SOFAZ | International Forum of Sovereign Wealth Funds

Santiago Principles Self-Assessment

State Oil Fund of the Republic of Azerbaijan

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Pillar 1: Legal
Pillar 2: Institutional
Pillar 3: Investment

Principle 1

1. The legal framework for the SWF should be sound and support its effective operation and the achievement of its stated objective(s).

1.1. The legal framework for the SWF should ensure legal soundness of the SWF and its transactions.

1.2. The key features of the SWF’s legal basis and structure, as well as the legal relationship between the SWF and other state bodies, should be publicly disclosed.

The legal framework of SOFAZ is clearly defined in the “Statute of the State Oil Fund of the Republic of Azerbaijan” (hereinafter “Statute of SOFAZ”) approved by the decree of the President of the Republic of Azerbaijan.

SOFAZ is a legal entity separate from the government or central bank. The Fund's operation is guided by the Constitution and laws of the Republic of Azerbaijan, Presidential Decrees and Resolutions, and the Fund's Regulations.

All documents relevant to the legal basis and structure and the legal relationships between SOFAZ and the other government agencies are publicly disclosed and they are available on the Fund’s website.

http://www.oilfund.az/en/content/25

Principle 2

The policy purpose of the SWF should be clearly defined and publicly disclosed.

SOFAZ was established for the purpose of accumulation and management of the revenues generated from implementation of oil and gas agreements.

SOFAZ’s primary objectives are to help maintain macroeconomic stability in the country (neutralise the negative impact of the currency inflows) and to generate wealth for present and future generations.

The purpose of establishment and primary objectives discussed above are publicly disclosed on the Fund’s website.

http://www.oilfund.az/en/content/25/9

http://www.oilfund.az/en/content/3

Principle 3

3. Where the SWF’s activities have significant direct domestic macroeconomic implications, those activities should be closely coordinated with the domestic fiscal and monetary authorities, so as to ensure consistency with the overall macroeconomic policies.

According to its bylaws, SOFAZ is not permitted to invest domestically. Expenditures of SOFAZ constitute part of the consolidated state budget approved by the Parliament. According to Budget System Law, the consolidated state budget is prepared in close consultation with all relevant government entities (Ministry of Finance, Ministry of Economy and Industry, etc.) and involvement of SOFAZ.

http://www.oilfund.az/en/content/25/154

http://www.oilfund.az/en/content/25/156

http://www.oilfund.az/uploads/budget%20system-1_eng.pdf

Principle 4

4. There should be clear and publicly disclosed policies, rules, procedures, or arrangements in relation to the SWF’s general approach to funding, withdrawal, and spending operations.

4.1. The source of SWF funding should be publicly disclosed.

4.2. The general approach to withdrawals from the SWF and spending on behalf of the government should be publicly disclosed.

SOFAZ’s Funding and Withdrawal rules are clearly defined by the “Statute of SOFAZ” and "Rules on the preparation and execution of the annual program of revenues and expenditures (budget) of the State Oil Fund of the Republic of Azerbaijan" (hereinafter “Rules on the budget of SOFAZ”) which are publicly disclosed on the Fund’s website.

http://www.oilfund.az/en/content/25/154

http://www.oilfund.az/en/content/25/156

http://www.oilfund.az/uploads/budget%20system-1_eng.pdf

Principle 5

5. The relevant statistical data pertaining to the SWF should be reported on a timely basis to the owner, or as otherwise required, for inclusion where appropriate in macroeconomic data sets.

SOFAZ submits monthly statistical reports to the President and Ministry of Finance, as well as quarterly and yearly reports to the State Statistical Committee. SOFAZ also reports on its revenues and expenditures to the Parliamentary Chamber of Accounts and on other relevant information to the Ministry of Taxes, State Social Protection Fund and other relevant government agencies. Additionally, SOFAZ regularly provides information on its activities to the World Bank and International Monetary Fund.

All relevant statistical data pertaining to the fund is publicly disclosed on the Fund’s website (audited annual reports, quarterly statements, etc.)

http://www.oilfund.az/en/content/25/154

http://www.oilfund.az/en/content/25/156

http://www.oilfund.az/uploads/budget%20system-1_eng.pdf

Principle 6

6. The governance framework for the SWF should be sound and establish a clear and effective division of roles and responsibilities in order to facilitate accountability and operational independence in the management of the SWF to pursue its objectives.

