FC 104/13 |
|
FC 104/13 |
Hundred-and-fourth Session |
15-19 September 2003 |
Split Assessments |
Annex A
SPLIT ASSESSMENT FAQS – FREQUENTLY ASKED QUESTIONSAnnex B
Alternative Budget Presentation and Euro/US Dollar Rate of Exchange
1. This document is the most recent in a series which has been produced to support the Finance Committee’s extensive deliberations on the protection of the approved programme of work from exchange rate fluctuations, focusing on the proposal for split assessments.
2. To assist those Members new to the Committee, the following references are provided to the five previous document prepared on this subject1.
3. Although the Finance Committee has not completed its deliberations, the following general conclusions have been reached as reiterated by the Council at its Hundred and Twenty-fourth Session in June 2003:
4. Furthermore, the following view, reflected in expert advice received by the Finance Committee, is shared by many Council members and endorsed by the majority of the Finance Committee members:
5. This document responds to the most recent request of the Finance Committee to prepare an additional methodology that provides information on the impact of exchange fluctuations. Also, a “Frequently Asked Questions” paper (Annex A) is attached, which responds to the Council’s suggestion that additional general clarifications be provided on the impact of the proposal both on the Secretariat and on the Membership5.
6. The Split Assessments document examined at the May 2003 Finance Committee session outlined a proposed approach for the budget presentation and Euro/US Dollar rate of exchange and compared it to the current methodology6.
7. In that proposal, the fundamental difference from the current methodology was the elimination of the effect on assessed contributions of the budgeted exchange rate since total assessments would be approved as absolute amounts of US dollars and euros. The exchange rate would be updated biennially on 1 January following approval of the budget (based upon the average UN official rate for the just completed biennium). The budgeted exchange rate would be utilised in the calculation of the base budget to be used for comparison to expenditure in Statement IV of the accounts and in the preparation of the budget for the following biennium.
8. Annex B outlines an alternative approach for presenting the budget and adopting the Euro/US Dollar rate of exchange which provides additional detail on the impact of exchange fluctuations between biennia, as requested. Annex B also includes the current approach and the Secretariat’s original proposal for comparative purposes.
9. The fundamental difference with this alternative method is that the budget rate would be determined in advance of the Programme of Work and Budget document preparation which would allow for separate identification of the impact of the new budget rate (either a gain or loss) on the proposed budget. This exchange rate effect would be shown in a summary table (by Chapter or Major Programme) in the Resources (ex. Budgetary Framework) section of the document. A sample of the proposed table is shown below (figures are for illustrative purposes only), in which the impact of the programme change, the cost increases, and the exchange rate are all shown separately.
10. The detailed programme budget would continue to be shown at the current budget rate but each table produced at the lowest level of detail would now include the exchange rate effect on the programme in the same way as cost increases are shown today. The sample table below demonstrates the approach.
| Programme Entity | 2002-03 Programme of Work | RG
Programme Change |
RG 2004-05 Programme of Work | ZRG Programme Change | ZRG 2004-05 Programme of Work | |
| 2.2.0.A1 | Food Insecurity and Vulnerability Information for Better Policy Targeting (FIVIMS) | 0 | 3,835 | 3,835 | (75) | 3,760 |
| 2.2.0.P1 | World Food Summit and Millennium Development Goals Monitoring and Action | 0 | 1,641 | 1,641 | (54) | 1,587 |
| 2.2.0.S1 | Servicing the Committee on World Food Security | 0 | 524 | 524 | 0 | 524 |
| Total | 0 | 6,000 | 6,000 | (129) | 5,871 | |
| Cost Increases | 221 | 217 | ||||
| Effect of change in budget exchange rate from €1=US$ 0.880 to US$ 1.150 |
931 |
911 | ||||
| Total – recosted | 7,152 | 6,999 | ||||
11. This alternative methodology still eliminates the effect on split assessed contributions of the budgeted exchange rate since total assessments would be approved as absolute amounts of US dollars and euros. However, unlike the original method proposed by the Secretariat, this approach will result in a new consolidated figure in US dollars for the Appropriation which will include the impact of the exchange rate. The budget would be approved by Chapter at the new budget rate.
12. As noted above, under this methodology the budget rate would need to be established in advance of the document preparation, which means by early July of the Conference year. Options for adopting the budget rate include changing to a one or two year moving average or establishing a nominal rate in advance of the PWB. The Secretariat proposes establishing a nominal rate in advance of the PWB, specifically by adopting as the new budget rate the blended or average forward rate for two years on 1st July of the Conference year.
13. This approach has the advantage that the full PWB document will portray a budget at the exchange rate which is intended to be used in its adoption. This is unlike the current method where selection of the budget rate is left until the day of the Conference thus immediately making obsolete the numeric content of the PWB document. The “alternative proposed approach” avoids this weakness and would be possible because the exchange rate would no longer have any effect on the amounts of the assessed contributions split between US dollars and Euro.
