Background

A new Commonwealth Government foreign exchange risk management framework came into effect from 1 July 2002. With one exception,¹ the Revised Government Foreign Exchange Risk Management Policy (the Revised Policy) applies to Financial Management and Accountability Act 1997 (FMA Act) agencies and Commonwealth Authorities and Companies Act 1997 (CAC Act) entities in the General Government Sector (GGS). The key features of the Revised Policy are:

• a general prohibition on external hedging;
• each individual entity remains responsible for managing its foreign exchange risk; and
• some entities receive budget supplementation for foreign exchange losses and are required to return foreign exchange gains.

Commonwealth financial management is currently undertaken in a principles-based regulatory environment. In addition, entity Chief Executives and other officials have broad responsibilities under the Public Service Act 1999, the FMA Act and the CAC Act.

The Revised Policy is given effect by:

• a Government Decision announced by the Finance Minister on 28 May 2002;
• a Finance Circular issued on 26 June 2002 which describes the major features of the Revised Policy; and
• Guidelines for the Management of Foreign Exchange Risk issued by Finance in November 2002, with the agreement of the Finance Minister. The Guidelines set out principles for foreign exchange risk management and the key features of the Government decision. They also incorporate principles-based guidance in relation to exposure management and controls and include prescriptive risk identification, measurement and reporting requirements.

Consistent with the Commonwealth's financial framework legislation, each entity captured by the Revised Policy is responsible for the management of its foreign exchange risks. Specifically, entities are expected to:

• implement foreign exchange risk management practices that are consistent with the Guidelines;
• provide, in a timely manner, foreign exchange information and reports requested by Finance; and
• certify to Finance that proper risk management practices, consistent with the Policy, are in place.

Finance's role relates to oversighting the implementation of the Revised Policy. At the whole of government level, this includes monitoring, analysis and reporting of foreign exchange exposures, gains and losses. Finance's role does not extend to auditing entities' compliance with the Revised Policy or detailed analysis of their risk management practices, although it is expected to review entity practices and advise Government accordingly.

Audit approach

An ANAO audit report tabled in May 2000 examined the foreign exchange risk management practices of four agencies with large foreign exchange payment exposures.²  Among other things, the audit report recommended that Finance, in consultation with relevant agencies and, as appropriate, the Government, develop an overarching Commonwealth position statement on foreign exchange risk management for agencies subject to the FMA Act.

In response to the 2000 audit report, the Government commissioned a Task Force on Commonwealth foreign exchange risk management practices. The Task Force reported to Government in July 2000. Following the report of the Task Force, further policy development was undertaken by Finance and the Department of the Treasury (Treasury). On 28 May 2002, the Finance Minister announced the Revised Government Foreign Exchange Risk Management Policy.

This current audit focused on procurement practices and contracts involving foreign currencies in four entities. It also examined the overarching implementation of the Revised Policy by Finance and GGS entities. The objectives of this performance audit were to:

• examine whether agencies are effectively managing risk in accordance with the Revised Government Foreign Exchange Risk Management Policy;
• assess the effectiveness of overall management of Commonwealth foreign exchange exposures;
• assess the adequacy of administrative arrangements for foreign exchange exposure reporting by agencies; and
• follow up agencies' progress in implementing relevant reco mmendations made in the 2000 audit report.

Audit conclusions

With regard to the four audit objectives, ANAO concluded as follows.

Effectively managing risk by adoption of the Revised Policy

The Revised Policy was to apply to FMA Act and CAC Act entities within the GGS. ANAO found that all elements of the Policy, including the Finance Circular and the Guidelines, have been applied to FMA Act entities. However, the correct procedures for consulting with, and then notifying, CAC Act entities of the Policy were not followed by some portfolio Departments. Finance has commenced action to rectify this situation. More generally, as at July 2004, Finance was preparing a Finance Circular on the processes for applying general policies of the Government to CAC Act entities.

Management effectiveness

In announcing the Revised Policy, the Finance Minister stated that the approach being adopted was the most effective way to minimise the cost to the Commonwealth of currency fluctuations. In terms of the key features of the Revised Policy, ANAO found as follows.

