.0

39,864.6 38,110.0 The credit quality of cash at banks, deposits with banks and other financial institutions and debt securities, analysed by the ratings designated by Moody’s or their equivalents, at the reporting date is shown below:

2019 2018

Cash at banks and deposits with banks and other financial institutions, by credit rating

Aa1 to Aa3 2,426.2 3,598.1

A1 to A3 10,351.2 9,095.5

12,777.4 12,693.6

47

-2019 2018

Debt securities, by credit rating

Aaa 4,066.8 5,037.5

Aa1 to Aa3 8,035.5 7,355.7

A1 to A3 12,475.7 10,548.7

Baa1 to Baa3 1,869.3 1,654.9

Ba1 or not rated 20.1 36.3

26,467.4 24,633.1

(d) Liquidity risk

Liquidity risk is the risk that the Fund will encounter difficulty in meeting obligations associated with financial liabilities. The Fund monitors the liquidity requirements on a continuous basis and maintains a level of short-term deposits and cash to pay withdrawals by ex-contributors as necessary. Hence the Fund does not have significant exposures to liquidity risk.