14. The draft of the appropriation resolution for adoption by the Conference for 2004-05 under a split assessment strategy using the alternative methodology would have the following features:
15. It is critical that the Committee make a decision at its current session upon what it wishes to recommend to the Council on this matter. The PWB has been prepared in a manner which would allow the old or new methods to be applied, but the Council needs clear guidance from its expert Committee in order for it to arrive at is own decision.
16. Given the expressed view of the Council that the approved Programme of Work and Budget should be protected to the extent possible from the effects of the fluctuating exchange rates;
17. Acknowledging the view of the Cour des Comptes (FAO’s External Auditor at the time) wherein they indicated the potential use of split assessments as the means of protecting the Programme of Work from exchange rate fluctuations;
18. Accepting the expert advice from an internationally recognized accounting firm to the effect that split assessment has the strong advantage of providing protection to FAO’s programme of work in the long run, and is, therefore, the single most effective hedging strategy for FAO;
19. Fully recognizing that this passes the risk of exchange losses and gains back to the membership where it had been prior to the 1994-95 PWB; but
20. Noting that split assessments reduces the range of currency risk variations for the vast majority of the Membership;
21. Taking into account the points raised by the Finance Committee and its Members at their last session;
22. the Director-General recommends that split assessment be adopted as the means by which the approved Programme of Work and Budget would be protected from the effects of the fluctuating exchange rates and by which increased financial stability would be brought to the Organization. The Director-General also recommends adoption of the alternative methodology described in the paper as this best takes into account the concerns of some Members.
23. Currently, the budget is approved in US dollars and Members are assessed in US dollars. Under split assessment, the budget would still be developed in US dollars but the approved amount would be split between US dollars and Euros. Members liability to the Organization would be stated as two amounts – one in each currency.
24. FAO spends a high proportion of its budget in Euros (e.g. 44% in 2002). Because it receives all of its assessed contributions in US dollars, it has to buy Euro to meet those Euro expenditures. Any such purchase presents the possibility of an exchange variance (i.e. either a loss or a gain) between the rate budgeted and the rate actually achieved. Split assessment would allow the Organization to match income to its expenditure in its two major operational currencies and hence largely avoid the need to purchase Euro, thus eliminating the risk.
25. There was no problem for the period from inception up to the early 90’s because on the day that the Conference voted the programme budget, it also revised the budget rate to the spot rate on that day and accepted the consequences that had for the budget level – in other words, it meant that if the assessed contributions went up due to fluctuation in the exchange rate, the Membership automatically accepted the increase – and obviously the same was true if the assessed contributions went down.
26. Then the era of Zero Nominal Growth (ZNG) budgets came in. What was particular about the ZNG strategy was that the budget is pre-established as an absolute amount during the negotiation process and no adjustment is made on the day the budget is adopted for any change in the exchange rate. In effect, this strategy has passed the change in exchange rate variances between one biennium and the next away from the Membership to the Programme of Work. This can represent a massive risk to the Organization’s programme of work.
27. It should be clarified that this proposal has been under discussion with the Finance Committee for the last three years. Initially, the urgency was eased by the fact that the US dollar was strengthening through this period. However, the persistent weakening of the US dollar has meant that the Programme of Work now faces a massive loss of purchasing power in the shift from the budget rate for 2002-03, which was approved at €1=US$ 0.880, to the rate which needs to be approved for 2004-05. For example, if the current rate of €1=US$ 1.15 were to be approved as the budget rate, the figure for cost increases under a ZRG budget would have to be increased by approximately US$ 100 million.
28. As it is the expressed view of the Council that the approved Programme of Work and Budget should be protected to the extent possible from the effects of the fluctuating exchange rates, the issue now needs to be treated with some urgency.
29. Under split assessment, the risk of exchange losses and gains arising from the fluctuation of exchange rates between biennia returns to the Membership. Up until the introduction of the ZNG strategy all Members, including those with US dollar-based currencies, shared in carrying the burden of the loss or gain by virtue of the fact that the Appropriation was always adjusted to the spot rate on the day the Conference approved the budget.
30. Under the traditional methodology (assessment in US dollars) and ZNG budgets, all members, whose national currency is not US dollars (or US dollar-linked), are exposed to an exchange risk. Being assessed in two currencies does not double that exchange rate risk but rather diversifies the risk, and in some cases even offsets the risk. Indeed, an analysis of 74 world currencies comparing the US Dollar exchange rates since 1996 to simulated split assessment exchange rates showed that, when paying annual assessments in split currencies (Euro and US dollar), currency exchange variations decreased for 80% of the currencies analysed, thus decreasing their exchange rate risk. For one currency (Japanese Yen) the variation increased slightly (6%). The remaining group (18% of the currencies analysed) had US dollar or US dollar-linked currencies and would move from zero exchange risk to risk exposure in one currency (Euros).
