Content

1. ABOUT SOFAZ 2

2. FACTS AT GLANCE 8

3. GOVERNANCE AND TRANSPARENCY 12 3.1. SOFAZ management 12 3.2. Transparency and accountability 18

4. NATIONAL ECONOMY AND SOFAZ 24 4.1. Macroeconomic development 24 4.2. SOFAZ Revenues 33 4.3. SOFAZ Expenditures 38

5. INVESTMENT REPORT 48 5.1. Investment Strategy 48 5.2. SOFAZ Investment portfolio 53 5.3. SOFAZ Investment portfolio 69 performance 5.4. Risk management 72

6. 2016 SOFAZ BUDGET EXECUTION 78

7. CONSOLIDATED FINANCIAL 86 STATEMENTS OF SOFAZ

APPENDIX 149

“Baku-2015” first European Games torch 01 ABOUT SOFAZ

SOFAZ’s mission is to transform depletable 1 ABOUT SOFAZ hydrocarbon reserves into financial assets generating perpetual income for current and future generations. The State Oil Fund of the Republic of Azerbaijan (SOFAZ) Objectives Legal framework was established in accordance SOFAZ’s activity is directed to SOFAZ’s operations are guided SOFAZ’s investment and risk the achievement of the following by the Constitution and laws management policies are objectives: of the Republic of Azerbaijan, defined by “Investment Guide- Presidential decrees and lines” and “Investment Policy” with the Decree of national 1) Supporting macroeconomic resolutions, SOFAZ Statute approved by the President stability, participating in and regulations. of the Republic of Azerbaijan ensuring fiscal-tax discipline after the review of the Super- and decreasing dependence SOFAZ’s funding and withdrawal visory Board. According to its leader Heydar Aliyev No. 240 on oil revenues while stimulating rules are clearly defined by the “Investment Policy” SOFAZ’s development of the non-oil sector; “Statute of the State Oil Fund investment decisions should aim of the Republic of Azerbaijan” at maximizing the risk adjust- 2) Funding major national scale and the “Rules on the prepa- ed returns. According to the on December 29, 1999. projects to support socio- ration and execution of the “Investment Guidelines”, SOFAZ economic progress; annual program of revenues and makes investment decisions expenditures (budget) of the independently. 3) Ensuring intergenerational State Oil Fund of the Republic equality with regard to the coun- of Azerbaijan”. According to the In 2004, the President of the SOFAZ is a mechanism whereby energy-related earnings are try’s oil wealth, accumulating and Law “On budget system” of the Republic of Azerbaijan Ilham accumulated and efficiently managed for future generations. preserving oil revenues for future Republic of Azerbaijan, all SOFAZ Aliyev approved “Long-term generations. expenditures, except for operating Strategy on the management expenditures, are incorporated of oil and gas resources”. This SOFAZ is structured as an extra-budgetary fund and functions as part of an annual consolidated document is considered as a as the legal entity separate from the government or central government budget presented to crucial milestone for the long- bank. Statute of SOFAZ was approved in 2000. the Parliament for approval. Thus, term prosperity of the country, indirectly, all citizens participate outlining the development of in the discussions of the budget the non-oil sector, human cap- The cornerstone of SOFAZ’s philosophy is to ensure of SOFAZ. In compliance with this ital and competitive economy. intergenerational equality with respect to the benefit from the law, SOFAZ can only execute the SOFAZ is one of the central country’s oil wealth. expenditures envisaged by its components in the implemen- budget. tation of the Strategy.

2 3 01 ABOUT SOFAZ

Our Values: Respect, Team- work, Trust and Transparency

0.11% 6.5% 2.9% 10.2% 12.2% 2% 4.6% 2.35% 3.1% Since its very inception, SOFAZ 4.4% 1.29% 3.1% 3.4% $0.5 $2.5 $22.8 $34.1 $37.1 $33.6 $33.1 has built a strong cooperation bn. bn. bn. bn. bn. bn. bn. with a number of financial RESPECT 100% 100% 99.89% 94.36% 87.5% 82.1% 80% organizations and institutions in SOFAZ’s relations with international organiza- tions, financial institutions, - First investments - SOFAZ was - SOFAZ - Assets increased - Changes - SOFAZ - Changes Azerbaijan and globally. SOFAZ’s government bodies as were made. awarded with UN commenced to over USD 30 were made commenced were made well as its employees are Public Service investing into billion. to investment investing in real to investment relations with its partners are based on mutual respect. Award. private equity policy: allocation estate funds. policy: allocation Deeply rooted into the funds. - SOFAZ to equities to equities Fund’s philosophy, trust - Assets reached commenced increased from - Funds were increased from based on the principles of USD 2 billion. investing into 5% to 10%, while allocated into 10% to 15%; and respect are the main public equity, allocation to European stock allocation to real factors in maintaining gold and real fixed income markets through estate increased mutual respect, trust, teamwork healthy relations in work- estate. decreased from MSCI Europe ex- from 5% to 10%; place and cooperating 85% to 80%. UK index. and allocation and transparency. fruitfully with partners. - Currency to fixed income composition of - SOFAZ started decreased from fixed income in-house 80% to 70%. portfolio was management further diversified of public equity - Increased to include indexes. the share of Australian Dollar, allocations in Turkish Lira, and alternative asset TEAMWORK TRUST TRANSPARENCY Russian Ruble. classes.

