University of Saskatchewan

Financial Services Division (FSD)

Guidelines & Procedures

Derivatives Policy Guidelines

(The board of governors approved policy can be found at http://www.usask.ca/university_secretary/policies/index.php)

Purpose

The purpose of the Policy is to provide a framework for the use of derivative instruments in the management of foreign currency, interest rate and natural gas price risks within levels acceptable to the Board of Governors.

Risk Management Objectives

Sources of Risk

Foreign Exchange Exposure

Gains or losses can occur from changes in foreign exchange rates from the time a transaction is contemplated to when the transaction is settled.  For every $1 million in net foreign exchange exposure, a $.01 change in the exchange rate will affect annual expenses by $10,000.  The University has an exposure of between $2 and $3 million in annual net foreign exchange exposure. 

Interest Rate Exposure

Interest rate risk exists wherever there is a mismatch in the term of the debt used to finance long-term investments and the economic life of the investment.  Underlying this risk is the liquidity risk in the markets being used to seek financing.   For every $10 million of debt held in a year, a 1.0% change in the interest rate will affect annual interest expense by $100,000.  The University has an exposure of approximately $30 million in interest rate exposure.

Natural Gas Price Exposure

There is a risk that the market price of natural gas will fluctuate and that the natural gas costs will rise above the budgeted rate.  A $1.00 change in the market price of natural gas affects the annual operating budget by approximately $700,000.

Counterparty Credit Risk

Risk of financial loss can occur due to the financial failure of counterparties.

Risk Management Approach

  1. Foreign Exchange
    • The University will employ a zero cost program utilizing forward contracts or offsetting options when it is highly probable a foreign currency transaction, above the thresholds below, will occur.  Amounts below the threshold levels are managed by netting foreign currency revenues against expenses.
    • Threshold levels above which a foreign currency exposure requires protective action:
      • Single foreign currency transactions exceeding Canadian $250,000.  
      • Monthly net exposure exceeding Canadian $250,000.
  2. Interest Rate
    • The University will use interest rate swaps to mitigate the risk of rising interest rates and to reduce borrowing costs when it is highly probably borrowing will occur.
    • The financial analysis of the project being funded will include a determination of the notional value of any derivatives required.
  3. Natural Gas (NG)
    • In order to provide stability and predictability in natural gas costs, the following guideline is to be followed when purchasing  natural gas futures:
      Year 1 Year 2 Year 3 Year 4 Year 5 Year 6 Year 7 Year 8 Year 9 Year 10
      Max% 100 100 75 75 50 50 50 50 25 25
      Min% 75 50 50 50 25 0 0 0 0 0
    • Years are defined in gas years which run from November 1st to October 31st.  Year 1 is defined as the next gas year, with the current gas year being Year 0. 
    • The volumes purchased in each year will be based on an estimated quantity of gigajoules required in that year, net of inventory.
    • Inventory levels are to be managed such that we can cover daily usage as a lower limit and remain within a reasonable range of our contracted capacity as an upper limit.

Control Procedures

Permitted Derivative Instruments and Strategies

RISK SWAPS FORWARDS FUTURES OPTIONS
Interest Rate X
Foreign Exchange X X*
Commodity
(Natural Gas)
X X

 

* Foreign currency caps & floors

Prohibited Activities

Certain derivative transactions are prohibited.  Prohibited transactions include, but are not limited to:

Counterparties

  1. Counterparties must have at a minimum an investment grade credit rating as determined by a recognized credit rating agency. Recognized credit rating agencies include Dominion Bond Rating Agency (DBRS), Moody Investment Services or Standard and Poors.
    • Contracts less than 5 years - a minimum credit rating of BBB
    • Contracts greater than 5 years - a minimum credit rating of A
    In the event a counterparty rating drops below the minimum credit rating, a report will be given to the appropriate Associate Vice-President recommending an appropriate course of action.
  2. An International Swap and Derivatives Association (ISDA) or comparable contract must be in place with the counterparty.