31. Split assessments does not remove budgetary decision making power; rather, it is a methodology which complies with the Membership’s stated objective to protect the approved programme of work and budget to the maximum extent possible from the effects of fluctuating exchange rates. Thus while the Membership would not be deciding upon how to handle exchange rate variances, it would have to decide on the level of cost increases to be funded (if any) and, more importantly, the extent of programme increases or decreases. For example, a ZNG budget under the split assessment methodology would be stated in two pre-established absolute amounts (a US$ amount and a Euro amount) at a level which absorbs cost increases. Any exchange losses or gains between biennia arising from the fluctuation of US dollar/Euro exchange rates would be automatically handled by the split assessment and effectively be borne by the Membership.
32. No, the absolute Euro amount and US Dollar amount of the split assessment remain the same independent of the budget rate adopted. Options for adopting the budget rate include not changing the rate at all between biennia (a common practice in the UN system), changing to a one or two year moving average, establishing a nominal rate in advance of the PWB (e.g. the blended or average forward rate for two years on 1st July of the Conference year), or continuing to rely on the spot rate. As, however, under split assessments, the Organization’s Euro requirements are paid by members in Euros, the exchange rate effect does not come into play. In effect, the overall US dollar figure for the assessed contributions (which does depend on the exchange rate adopted) becomes a nominal figure. The actual cost to each Member in terms of their own currency will, as it always has in the past, depend upon the rate of exchange between the Member’s currency and the assessed currency or currencies.
33. Most agencies assess in a single currency which is usually the functional currency of the Organization (e.g. US dollars for the New York based agencies and Swiss Francs for the Geneva based agencies), and then handle the remaining risk by hedging. It should be noted that, almost without exception, these agencies face a much lower currency risk as their second most significant currency tends to be a very low proportion of the total budget (e.g. less than 15%). Where this is not the case, (i.e. in Paris with UNESCO and with IAEA in Vienna) split assessment has been employed. It should be noted that FAO is unique in the high proportion of its budget which is incurred on a single currency which is NOT its currency of assessment (i.e. 44% in Euro in 2002) – more than even those agencies which do already use split assessment.
34. Yes it has. The Cour des Comptes (FAO’s External Auditor at the time) in its advice to the 99th session of the Finance Committee indicated “the importance of reviewing the functional currency of the Organization and the means of protecting the Programme of Work from exchange rate fluctuations, noting, in particular the potential use of split assessments in this regard”. The subsequent report KPMG, one of the major internationally recognized accounting firms, advised explicitly that “This option (split assessment) has the strong advantage of providing protection to FAO’s programme of work in the long run, so we believe the split assessment is the single most effective hedging strategy in FAO”. No alternative strategy has been found which meets the Council’s concern that the approved Programme of Work and Budget should be protected to the extent possible from the effects of the fluctuating exchange rates.
35. In theory, the forward purchase can provide protection of the budget during a biennium. Given the biennial Appropriation, it is viable to enter into a contract and buy forward our Euro needs for the entire biennium. For example, we did this for 2002-03 and hence are still buying our Euros month by month at a rate of €1=US$ 0.880 - thus effectively protecting the programme of work throughout the current biennium and even generating gains. However, the forward contract does not provide full protection within a biennium when the forward rate is different from the budget rate, and market rates move against the forward rate. This was the case in 2000-01 when the Organization sustained some US$ 20 million in exchange losses. In addition, the current forward contract runs out at 31 December 2003 at which point we will have to start paying 30% more in dollars for the same quantity of Euro.
36. This is the nub of the problem – forward purchase cannot be applied across several biennia within the existing Financial Regulations and, even if it could, there is a limit on how far forward the market would be prepared to contract. In other words, forward purchase can be a solution during a biennium but cannot function between biennia.
37. Firstly, the SRA was NOT established under its legislation to assist protecting the programme of work against fluctuations in exchange rates between biennia. Rather it is available to collect the losses and gains on certain transactions thus enabling them to be netted off instead of impinging on the Programme of Work during the biennium.
38. In theoretical terms, the ceiling of the SRA is 5% of the effective working budget (i.e. US$ 32.6 million) which would not be sufficient to cover the currently envisaged loss of purchasing power estimated at US$ 100 million. In practical reality, the situation is worse in that the SRA currently only has a balance of US$ 15 million.
39. The SRA is not a suitable vehicle for protecting the programme or work between biennia.
40. Yes – in each biennium since the introduction of the ZNG strategy FAO has had to face the absorption of cost increases. This has been made easier by the fact that the purchasing power of the same ZNG dollar appropriation has risen in terms of Euro expenditures.