It is through teamwork Since its inception, SOFAZ SOFAZ’s activities are and joint efforts that adheres to the highest based on the principles SOFAZ succeeds in all standards of ethical behavior of transparency and of its endeavors and and honesty to gain the accountability. Internationally strengthens its prestige trust of its partners. SOFAZ praised as a credible and Fixed income Equities Gold Real estate locally and worldwide. expects all of its business transparent institution, SOFAZ, Building strong working partners to operate on the in line with the foremost relationships, praising same principles of mutual international practices, Note: The diagram illustrates year by year AuM and breakdowns of the personal, achievements trust and cooperation. ensures the highest level of investment portfolio by asset class. and encouraging transparency towards its teamwork contribute to counterparties, employees the establishment as well and external managers. as further development of professional work environment.

4 5 2015 European Games

The first European Games were held in Baku on 12-28 June, 2015. 6000 athletes from 50 European countries participated in these games. A total of 20 sports were represented: 16 Olympic sports and 4 non-Olympic sports.

Russia led the medal table with 164 total medals, Azerbaijan was the second with 56 medals, followed by Great Britain (47 medals). 02

Chart 2.3. Currency composition (as percentage of Investment Portfolio)

52.6% USD+ Gold

34.3% FACTS AT GLANCE EUR 2 4.8% GBP

0.6% AUD

1.1% 37.1 TRY

Chart 2.1. 52.79% 35.9 1.6% 34.1 RUB Growth in SOFAZ 33.6 33.1 assets (USD billion) 1.2% 29.8 KRW

1.4% CNY 32.81% 22.8 30.89% 1.1% JPY

1.3% 14.9 Others 14.53% 0% 10% 20% 30% 40% 50%

5.12% 3.42% Growth in AuM 31.12.16 30.06.16 31.12.15 -1.27%

AuM -9.52% 2009 2010 2011 2012 2013 2014 2015 2016

3.4% 4.4%

12.2% Chart 2.2. Annualized rate of return on investment portfolio

Last 10 years 2.19%

Last 5 years 1.72%

Chart 2.4. Asset allocation (as percentage of Last 3 years 1.56% Investment Portfolio), 31.12.2016

Fixed income Real estate 2016 1.92% 80% Equity Gold

8 9 The closing ceremony of the European Games June 28, 2015 03 GOVERNANCE AND TRANSPARENCY

3 GOVERNANCE AND TRANSPARENCY

3.1. SOFAZ MANAGEMENT

Supervisory Board The Supervisory Board, consisting of representatives of the state authorities and public organizations, carries out general oversight of SOFAZ’s operations.

The Board reviews and evaluates Supervisory Board consists of the In 2016, the Supervisory Board of SOFAZ’s draft annual budget, annual following members: the State Oil Fund took a number report and financial statements, of decisions regarding the SOFAZ’s along with audit report. Members of Artur Rasizade activities. the Supervisory Board are approved Prime Minister of the Republic of by the President of the Republic of Azerbaijan Taking into account the changes Azerbaijan. The board members act made to the Law “About the entirely on a voluntary basis. Valeh Alesgerov state budget of the Republic of Vice-Speaker of the Parliament Azerbaijan in 2016”, the Supervisory (Milli Majlis) of the Republic of Board of SOFAZ with its decision Azerbaijan from 14 March, 2016 introduced certain changes to the Fund’s Vahid Akhundov 2016 budget with the purpose State Economic Policy Adviser of of adjustment the budgetary the Republic of Azerbaijan revenues and expenditures for 2016. According to these changes, Samir Sharifov the Fund’s revenues projection Minister of Finance of the Republic was decreased from of Azerbaijan AZN 6 711 564.1 thousand to AZN 4 578 474.6 thousand, while Shahin Mustafayev the expenditures were revised Minister of Economy of the from AZN 8 181 399.7 thousand to Republic of Azerbaijan AZN 10 688 933.7 thousand.