SOFAZ has a three-tier governance structure, with the President of the country being a supreme governing and reporting authority for the Fund.

SOFAZ's activities are overseen by a Supervisory Board which is headed by the Prime Minister and consists of the Minister of Finance, Governor of the Central Bank, Minister of Economy and Industry, Vice-Speaker of Parliament and the Economic Advisor to the President.

The operational management of SOFAZ is vested in the Executive Director. The relevant duties and responsibilities of the President of the country, Supervisory Board and Executive Director are clearly defined in the “Statute of SOFAZ”.

http://www.oilfund.az/en/content/25/154

Principle 7

7. The owner should set the objectives of the SWF, appoint the members of its governing body(ies) in accordance with clearly defined procedures, and exercise oversight over the SWF’s operations.

The objectives of SOFAZ are clearly defined in “Statute of SOFAZ” approved by the President of the Republic of Azerbaijan.

Please see also the response on GAPP 5 and 6.

http://www.oilfund.az/en/content/25/154

Principle 8

8. The governing body(ies) should act in the best interests of the SWF, and have a clear mandate and adequate authority and competency to carry out its functions.

The Supervisory Board of the Fund, which is headed by the Prime Minister and consists of the Minister of Finance, Governor of the Central Bank, Minister of Economy and Industry, Vice-Speaker of Parliament and the Economic Advisor to the President, has a clear mandate and adequate authority and competency to fulfil its functions. All roles and responsibilities of the Supervisory Board are clearly defined in the relevant legislation.

http://www.oilfund.az/en/content/25/154

Principle 9

9. The operational management of the SWF should implement the SWF’s strategies in an independent manner and in accordance with clearly defined responsibilities.

“Statute of SOFAZ”, “Rules on management of foreign currency assets of the State Oil Fund of the Republic of Azerbaijan” (hereinafter “Investment guidelines”) and “Rules on the budget of SOFAZ” clearly define the role and responsibilities of the Executive Director. In accordance with these roles and responsibilities, the Executive Director has independence in operational management.

http://www.oilfund.az/en/content/25/154

http://www.oilfund.az/pub/tiny_upload/Inv_guide.pdf

http://www.oilfund.az/en/content/25/156

Principle 10

10. The accountability framework for the SWF’s operations should be clearly defined in the relevant legislation, charter, other constitutive documents, or management agreement.

The accountability framework of SOFAZ is clearly defined in the “Statute of SOFAZ”, “Investment guidelines”, “Rules on the budget of SOFAZ” and Budget System Law all of which are available on the Fund’s website. The fund produces and publicly discloses audited annual reports and quarterly reports. Information about the Fund’s activities is also disseminated through regular press conferences and published on the Fund’s website.

See also response on GAPP 5.

http://www.oilfund.az/en/content/25/154

http://www.oilfund.az/pub/tiny_upload/Inv_guide.pdf http://www.oilfund.az/uploads/Inv_policy1.pdf

http://www.oilfund.az/uploads/budget%20system-1_eng.pdf

Principle 11

11. An annual report and accompanying financial statements on the SWF’s operations and performance should be prepared in a timely fashion and in accordance with recognized international or national accounting standards in a consistent manner.

Since the start of its operations, SOFAZ has prepared annual reports and accompanying financial statements.

All financial statements are prepared in accordance with International Public Sector Accounting Standards (“IPSAS”) issued by the International Public Sector Accounting Standards Board (“IPSASB”) of the International Federation of Accountants (“IFAC”). IPSAS are developed by adopting International Financial Reporting Standards (“IFRS”) to the public sector context.

All annual reports and accompanying financial statements are published on the Fund’s website.

http://www.oilfund.az/en/content/25/154

http://www.oilfund.az/en/account

Principle 12

12. The SWF’s operations and financial statements should be audited annually in accordance with recognized international or national auditing standards in a consistent manner.

Since the start of its operations SOFAZ has been audited by reputable international audit firms. In line with the Public Procurement Law, the Fund conducts open market tender processes to select its auditor. Price Waterhouse Coopers has been appointed to audit SOFAZ financial statements for years 2013-2015.