41. A sense of the benefit can be obtained from the following basic statistics. Over the ten year period, inflation in Italy has risen a cumulative 35%. However, FAO’s loss of purchasing power has been a substantial but more manageable 15%.
42. Undoubtedly yes, it is worth it. While the total costs is not yet fully determined, it is expected that the one-time programming work to develop the data warehouse environment needed as well as the revised reports for budget holders and for corporate management should not be costly. The running costs should be minor and may result in some temporary assistance to handle the extra calls for funds and reconciliation of assessments received. When set against a risk which currently could be measured as a real loss of US$ 100 million to the programme if a ZNG budget were adopted, the answer is – “Yes” it is worth it.
43. No – at least, it is not essential to pay in the two currencies as it is acceptable to pay in any convertible currency and leave it to FAO to convert the amount into the two assessed currencies. However, as already established under the current rules, FAO will convert at the market rate on 1st January of the calendar year in which the assessment is due or the rate in effect on the day the payment is made, whichever is more favourable to the Organization. As National Treasuries are likely to obtain better rates when acquiring a currency, it may be more economical to pay in the two currencies of assessment.
44. As indicated above – yes, so long as the currency in question is fully convertible into US dollars and/or Euro.
45. This entire proposal is about protecting the Programme of Work to the extent possible from the effects of the fluctuating exchange rates. If it is successful in this regard, all Members will benefit from the introduction of split assessment due to the stability it will bring back to the Organization’s work.
46. Furthermore, most Members will experience reduced currency exchange variations due to the diversification of risk among two currencies. Finally, although a small group of Members, whose currency is the US dollar or is a currency linked to the US dollar, will face exchange rate variations for the first time since the introduction of the ZNG strategy, even they will face both gains and losses over time and hence this proposal does not result in a “winners and losers” scenario among the Membership.
| Step | Current Approach | Proposed Approach
(FC 102/18) |
Alternative Proposed Approach |
| SPWB(May FC/PC – June CL) | Programme proposals are stated in US$ at constant cost using the same exchange rate for the base and the proposal.An estimate of the potential exchange rate effects is provided in the Resources (ex. Budgetary Framework) section of the document. | No change. | No change. |
| Full PWB as proposed(Sept FC/PC,Nov CL and Nov C) | Programme proposals are shown with separately identified cost increases at the lowest programme level. All amounts are stated in US$ with the exchange rate the same for the base and the proposal. | No change except that an estimate of the total appropriation and total Programme of Work split between Euro and US dollars would be provided. | Establish the budget exchange rate based on a pre-agreed methodology (e.g., the blended or average forward rate for two years on 1st July of the Conference year); revise the proposal by Chapter at the new budget exchange rate, separately identifying the currency effect in US dollar terms.
Detailed programme proposals would be shown at the current budget rate separately identifying: a) cost increases; and b) exchange rate effect, both at the lowest level of programme detail. Data on the split between Euro and US dollars of the total appropriation and total Programme of Work would be provided. |
| PWB Approval (Nov C) | Budget as shown in the Appropriation Resolution is modified and approved at the Chapter level at an approved budget rate of exchange based on either the rate achieved through forward purchase or the spot rate on the date of adoption. | Budget as shown in the Appropriation Resolution is not amended but approved at the Chapter level at same rate used in the base. The Resolution would include a statement of the absolute amount of Euros and US dollars required. The Resolution would provide that the rate to be used in the next biennium would be the average UN rate for the current biennium. | Budget as shown in the Appropriation Resolution is not amended for exchange rate effect but approved at the Chapter level at new budget exchange rate as determined above for the full PWB document. The Resolution would include a statement of the absolute amount of Euros and US dollars required. |
| Restatement of budget following approval | Immediately following the
Conference, the budget is revised at the programme level to reflect the amounts
approved by Chapter at the approved budget rate of exchange.
The revised budget (at the approved budget rate of exchange) is utilised in the subsequent budget as the base. |
At 1 January of the new biennium,
the programme level budget base would be revised to reflect the approved budget
rate (average UN rate for the just completed biennium). The resulting budget
would be utilised in Statement IV of the Financial Statements. The revised budget (at the approved budget rate of exchange) is utilised in the subsequent budget as the base. |
No adjustment required as the
Appropriation would have been approved at the applicable budget rate and the
same data will be used for Statement IV of the Financial Statements. The approved budget is utilised in the subsequent budget as the base. |
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1 These documents can be found on FAO’s website by selecting the relevant meeting number from the bottom of the following page: http://www.fao.org/UNFAO/Bodies/fc/fc-e.htm
2 CL 124/REP, paragraph 93
3 idem. paragraph 94
4 idem. paragraph 93
5 idem. paragraph 96
6 FC 102/18, paragraph 21