Elman Rustamov The decision of the Supervisory Governor of the Central Bank of Board of SOFAZ from 3 May 2016 the Republic of Azerbaijan approved SOFAZ’s annual report

The opening ceremony of the first European Games June 12, 2015

12 13 03 GOVERNANCE AND TRANSPARENCY

for 2015 and the independent State Oil Fund of the Republic management and investment of Investment Department In addition, this department is also Budget Forecasting Auditor’s (PricewaterhouseCoopers) of Azerbaijan” and “Rules on the SOFAZ’s’s assets in accordance responsible for performance at- and Projects Report on the Fund’s financial preparation and execution of with the Guidelines approved by The Investment Department is re- tribution, modelling and research, activities. The Supervisory Board the annual program of revenues the President of the Republic of sponsible for developing investment compliance, and supervision of Department recommended the Fund’s 2015 and expenditures (budget) of the Azerbaijan. strategy, investing across eligible external managers. budget execution project for the State Oil Fund of the Republic asset classes, including fixed income, The budget forecasting approval by the President of the of Azerbaijan” proposed by the Deputy Executive money market instruments, equity, The department has 2 divisions: and projects department is Republic of Azerbaijan. Executive Director of the Fund and • Quantitative solutions and perfor- Director real estate and gold. responsible for forecasting recommended the amendments for mance measurement division; SOFAZ’s revenues and A meeting of the Supervisory Board the approval by the President of the The department has 3 divisions: • Alternative investments risk expenditures, organizing of the Fund was held on December Republic of Azerbaijan. Deputy Executive Director is • Fixed income and money market management division. budgeting, economic analysis, 29, 2016. At the meeting, the Board, appointed by the President of division; strategic research and having viewed the SOFAZ’s 2017 the Republic of Azerbaijan. Israfil • Equity and alternative investment Settlements macroeconomic modelling budget project as well as the Executive Mammadov was appointed as division; work, as well as organizing and data on the Fund’s expenditures Department Director Deputy Executive Director of SOFAZ • Real estate division. supporting the activities of submitted by SOFAZ’s Executive on July 23, 2013. SOFAZ’s Supervisory Board and Director, recommended the Fund’s Settlements department operates the financing of fund-sponsored 2017 draft budget, including the SOFAZ’s day-to-day activities are SOFAZ organizational Risk Management under the SOFAZ’s Finance and projects. major directions of its investment managed by the Executive Director structure Department Operations Administration. policy and its draft operating appointed by the President of the The Settlements department is The department has 2 divisions: expenditures plan for the approval Republic of Azerbaijan. responsible for verifying trades • Budget and forecasting division by the President of the Republic of Investment activity at SOFAZ The Risk Management Depart- with counterparties, settling • Projects division Azerbaijan. The Executive Director represents is conducted by Investment ment is responsible for assessing trades with the custodian and the Fund, appoints and dismisses Department, Risk Management investment activities, proposing correspondent banks, reconciling Board members had also discussed employees of SOFAZ in a manner Department and Settlements changes to the SOFAZ’s invest- cash and transactions with state- the amendment proposals to determined by the legislation, Department. ment policy and strategic asset ments from the banks, as well as the “Rules on management of carries out operational management allocation (SAA), selecting bench- reconciling external managers’ the foreign currency assets of the of SOFAZ’s activities, ensures the marks and defining the risk limits. transactions and positions.

14 15 03 GOVERNANCE AND TRANSPARENCY

Figure 3.1. SOFAZ’s organizational structure

16 17 03 GOVERNANCE AND TRANSPARENCY

Rules of ethical conduct

Rules of ethical conduct came corporate values, environment, in fostering ethical workplace media representatives in order to in answering questions of public, of the Republic of Azerbaijan on into force in December 2013. etc.). culture at SOFAZ. These are keep them updated on SOFAZ’s and replies to all verbal and Right to obtain information”. This document outlines SOFAZ’s the key factors which have activities. written Fund-related enquiries attitude towards ethical behavior Attributes such as teamwork, contributed to the success of directed to the SOFAZ within the and professional conduct enthusiasm, openness to new SOFAZ both in Azerbaijan and SOFAZ always takes an interest timeframe envisaged by the “Law (Confidentiality of information, ideas, and willingness to share abroad. anti-corruption measures, experience play a crucial role