All annual reports and accompanying financial statements are available on the Fund’s website.

SOFAZ also has an internal auditor who prepares periodic internal audit reports.

http://www.oilfund.az/en/content/25/154

http://tender.gov.az/new/docs/tlotroa.doc

Principle 13

13. Professional and ethical standards should be clearly defined and made known to the members of the SWF’s governing body(ies), management, and staff.

Professional and ethical standards are clearly defined in the "Investment Guidelines".

Management and staff of the Fund have to comply with ethical norms and rules of the International Financial Markets Association (ACI, Paris) and “Rules of Ethical Conduct for the Employees of SOFAZ”.

http://www.oilfund.az/pub/tiny_upload/Inv_guide.pdf

http://www.oilfund.az/en_US/about_found/etik-davranis-qaydalari.asp

Principle 14

14. Dealing with third parties for the purpose of the SWF’s operational management should be based on economic and financial grounds, and follow clear rules and procedures.

The fund’s activities related to third parties are based on economic and financial grounds. The Fund’s "Investment Guidelines" and “Investment Policy” regulate SOFAZ’s dealing with third parties.

All aspects of dealing with external managers are clearly defined in relevant documentation about the Fund’s activity. Appointment of external managers is carried out in compliance with the current legislation of Azerbaijan Republic on “State Procurement”. External managers are selected on the basis of the criteria, such as credit rating of the manager, assets under management, experience in the asset management industry, proposed rate of return and risk, proposed fees schedule, etc. Compliance of the external managers’ investments to their mandate is monitored daily. Performance of external managers’ portfolios is monitored monthly.

http://www.oilfund.az/pub/tiny_upload/Inv_guide.pdf

http://www.oilfund.az/uploads/Inv_policy1.pdf

Principle 15

15. SWF operations and activities in host countries should be conducted in compliance with all applicable regulatory and disclosure requirements of the countries in which they operate.

The Fund conducts its operations and activities in host countries in compliance with all applicable regulatory and disclosure requirements of those host countries

Principle 16

16. The governance framework and objectives, as well as the manner in which the SWF’s management is operationally independent from the owner, should be publicly disclosed.

The fund’s governance framework, objectives and its operational independence are clearly defined in the relevant legislation.

http://www.oilfund.az/en/content/25/154

Principle 17

17. Relevant financial information regarding the SWF should be publicly disclosed to demonstrate its economic and financial orientation, so as to contribute to stability in international financial markets and enhance trust in recipient countries.

Audited financial statements are published in the Fund’s annual report, which is publicly available. Quarterly reports and all other relevant financial information about the Fund’s activities are published on the Fund’s website. Disclosed financial information includes AUM, asset allocation, benchmark, annual rates of return, etc.

http://www.oilfund.az/en/account http://www.oilfund.az/en/content/20/249

Principle 18

18. The SWF’s investment policy should be clear and consistent with its defined objectives, risk tolerance, and investment strategy, as set by the owner or the governing body(ies), and be based on sound portfolio management principles.

18.1. The investment policy should guide the SWF’s financial risk exposures and the possible use of leverage.

18.2. The investment policy should address the extent to which internal and/or external investment managers are used, the range of their activities and authority, and the process by which they are selected and their performance monitored.

18.3. A description of the investment policy of the SWF should be publicly disclosed.

“Investment Guidelines” and “Investment Policy” set up SOFAZ’s asset management framework and ensure the transparency in its investment decisions. Among other things, they define strategic asset allocation, currency composition, benchmarks, risk limits, minimum requirements for the Fund’s external managers and limitations on the investment directions, as well as the credit quality limits for the Fund’s counterparties (custodian banks, correspondent banks, etc.).

Derivatives (i.e. swaps, forwards, futures, etc) may only be used for hedging or optimising the currency composition and asset allocation of the Investment Portfolio.

For policies and procedures related to the Fund’s external managers please see our response on GAPP 14.

