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Financial Risk Tolerance and Country Based Pooled Funds
E. Rackley, OCHA consultant
Comments to Jock Paul:
I. Executive Summary
The practices and protocols of financial risk management and mitigation across UN operations, and OCHA-managed Country Based Pooled Funds specifically, have evolved significantly since the 2005 Humanitarian Reform effort for greater aid effectiveness that led, in part, to this creation of this multi-donor funding instrument. Since then the number of CBPFs has increased dramatically, and they now serve an unprecedented number of humanitarian crises. With their consultative decision-making processes and inclusion of implementing partners (national and international NGOs), donors, and UN agencies, CBPFs are uniquely positioned to analyze risk and develop mitigation strategies to ensure the effective delivery of life-saving assistance in extremely volatile, constantly evolving emergency environments.
The purpose of this study is to foster dialogue among CBPF stakeholders around the various aspects of financial risk (appetite, tolerance and thresholds) that arise the in the CBPF context, including those stemming from third party implementing partners operating in remote areas without direct oversight. Questions pursued by the research include: To what degree does the existing CBPF architecture and its consultative management approach allow for enhanced risk sharing among partners—or are financial risks simply being transferred down the fiduciary chain of actors, with the highest risks borne by implementing partners on the ground? How do different CBPF partners perceive risk tolerance (appetite or aversion), and how do these perceptions change depending on one’s position within the fiduciary chain? Is there a shared willingness to consider an explicit risk tolerance policy—would partners agree to an acceptable amount of loss, for instance?
Salient findings include:
· Given the consultative decision-making processes of CBPFs (with multi-stakeholder Advisory Boards and Humanitarian Coordinators), the instrument offers a strong, even unique degree of collective oversight, which translates into a qualified form of risk sharing. Yet more effort can be made to identify evolving risks, improve mitigation measures, and maximize the comparative advantage of the CBPF consultative dynamic to enhance performance in the face of evolving risks as emergency needs fluctuate in country. Overall, donors realize that given the volatility of CBPF contexts, loss and leakage will occur, but are not interested in an explicit policy that quantifies acceptable loss.
· While donors appreciate the heightened risks of CBPFs in the world’s most corrupt and volatile states, they are adamant about ‘zero tolerance’ for weak risk management among fund managers and program implementers. In other words, donors are tolerant of risk but intolerant of poor risk management. They expect the same intolerance and vigilance of all partner institutions, particularly the custodian of a given CBPF. OCHA’s challenge is to raise the quality of financial risk management across all CBPFs to an equally high standard.
· Discussions of risk tolerance (appetite or aversion) are therefore important only if the risk management policies and practices in place are robust. Donors and partners concur that a well-managed, responsive fund can increase risk appetite, just as a poorly run or slow fund has the adverse effect. While useful to distinguish risk management from risk tolerance for the purposes of improving the structure and performance of CBPFs, the two concepts and behaviors are inextricable and causally linked. Without tested and effective risk management systems, discussion of risk tolerance is a pointless exercise.
· Similarly, a well-designed risk management system does not guarantee its effective application—both conceptual and operational dimensions must be robust and visibly effective. The quality of the risk management framework in place is also distinct from the operational strength of the fund itself, both of which can influence risk tolerance.
· And even where risk management systems are implemented effectively, loss can still arise--‘residual risk’. CBPF Advisory Boards work to identify risks and formulate mitigation strategies in a consultative, consensual manner, so that all partners are apprised of the risks at hand before the funds flow. Standard Operating Procedures are triggered whenever a case of residual risk arises. Many partners therefore see ‘risk sharing’ as a distraction from the emphasis on continued improvement of CBPF risk management systems, as well as the collective risk assessment work of the Advisory Boards. If all these are solid, risk-sharing considerations are moot.
· Strong local partners are essential to accessing remote populations, yet they are widely viewed as the greatest financial risk within a CBPF. How to strengthen the weakest link in a CBPF fiduciary chain? All parties stressed the importance of capacity building for local partners to improve their internal systems and reporting. “Not just local partners but equal partners should be a performance outcome of these funds,” said one. Enabling local partners to be fully accountable is linked to “our accountability to populations, not just to donors,” said another.