Extractive Industries Transparency Initiative

The Extractive Industries by the Executive Director of to investors and to international Transparency Initiative (EITI) State Oil Fund of the Republic financial institutions. The EITI 3.2. TRANSPARENCY AND is designed to promote of Azerbaijan (SOFAZ), consists acts as an incentive to improve ACCOUNTABILITY transparency and accountability of representatives of the accountability and governance in the extractive industry. It was ministries of Foreign Affairs, in a politically stable and rapidly Transparency and accountability have announced in September 2002 Economy, Energy, Finance, Taxes, growing country. This, in turn, in Johannesburg by the former Ecology and Natural Resources, helps to avoid any possible been the key principles in SOFAZ’s British Prime Minister, Tony Labour and Social Protection conflicts that may arise over Blair. The first EITI conference of Population, State Statistical the revenue distribution in the was held in London on June 17, Committee and SOCAR. extractive industries. operations since its inception. 2003. At the 1st International EITI Conference held in London in The EITI is a voluntary initiative, The EITI is implemented in Regular auditing of SOFAZ’s of Azerbaijan “On Obtaining about its assets, projects, June, 2003, the President of the supported by companies, accordance with updated financial statements by Information” with the purpose revenues and expenditures, Republic of Azerbaijan Ilham governments, investors and Memorandum of Understanding a reputable international of efficient management of the investment activity and etc. Aliyev declared the decision of civil society organizations. The (MOU) on implementation audit firm is used as the Fund’s information exchange the government of Azerbaijan governments’ joining to the EITI of the EITI in the Republic primary safeguard to ensure with stakeholders and the SOFAZ publishes quarterly to join the EITI and support the and companies’ participation of Azerbaijan signed by the the transparency of SOFAZ public and to protect and revenue and expenditure international efforts aimed in this process ensure Commission on EITI, local and operations. SOFAZ’s financial develop its transparent state statements, through the at ensuring transparency in adherence to transparency foreign extractive companies performance in 2016 was entity reputation. Information press, its own website (www. extractive industries. Azerbaijan and accountability standards and non-governmental audited by Price Waterhouse Policy defines principles, oilfund.az) and official pages volunteered to become at local and international organizations Coalition for Coopers. purposes and objectives of the in social media. It ensures the a pilot country in the EITI levels in public life, public Increasing Transparency in the provision of information about transparency of the revenues implementation. administration and business Extractive Industries (ITEI NGO SOFAZ’s public relations are its operations and activities from the management of the environment. It provides the Coalition) in 2014 (first MOU was managed in accordance with to stakeholders and the public natural reserves and their The Commission on EITI was set implementing countries with signed in 2004). The government its Information Policy. SOFAZ’s under the purposes and utilization. up by the Cabinet of Ministers a significant capacity to of Azerbaijan discloses its Information Policy has been objectives of the Fund. of the Republic of Azerbaijan by demonstrate a completely EITI reports according to the developed in accordance Press conferences with CEO its decree dated November 13, transparent investment mechanism stipulated by the with the Law of the Republic SOFAZ issues press releases participation are held for 2003. The Commission, chaired environment that is attractive Memorandum. In accordance

18 19 03 GOVERNANCE AND TRANSPARENCY

International Forum of Sovereign Wealth Funds

with the Memorandum, a part in the EITI National informed about the EITI The International Forum of held a workshop on Knowledge including senior member competition is held to select Expo held in the framework implementation in Azerbaijan Sovereign Wealth Funds (IFSWF Sharing in Baku. delegates, representatives a credible international of the Global Conference and activities carried out in this or Forum) was established by the from the International Monetary audit company to analyze and shared experience on field. International Working Group of This workshop, initiated and Fund, the World Bank and and reconcile government’s the EITI implementation with Sovereign Wealth Funds, at the organized by SOFAZ, is the first other international financial and companies’ reports. The participants. Petronas Azerbaijan (Shah meeting in Kuwait City on 5-6 event outside IFSWF’s annual institutions attended the successful bidder is selected Deniz) S.A.R.L., newly operating April 2009. IFSWF is a voluntary meetings. SOFAZ is represented meeting. The theme for the open by the EITI Multi-stakeholder The 2015 EITI Progress Report company in Azerbaijan signed the group of Sovereign Wealth Funds in this workshop by the sessions of this year’s meeting Group (MSG), consisting of was published on June 29, 2016. Instrument of Accession to MOU (SWFs), which meets, exchanges delegation headed by the CEO was investing in a Climate of representatives of the parties to on implementation of the EITI in views on issues of common Shahmar Movsumov. Uncertainty, while participants the Memorandum. The next Validation in Azerbaijan Azerbaijan on October 20, 2016. interest and facilitates an also discussed many other was commenced on July 1, 2016. Thereby, number of companies understanding of the Santiago The purpose of the workshop investment and risk management All companies operating in signed MOU on implementation of Principles and of SWF activities. is to discuss the development related issues, including topics extractive industries, as well The seminar on EITI reporting the EITI in Azerbaijan reached 40. of knowledge sharing platform related to New Zealand economy as relevant state enterprises was conducted in SOFAZ on July SOFAZ is an active member of for the Forum and to achieve during the conference. are involved in the EITI 22, 2016. The main goal of the Delegation headed by Shahmar IFSWF and has systematically specific results in this field. implementation process. The event was to improve the quality Movsumov participated at the participated in its meetings. In accordance with Santiago government has also ensured of the data and decrease the 35th EITI Board Meeting (Astana, IFSWF held its first meeting On 8-11 November, 2016 The Principle No. 24, SOFAZ active participation of the number of discrepancies in the Kazakhstan). At the meeting the in Baku organized by the New Zealand Superannuation published its first self- civil society in development, launched 2015 EITI reporting EITI Board decided to maintain government of Azerbaijan and Fund hosted the 8th annual assessment report on its monitoring and evaluation of the cycle. Along with the companies Azerbaijan’s “Candidate status” SOFAZ on 8-9 October, 2009. meeting of the International adherence to these Principles in EITI implementation process. (joined to the MOU) and taking into account considerable Forum of Sovereign Wealth May 2011. This report is reviewed government representatives, improvements noticed during On March 1-2, 2016 IFSWF Funds in Auckland, New on an annual basis and is 8 meetings of MSG dedicated to civil society representatives and Validation. members, including SOFAZ, Zealand. Over 200 people presented in the Appendix. the EITI implementation in Azer- the ITEI NGO Coalition members baijan were held in 2016. also participated in the seminar. Representatives of the World Bank held the consultation 2014 EITI Report was published The MSG’s Code of Conduct was seminar on the EITI Mainstreaming on January 26, 2016. accepted on August 22, 2016. (aims to embed EITI reporting into the routine disclosure and The Co-Investment Roundtable of Sovereign Delegation headed by Shahmar The press conference for mass reporting procedures of the Movsumov, the Chairman media was held in SOFAZ government agencies) for MSG and Pension Funds (CROSAPF) of the Сommission on EITI on October 12, 2016. At the members on December 20, 2016 participated at the 7th EITI press conference held with in SOFAZ. ITEI NGO Coalition’s On September 20-21, 2016 the world. The senior Global Conference held on participation of the MSG members participated in the SOFAZ hosts the third Annual representatives of leading February 24-25, 2016 in Lima, members EITI reports for the seminar. Summit of the Co-Investment sovereign and pension funds as Peru. During the conference years 2013 and 2014, Opinion of Roundtable of Sovereign and well as investment management the updated version of the EITI the ITEI NGO Coalition on the The Roadmap on Beneficial Pension Funds (CROSAPF) firms have discussed current Standard (the main document 2014 EITI Report and Ownership disclosure, the MSG’s in Baku. At this event, 100 global opportunities and on the EITI implementation) www.azeitireport.org website Open Data Policy and 2015 EITI participants represented challenges in financial markets was presented and approved. were presented to participants, Report were published by the approximately 60 prominent and improve the cooperation Azerbaijani delegation took media representatives were MSG on December 30, 2016. organizations from around amongst the investors.