Documentation and Confirmation Requirements

  1. All transactions must be verified by written confirmation from the dealer outlining the terms and conditions of executed transactions. 
  2. Counterparty confirmations are sent to and reviewed by persons independent of the person initiating the transaction.
  3. All agreements, confirmations or other documents related to the derivative instrument require written authorization by two (2) authorized signing officers in accordance with the Signing Authority Policies.
  4. Documentation supporting the details of the derivative contract will be attached to the initiating document (e.g. invoice).

Reporting Requirements

  1. Quarterly reports will be submitted to Financial Reporting summarizing all outstanding derivative contracts as of the last business day of the quarter.  The reports will use current market values as determined internally.  This will be used for interim financial reporting purposes.
  2. Annual reports will be submitted to the Vice-President (Finance and Resources) summarizing all outstanding derivative transactions as of the last business day of the fiscal year.  The report will use market values that are independently verified.
  3. Annual reports will be submitted to the Vice-President (Finance and Resources) evaluating transactions executed under the derivative contract completed during the fiscal year as compared to cash market rates.
  4. An annual report summarizing the cost and effectiveness of the derivatives will be provided to the Board of Governors as part of the year end reporting schedule.

Responsibilities

Responsibility
Vice-President, Finance
and Resources
  • Management of derivative usage is the responsibility of the office of the Vice-President Finance and Resources within policies approved by the Board of Governors.
Financial Services
Division (Treasury)
  • Day to day operation, execution, implementation, managing and monitoring of foreign exchange and interest rate derivatives.
  • Segregation of duties - written dealer confirmations are independently reviewed
Facilities Management
Division (Finance)
  • Day to day operation, execution, implementation, managing and monitoring of natural gas derivatives.
  • Segregation of duties - written dealer confirmations are independently reviewed.
Audit Services
  • Perform audits on an as-required basis.
  • Investigate complaints of financial irregularities.

Contacts

For questions about specific issues, call the following offices:

Subject Contact Telephone
Natural Gas Facilities Management 966-1690
Interest Rate Treasury 966-4604
Foreign Exchange Rates Treasury 966-4604

Definitions

Credit Risk The risk that a counterparty will not pay an amount due as called for in the original agreement, and may eventually default on on obligation.
Counterparty The other party to a derivative contract.
Derivative

Financial instruments or other contracts with all of the following characteristics:

  • Value changes in response to a change in a specified “underlying”
  • Requires little or not initial net investment
  • Is settled at a future date
Forward An agreement to buy and sell the Underlying Interest of the agreement at a designated future date at a price established or determinable by reference to the agreement.
Future A type of forward contract trading on an organized exchange.  The futures contract is an agreement to buy or sell a specific amount of a financial instrument or commodity at a designated price at a stipulated time.
Embedded Derivative An agreement or contract which includes a financial instrument considered a derivative under accounting regulations.
Interest Rate Swap An agreement to exchange floating interest payment for fixed interest payments, or the reverse, based on a predetermined notional amount and term.
Investment Grade Long Term Debt rating awarded by rating agencies:
Standard & Poors - BBB
Moody's - Baa2
Dominion Bond Rating - BBB (mid)
ISDA The International Swap and Derivatives Association, Inc.
Leverage A relatively small change in the amount or price of the Underlying Interest of the Derivative will have a proportionally larger change on the current market values of such Derivative.
Market Value The quoted price of a Derivative traded on a recognized market or exchange and, for Derivatives not traded on a recognized market or exchange, the amount that a buyer would pay or be paid by an arm’s-length third party to have the Derivative assigned to such party.
Option An agreement providing the holder the right, but not the obligation, to purchase or sell a specified quantity of the underlying interest of the agreement at a price and at a time established or determinable by reference to the agreement.
Swap An agreement for the periodic exchange of payments between two counterparties for a specified period of time based on notional principle.
Underlying Interest The securities, financial instruments, currencies, interest rates, foreign exchange rates, commodities, or other benchmarks of any kind on which the market price, value or payment obligations of a Derivative are derived or based.