• The Revised Policy only permits hedging where the Finance Minister has granted an exemption from the general hedging prohibition. However, some CAC Act entities have continued to use financial derivatives to hedge foreign exchange exposures, despite not having the Finance Minister's approval to do so.³ There was also no clear guidance regarding the transition to the Revised Policy provided to entities that already had hedging arrangements in place.
• Individual entities' adoption of the Revised Policy has been patchy. For example, important procedural documentation has not been updated and/or finalised in a timely manner in three of the four entities audited. Significant variability was also found in the reliability of risk identification and measurement approaches adopted by individual entities.
• A consistent approach has yet to be adopted for calculating budget supplementation for foreign exchange gains and losses. In each of the three entities examined,⁴ ANAO found that application of the approach specified in Finance's Guidelines would have led to further returns to the Budget of $1.6 million for 2002–03. At the time of the audit, two of the three entities did not accept that Finance's Guidelines should be applied to their 2002–03 calculations. In both instances, the respective entity was calculating its budget supplementation consistent with its longstanding resource agreement with Finance, rather than adopting the approach outlined in Finance's Guidelines for the Revised Policy. In September 2004, Finance advised ANAO that it is working with the entities to clarify the position regarding the Revised Policy vis a vis the existing resource agreements.

Foreign exchange reporting

The Revised Policy requires reporting by entities to Finance of foreign exchange exposures, gains and losses, and subsequent consolidated reporting by Finance to Government. To date, there has been incomplete implementation of the reporting requirements. Finance has yet to obtain reports from all relevant entities that have exposures, gains and/or losses. In this context, Finance has undertaken to improve its reporting to Government.

Follow-up of previous audit

ANAO found that, for the significant majority of relevant recommendations from ANAO's 2000 audit report, they have been implemented, or satisfactory progress has been made on their implementation.

Recommendations and entity responses

In July 2004, Finance advised ANAO that it was going to revise parts of its Guidelines for the Management of Foreign Exchange Risk. In addition, ANAO has made five recommendations to improve the implementation of the Government's Revised Foreign Exchange Risk Management Policy.

The following general comments were made on the proposaled report of this audit.

Finance

The Department of Finance and Administration (Finance) welcomes the work undertaken by the ANAO in examining this area and its findings. Finance notes that the report identifies scope for some improvements in the notification process for CAC Act entities and enhancements in ancillary aspects of the policy, such as reporting.

Finance supports each of the recommendations made in the report.

Since the 2000 audit report on foreign exchange, Finance has:

• issued Finance Circular 2002/01 ‘Foreign Exchange (FOREX) Risk Management', setting out the Government's foreign exchange risk management policy;
• published the Guidelines for the Management of Foreign Exchange Risk Management, November 2002;
• issued Finance Circular 2004/11 ‘Unwinding hedges under the foreign exchange (forex) risk management policy', clarifying the application of the Foreign Exchange Risk Management Policy to entities that had pre-existing hedging arrangements;
• developed a Finance Circular in relation to the application of general policies of the Australian Government to bodies under the Commonwealth Authorities and Companies Act 1997 to be released in the near future;
• committed to reviewing the Guidelines for the Management of Foreign Exchange Risk to clarify a number of areas; and
• undertaken to provide an expanded report to Government that includes: 
  - the level of foreign exchange exposures; 
  - whether any agency's foreign exchange exposures have material implications for their financial health; 
  - whether there are any unusual movements in the aggregate data, and the reasons for those movements; 
  - whether the foreign exchange policy should be adjusted; and
  - proposed supplementation or return to-budget arrangements for entities' foreign exchange losses or gains.

AusAID

AusAID has read this report, noting that the recommendations are for the Department of Finance and Administration to address. AusAID liaises with Finance on a regular on-going basis regarding its management of foreign exchange risks.

Defence

Defence notes that ANAO's five recommendations are primarily recommendations for action by Finance.

Defence supports improvements to the Commonwealth's foreign exchange risk management practices, and acknowledges that agencies should identify and manage their foreign exchange exposures within the Revised Government Policy. Accordingly, Defence supports all the recommendations and undertakes to assist Finance, where required, in Finance's implementation of the recommendations.

Footnotes

1 The Australian Office of Financial Management is excluded from the arrangements of the Revised Policy.

2 ANAO Audit Report No.45 1999–2000 Commonwealth Foreign Exchange Risk Management Practices, Canberra, May 2000.

3 Those entities include the Australian Nuclear Science and Technology Organisation (ANSTO) and the National Gallery of Australia (NGA). See paragraphs 2.47 to 2.48 for further discussion.

4 The fourth audited entity does not satisfy the criteria for participating in the budget supplementation arrangements.