20 21 The first European Games, athletes of Azerbaijan June 12, 2015 04 NATIONAL ECONOMY AND SOFAZ

National economy real terms (1.1% in 2015 and of the people’s incomes were The “regulated floating regime” 2.8% in 2014). directed to consumption, 8.4% of the manat announced by were spent on paying taxes, NATIONAL ECONOMY AND SOFAZ the Central Bank, crude oil In 2016 the GDP per capita insurance and membership 4 prices in the global markets constituted AZN 6 266.3. At fees, 12.4% channeled into and the country’s balance the same time, the GDP per saving and 2.9%- to paying of payments were the major capita adjusted to purchasing interest due on credit. 4.1. Macroeconomic development factors that influenced the power parity (PPP) dropped manat’s exchange rate in to USD 17 688, shrinking by After all mandatory and 2016. Price of manat per 1 USD 1.9%. The nominal income of voluntary disbursements, the strengtheted by mid-year to the population in 2016 rose by overall disposable income of Global economy about 1.50 from its beginning 8.7%, reaching AZN 45 395.1 the population amounted to of the year rate of 1.58 and million. The income per AZN 41.56 billion, or 8.8% higher fell again to 1.77 by the end capita increased by 7.5% and than in 2015 in nominal terms. 2016 will be remembered as the year when of 2016. The average annual equaled AZN 4 709.8, whereas The 65.9% of the country’s GDP inflation was 12.4%. The GDP the average nominal monthly (a slightly smaller share than global oil prices found a relative stability of Azerbaijan, while rising to salary rose by 6.9% up to in 2015) was attributable to AZN 60.39 billion in nominal AZN 498.6. As regards the the non-oil sector. after the protracted drastic fall. figures, declined by 3.1% in expenditure breakdown, 76.3%