Recommendations include:
· For OCHA and donors: A risk tolerance policy is not only not feasible, but innocuous. Continuing to empower donors and all CBPF stakeholders with the tools and opportunities to identify and manage context-specific risks will increase risk appetite in situations of extreme urgency. This should be happening across all CBPFs when Humanitarian Coordinators issue an allocation strategy, the result of Advisory Board consultations. All risks should have been discussed ahead of any fund allocation, with clear knowledge of how risks will be managed.
· For OCHA and donors: Should CBPFs contribute to the ‘localization of aid’ and ‘national resilience’ agendas by increasing support for risk management training for local NGOs by third party service providers? Increased funding for risk management capacity training for local NGOs will balance out the perception of ‘risk dumping’ and further the localization of aid agenda, the latter an anticipated theme of the World Humanitarian Summit. OCHA’s stance is that CBPFs should enable front line responders to deliver assistance (be it national or international NGOs) and, to do that, there are systems in place to identify and assess the capacity of viable partners.
· For OCHA and donors: Consider early and midway real-time monitoring of CBPFs to identify RM vulnerabilities and strengths. Proactive monitoring and analysis that mimics the speed of operations (from proposal to allocation to delivery) as opposed to end-of-program (forensic) evaluations can improve how risk is being handled institutionally and collectively, and offer preventive corrections. Such exercises will correct flaws early, spread best practices and incentivize vigilance, transparency and communication around risk, fraud, diversion, etc.
· For OCHA, donors and implementing partners: Consider funding for capacity building in financial management for qualifying local partners, so they can meet eligibility requirements to receive CBPF funds. This is not a short-term solution to spreading risk, but it helps local partners become, eventually, equal partners. Currently INGOs may choose to limit their risk by avoiding local NGOs who are unable to meet their compliance requirements. The result is less delivery of emergency services. “The UN needs INGOs to reach national NGOs, but their [fiduciary] limitations make this impossible,” said one INGO representative.
II. Introduction
1. Funding through OCHA-managed CBPFs (i.e. Common Humanitarian Funds and Emergency Response Funds) in 2014 accounted for 2.6% of the international humanitarian response for a total of over US$453 million.[1] CBPFs routinely operate in high-risk environments with severe access restrictions due to insecurity. In this regard, remote management modalities have been increasingly adapted to provide assistance in areas deemed unsafe for UN staff while shifting responsibilities for programme delivery to local third-party implementing partners (local and international NGOs, Red Cross and civil society organizations). CBPFs are targeted towards providing effective, efficient and supplemental support to the country’s Humanitarian Response Plan and often endeavor to strike a balance between providing life-saving assistance and putting in place effective oversight mechanisms on third-party implementing partners.
II. Purpose of Study
2. The study aims to foster dialogue among stakeholders around the various aspects of financial risk (appetite, tolerance and thresholds) that arise the in the CBPF context, including those arising from third-party implementing agencies operating in remote areas without direct oversight. There is a need to create a common understanding of risk tolerance across all CBPFs to then be shared with all stakeholders. Such a common understanding would not change existing due diligence standards, but enrich partner perceptions of sharing risk as distinct from risk transfer between donors, OCHA and implementing partners.
3. The study also looks at the need for proper messaging aimed at increasing literacy in risk tolerance, and wider communications around the subject. Study findings and recommendations will feed into OCHA Funding Coordination Section (FCS) risk management policy to enhance risk management within Country Based Pooled Funds.
4. Finally, the study aims to collect and represent the diverse views of CBPF stakeholders on matters specific to risk sharing such as percentage of acceptable loss, fiduciary capacity of local partners, and how risk tolerance relates to the original objectives of the aid reform agenda of 2005. In advance of the upcoming World Humanitarian Summit and its theme of ‘nationalizing response’ (national preparedness, resiliency), these findings will help OCHA and partners develop a position on increasing national response capacity, be it self-funded or through international partnerships. Investing in national capacity is arguably in OCHA’s interest as well, with stronger risk management system across all CBPFs the desired result.