The Fund's “Investment guidelines” and “Investment Policy” are available on its website.

http://www.oilfund.az/pub/tiny_upload/Inv_guide.pdf

http://www.oilfund.az/uploads/Inv_policy1.pdf

Principle 19

19. The SWF’s investment decisions should aim to maximize risk-adjusted financial returns in a manner consistent with its investment policy, and based on economic and financial grounds.

19.1. If investment decisions are subject to other than economic and financial considerations, these should be clearly set out in the investment policy and be publicly disclosed.

19.2. The management of an SWF’s assets should be consistent with what is generally accepted as sound asset management principles.

According to its “Investment Policy”, the Fund’s investment decisions should aim at maximising risk-adjusted returns. All investment decisions are made purely on an economic and financial basis according to sound asset management principles.

See also the response on GAPP 18.

http://www.oilfund.az/uploads/Inv_policy1.pdf

Principle 20

20. The SWF should not seek or take advantage of privileged information or inappropriate influence by the broader government in competing with private entities.

According to its bylaws, SOFAZ is not permitted to invest domestically. In line with the “Investment guidelines”, SOFAZ makes investment decisions independently of the government. Institutional and legal framework of SOFAZ has been designed in a way that the Fund cannot seek or take advantage of any privileged information.

http://www.oilfund.az/pub/tiny_upload/Inv_guide.pdf

http://www.oilfund.az/en/content/25/154

Principle 21

21. SWFs view shareholder ownership rights as a fundamental element of their equity investments’ value. If an SWF chooses to exercise its ownership rights, it should do so in a manner that is consistent with its investment policy and protects the financial value of its investments. The SWF should publicly disclose its general approach to voting securities of listed entities, including the key factors guiding its exercise of ownership rights.

SOFAZ has only recently started to invest in equities and has chosen not to exercise its ownership rights at this stage

Principle 22

22. The SWF should have a framework that identifies, assesses, and manages the risks of its operations.

22.1. The risk management framework should include reliable information and timely reporting systems, which should enable the adequate monitoring and management of relevant risks within acceptable parameters and levels, control and incentive mechanisms, codes of conduct, business continuity planning, and an independent audit function.

22.2. The general approach to the SWF’s risk management framework should be publicly disclosed.

Identification, assessment and management of the risks of the Fund’s operations play a crucial role in the Fund’s overall management framework. SOFAZ’s risk management system is supported by an appropriate legal framework (“Investment Guidelines”, "Investment Policy”, etc), a specialised risk unit (Risk Management Department), internal and external audit functions and tools like RiskManager 4 by RiskMetrics and proprietary models.

“Investment Guidelines” and "Investment Policy” set the main principles of the risk management framework and clearly define limits on major factors for market, credit, concentration and liquidity risks. Certain pre-trade limits are set based on these factors. Furthermore, these risk factors are monitored on a daily basis via regular risk and performance reports. In addition to the factors set in the “Investment Guidelines” and “Investment Policy”, a more in-depth analysis and monitoring of the market risk is performed on a regular basis through: interest rate sensitivity analysis (key rate durations, PV01, etc.), risk concentration analysis (duration by groups, VaR by groups, marginal VaR, etc.), tail events (conditional VaR, stress tests) and scenario analyses.

Operational risk is managed in accordance with Fund's Operational Manual and business continuity planning.

http://www.oilfund.az/pub/tiny_upload/Inv_guide.pdf

http://www.oilfund.az/uploads/Inv_policy1.pdf

Principle 23

23. The assets and investment performance (absolute and relative to benchmarks, if any) of the SWF should be measured and reported to the owner according to clearly defined principles or standards.

Comprehensive reports on assets of SOFAZ (including information on breakdown of investment portfolio by foreign currencies, asset class, credit ratings, maturities and geographic regions) are disseminated through the quarterly press releases. The performance of the Fund’s investments is measured according to best industry standards and reported on an annual basis. Annual reports and quarterly statements are posted on the Fund’s website.

http://www.oilfund.az/en/account

Principle 24

24. A process of regular review of the implementation of the GAPP should be engaged in by or on behalf of the SWF.

This report was first published on SOFAZ’s official website in April, 2011 and it is reviewed on an annual basis.

International Forum of Sovereign Wealth Funds

Santiago Principles Self-Assessment

State Oil Fund of the Republic of Azerbaijan

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