Thus, although a barrel of rates were observed on the reasons of the improved crude was sold at the level background of uncertainties economic growth outlook Chart 4.1.1. below USD 30 in January 2016, in the developed countries’ in the mentioned countries. GDP per capita, purchasing power the prices soon started to soar economic policy targets, low Nevertheless some salient parity (in current US Dollars) and by the end of the year inflation and weak growth risks persist: protectionist the price per barrel of Brent of investment and efficiency. tendencies gaining ground settled around USD 55, while Tightening credit opportunities in certain Western countries 11 942 13 348 14 568 15 355 15 562 16 063 17 132 17 785 18 030 17 688 its average spot price was in the developing countries may hurt global trade, and the USD 43.55 throughout the year. due to strengthening US dollar financial markets’ tightening and hike in the Fed interest may raise pressures on many Similar to the previous year, rates are considered to be countries, especially some global economic growth the major reasons for the more vulnerable developing turned out to be lower than decreasing growth. ones, pushing growth rates expected (The World Bank down. The World Bank has calculated the growth rate in A stronger global economic forecasted the 2017 growth 2016 to be 2.3% as opposed growth, compared to the figure to be 2.7% (1.8% for the to the forecasted 2.9%, the previous year, is predicted developed countries and 4.2% IMF provided growth rate of in 2017. A smooth increase in for the developing markets). 3.1% versus estimated 3.2%). commodity prices may help The IMF, demonstrating a more These figures are the lowest the countries dependent on optimistic approach, predicts since the 2008-2009 global natural resource exports that the annual growth of 3.4% (1.9% crisis. Growth in developed faced severe macroeconomic for the developed and 4.5% and developing countries challenges during the previous for the developing countries). constituted 1.6% and 3.4%, as two years. Expected fiscal Both of the organisations reported by the World Bank stimulus and systematic state forecast the GDP growth in (1.6% and 4.1% according support measures in the Azerbaijan to regain positive to the IMF), respectively. world’s two largest economies, dynamics (1.2%- World Bank, 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 Sluggish economic growth US and China, are the main 1.4%- IMF).

Source:IMF Note: the 2016 figure as calculated by the IMF is based on preliminary data

24 25 04 NATIONAL ECONOMY AND SOFAZ

Chart 4.1.2. Chart 4.1.4. Expenditure structure 2.9% The GDP structure of the household 7.6% income in 2016 12.4% 1.8%

6.8%

Consumption Industry Payment of taxes, social insurance and membership fees 8.4% Agriculture, forestry and fishery Household saving Construction Interest rate payments on credit Trade; repair of vehicles 37.2% 17.8% Accomodation of tourists and catering Source: The State Statistical Social and other services Committee of the Republic of Azerbaijan Transportation and storage Information and communications Net taxes on goods and imports 2.4% Source: The State 76.3% Statistical Committee of 5.6% 10.2% the Republic of Azerbaijan

10.6%

Chart 4.1.3. Chart 4.1.5. Sectoral growth rates The share of non-oil sector in the country’s GDP

The structure of the GDP which in 45.3% 2009 -4.4% Net taxes on goods and imports 2016 totalled AZN 60 393.6 million 4.5% Information and communication was as follows: 53.3% fell into the 2010 50.3% share of the production of goods, -0.5% Transport and storage 39.1% to services, while net taxes 2011 48.8% -2.5% Social and other services on goods and imports accounted 53.5% for the remaining 7.6%. Compared 2012 0.1% Accomodation of tourists and catering to 2015, the production of value- 1.5% Trade; repair of vehicles 2013 56.6% added in the non-oil sector -22.9% Construction declined by 4.5% in real terms, 2014 61.3% Source: The State 2.6% Agriculture, forestry and fishery while the respective indicator for Statistical Committee of the oil sector remained at the 2015 69.7% the Republic of Azerbaijan 0.3% Industry same level. The major reason for the decrease of the country’s GDP 2016 65.9% in 2016 was the decline observed in the construction sector (22.9%). In the reference year the amount investment in this total were Source: The State At the same time, the service Statistical Committee of of capital investment declined 42.8% and 57.2% respectively and sector preserved its relatively the Republic of Azerbaijan by 22.2% in real terms compared 73.4% of this amount was spent stable dynamics. The share of the to 2015 figures and totalled on the execution of construction industrial sector leading in the to AZN 15 526.6 million. The and installation works. Azerbaijani economy rose to 37.2% shares of domestic and foreign in contrast to 32.9% a year earlier.

26 27 04 NATIONAL ECONOMY AND SOFAZ

Dynamics of exchange rate and currency reserves in Strategic currency Chart 4.1.6. Dynamics of capital Russia, Kazakhstan and Azerbaijan reserves investment made in Azerbaijan (AZN billion) The sharp decline in oil exchange rate, nevertheless October 2015, from $105.37 bn Volatility in the energy markets, prices observed since 2014 avoiding devaluation turned out to $92.35 bn. Since July 2015,

17.9 has prompted hydrocarbon- to be impossible. For example, the national currency (tenge)

especially the slump in the oil 17.6 dependent economies like Kazakhstan total currency entered a period of dramatic prices, have led to a significant 16.0 15.5 decrease in the SOFAZ’s revenues 15.3 Russia, Kazakhstan and reserves (including both those depreciation, when its exchange