III. Methods
5. The study findings presented here issue from a comparative desk analysis of existing risk tolerance policies of relevant UN agencies, donors, Bretton Woods institutions, NGOs and the private sector. This was followed by a series of in-depth interviews with relevant donors, UN operational agencies (UNICEF, UNDP), senior OCHA staff in New York, Geneva and in CBPF countries (South Sudan, Afghanistan, etc.), international NGO partners, and some national partners. While these latter exist in several CBPF countries, the study did not have time to consult all.
IV. Growth of CBPFs and Risk Management
6. As mentioned above, CBPFs have multiplied in line with the unprecedented number of large-scale humanitarian crises today. Managing increasing levels of financial risk associated with this growth and scape of operations has resulted in two major areas of investment: protocols, procedures and safeguards to prevent financial loss and diversion (‘ex ante’), and a similarly standard procedures that are engaged once losses are suspected (‘ex post’), ideally resulting in their recovery. This study does not investigate the integrity of these risk management systems, but the state of their performance is a factor in determining the risk appetite of any CBPF.
7. In the field, CBPF management is supported by dedicated Humanitarian Financing Units (HFU) through the OCHA Country Office. Within these HFUs, Afghanistan and Somalia have also established Risk Management Units. These RMUs help stakeholders map and track financial risks, fiduciary vulnerabilities and challenges, establish common guidelines, and identify lapses in risk management procedures and protocols of participating institutions. They bring an additional level of independent oversight to help reduce the risks of such operations. In so doing, they arguably serve to increase risk awareness among donors and implementing partners.
8. Within CBPFs, remote management of operations and local implementing partners is an increasingly common, still evolving modality that carries great financial risk but whose primary dividend is access to otherwise isolated populations in danger. The fiduciary challenge of remote management is compounded in places like Syria, which has no history of non-state, third party or community organizations providing emergency relief under contract to the UN or to international NGOs. Other risk management studies have highlighted these challenges,[2] underscoring the reality that fraud occurs in high-risk settings and that some loss is to be expected when working in these environments. Donors actively participate in CBPF Advisory Boards so are well-apprised of all associated risks before funds are allocated to partners.
9. At the same time, risk management is increasingly viewed as a ‘tool for development’, a bridge towards greater national resilience and stronger local partners, with potential to increase local agency and autonomy in times of natural and man-made disasters.[3] For this reason, the study refers occasionally to ‘localization of aid’, ‘resilience’ and similar agendas which may be outside the specific mandate of CBPFs and risk tolerance but which many partners consider to be relevant, even connected.
V. Terms and challenges around risk literacy and CBPFs
10. Risk tolerance, appetite and aversion are related areas of interest that comprise the focus of this study. In their simplest form, risk attitude, appetite and tolerance are often used interchangeably to describe an organization's attitude towards risk taking—risk understood as the effect uncertainty on objectives. Risk averse, risk neutral and risk seeking are variations of these terms also be used to describe one’s risk attitude. Risk tolerance looks at acceptable/unacceptable deviations from what is expected. Risk appetite looks at how much risk one is willing to accept, and the variations across that appetite faced with specific threats or unknowns.
11. The consultative nature of CBPFs results in a qualified mode of risk sharing, attractive to the stakeholders interviewed for this study because the process mitigates the risk of bad programming decisions and large sums wasted on ineffective projects. Group decision-making is no guarantee against failure, but the domestic political pressures and accountability to which donors are subject prevent this risk pooling from providing false comfort, as donors and implementing agencies strive individually to assess the risks, potential for loss, and improve mitigation measures already in place.
12. In the humanitarian sector, where donors and the UN are under political pressure to show presence and to deliver results, as in Syria today, a higher risk appetite may be politically driven. This appetite may not be shared by CBPF implementing partners inside Syria who may be more cautious given the poor fiduciary capacity of their local partners operating remotely without oversight or strong management and reporting systems. Who then is best suited to extrapolate from these different perspectives the ‘risk tolerance level’ for that CBPF at a given time? All interviewed for this study see the Humanitarian Coordinator as the logical candidate for this role, with OCHA support, as custodian or steward of the CBPF.