since 2014. Hence, the revenues 12.8 Azerbaijan towards spending held by the Central Bank and rate weakened 93% against US from the sales of profit oil and their currency reserves in the Wealth Fund) fell by 12% dollar (rising from 187 to 358 per 9.7 gas in the reference year were attempts to preserve their between December 2014 and US dollar) in a few months. just one third of what they had been in 2014. At the same time, Chart 1. the role SOFAZ plays in preserving Exchange rates of the Russian ruble and the macroeconomic stability became Kazakhstani tenge against the US dollar much more pronounced against 2010 2011 2012 2013 2014 2015 2016 400 90 the backdrop of oil price volatility. Source: The Ministry of Economy of the 350 80 In order to be able to fulfil its Republic of Azerbaijan 70 consolidated and state budget 300 60 liabilities in time, SOFAZ year. SOFAZ assets amounted total amount of the country’s 250 regularly participated in the to USD 33 147.0 million by the strategic currency reserves 50 currency auctions organized end of 2016. At the same time, (SOFAZ and the Central Bank 200 40 by the Central Bank, turning the official currency reserves combined) constituted USD 150 into the key provider of foreign of the Central Bank had 37 121.4 million. Overall, SOFAZ’s 30 100 currency in Azerbaijan. Overall, diminished by approximately assets comprised 89.3% of the 20 SOFAZ sold USD 4.88 billion at AZN 1 billion (20.8%) totalling country’s strategic currency 50 10 these auctions throughout the USD 3 974.4 million. Hence, the reserves. 0 0 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16

Tenge (left vertical axis) Rubl (right vertical axis) Source: Bloomberg

Chart 4.1.7. Foreign exchange Chart 2. reserves (USD billion) 50.86 50.03 Exchange rates of the Azerbaijani manat 45.82 against the US dollar 40.28 38.59 37.12 1.8

1.6

29.18 1.4 37.10 35.88 34.13 33.15 33.57 1.2

29.80 1

22.77 0.8 14.15 13.76 0.6

0.4 11.69 10.48 6.41

5.02 0.2 3.97

2010 2011 2012 2013 2014 2015 2016 0 Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16

Central Bank SOFAZ Foreign currency reserves, total Sources: SOFAZ, CBA Manat Source: Bloomberg

28 29 04 NATIONAL ECONOMY AND SOFAZ

Since Russia switched to floating devalued from 1.05 to 1.56 against Bloomberg, in order not to hinder Securing fiscal exchange rate regime earlier than the US dollar. Getting over these periods, economic recovery, Central Bank of sustainbility other two countries, the mentioned the reserves of all above stated Kazakhstan had to start purchasing above processes were experienced countries and currencies of Russia and dollars from the market in order in Russia as well: its currency reserves Kazakhstan have been stabilised. to avoid excessive revaluation of Revenues of the state budget budgetary expenditure amounted fell by 20%, and Russian ruble tenge that could hinder economic amounted to AZN 17 499.1 million to AZN 17 743.6 million and hence, depreciated 68% against US dollar. The Chart 1 demonstrates that recovery. Despite the economic shock, in 2016, AZN 7 615.0 million the state budget deficit totalled Azerbaijan went through these after a short period of fluctuations contrary to the statements made in thereof (43.5%) being the share 0.4% of the country’s GDP (AZN processes in two phases: the first in the late 2015, ruble became less 2015 about Kazakhstan’s sufficient of the transfer from SOFAZ. The 60 393.6 million). devaluation of the manat covering dependent on the oil prices, and foreign currency reserves to maintain the period between October 2014 to in 2016 it was one of the three most its currency over many years, the Chart 4.1.9. February 2015, followed by the second appreciating currencies in the world. rapid devaluation of tenge played a State budget deficit/proficit in 2009-2016 (share of GDP, %) half of 2015, when the reserves fell In 2016, ruble and tenge rose by 22% positive role in the national economy from $44.2 bn to $38.6 bn and manat and 15%, respectively. According to over the medium-term. 0.6% 0.6%

Chart 3. 0.3% Currency reserves in Azerbaijan, Russia and Kazakhstan (USD billion) 2009 2010 2014 2015 2016 700 120

2011 2012 2013 600 100

500 -0.4% 80 -0.5% 400 -0.7% 60 -0.9% 300 Source: CBAR 40 -1.2% 200

20 100 During the period from 2003 to 2016, the cumulative transfer 0 0 from SOFAZ to the state budget has reached AZN 71.5 billion. 58.2% 57.3% Jan-14 Apr-14 Jul-14 Oct-14 Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 57.3% 50.7% Chart 4.1.10. 51.9% Source: Central Banks of Azerbaijan, Russia (left vertical axis) Kazakhstan (right vertical axis) Azerbaijan (right vertical axis) Russia and Kazakhstan Share of the SOFAZ transfers in 46.4% the state budget revenues 47.6% 43.5%

35.3%

Chart 4.1.8. SOFAZ assets-to-GDP ratio 87.6% 15.1%

8.6% 63.4% 8.2% 7.3% Source: The State Customs 9.7% Committee of the Republic 48.9% 48.4% 49.3% of Azerbaijan 42.8% 45.0% 33.6% 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 As in the previous years, the year 2016 witnessed an increase in the Despite the decline in SOFAZ’s inflows caused by the low compared to 2015 year-end. During the years of 2001- ratio of the SOFAZ assets to the oil prices, SOFAZ budget was executed with a surplus 2016, the inflows to SOFAZ constituted USD 130.8 billion, GDP. In US dollar terms this figure by the end of the year. Moreover, the extra-budgetary USD 33.15 billion (25.3%) thereof has been channeled into 2009 2010 2011 2012 2013 2014 2015 2016 reached to 87.6%. costs incurred from the shifting currency exchange saving. Sources: SOFAZ, The State Statistical Committee of the Republic of Azerbaijan rates resulted in a 1.27% decrease of SOFAZ’s assets,

30 31 04 NATIONAL ECONOMY AND SOFAZ

Chart 4.1.12.

Foreign trade 372.8 Major non-oil goods export (USD million) According to the State Customs constituting USD 9.14 billion and was observed, while exports 311.9 Committee of the Republic of USD 8.53 billion respectively. In declined by 28.2% (including a 291.1 Azerbaijan, the country’s foreign 2016, a reduction in the volume decrease in vegetable oils and 221.2

trade turnover in the reference of foreign trade turnover by animal fats exports by 88.8%, and 212.1 year amounted to USD 17.67 19.5%, compared to the relevant sugar exports - by 70.7%), and the 190.3 157 billion, the exports and imports indicator of the previous year, imports decreased by 7.4%. 153.3 112.5 96.1 98.1 99.0 86.1 86.8 80.0 76.1 62.0 55.9 43.9 34.9 31.9 25.8 18.7 17.1

Alcoholic and Fruit and Vegetable and Sugar Plastics and Aluminium Base metals Chemical non-alcoholic vegetables animal oil articles and articles and articles products beverages Chart 4.1.11. thereof thereof thereof Foreign trade turnover (USD billion) 36.4 33.6 34.7 31.0 2014 2015 2016 Source: The State Customs Committee of the Republic of Azerbaijan 28.0

20.8 20.6 17.6

4.2. SOFAZ’s revenues

As in the previous year, in year ending on December 31, from the management of 14.7 21.4 9.8 26.6 9.7 23.9 10.7 24.0 9.2 21.8 9.2 11.4 8.5 9.1 6.1 6.6 2016 the income received 2016, the SOFAZ’s revenues SOFAZ assets recorded a 2009 2010 2011 2012 2013 2014 2015 2016 by SOFAZ from the sales of obtained from the sales of the total of AZN 9 410.2 million, or hydrocarbons decreased in Republic of Azerbaijan’s share USD 5 891.1 million. In 2016, the line with the low oil prices, of hydrocarbons, the fees revenues decreased by 23.2% Import Export Trade turnover Source: The State Customs Committee of the Republic of Azerbaijan while there was a significant paid to Azerbaijan for the in dollar terms compared to increase in the revenues transit of oil and gas through the previous year’s results. from the management of the its territory, bonus payments, SOFAZ assets. In the reference acreage fees and revenues

Chart 4.2.1. SOFAZ revenues (USD million) and oil price (USD) dynamics

Non-oil sector 25 109.1 120.0 104.3 111.1 112.2 production 20 100.0 78.0 80.0 15 In 2016, non-oil export As the Chart 4.1.12. shows, 54.3 41.9 60.0 mainly consisted of fruit and major export items have 10 40.0 vegetables, plastics, sugar, declined considerably during aluminum, base metals and the last year. 5 20.0 16.3 19.8 17.4 17.3 16.2 7.7 5.9 articles, and chemical products. 0 0.0 2010 2011 2012 2013 2014 2015 2016

Fund’s income Average annual price per barrel of oil (right vertical axis)

32 33 04 NATIONAL ECONOMY AND SOFAZ

Proceeds from the sales of profit 70 Chart 1. Price per barrel of Brent crude oil and gas 60 oil (US dollars) 2015/16 50 The amount of SOFAZ’s revenue and gas extracted from the the expected annual level, in generated from the sales Azeri-Chirag-Guneshli and accordance with the contracts 40 of profit oil and gas in 2016 Shahdeniz fields. Out of these on natural gas trade within the equaled AZN 8 320.0 million, revenues, USD 5 100.23 million framework of the “Shahdeniz 30 or USD 5 189.1 million. In was attributed to Azeri- Phase 1” project concluded 20 accordance with the Chirag-Guneshli, and USD between SOCAR, representing Production Sharing Agreements 63.98 million-the sales of the the state of Azerbaijan, and the 10 that regulate oil production profit gas from Shahdeniz buyers). The remaining USD 24.9 both onshore and offshore, (excluding the amount paid million was earned from the 0 Source: ycharts.com 98.3% of these revenues by SOCAR (USD 135 million) for sales of oil extracted from the Jan-15 Apr-15 Jul-15 Oct-15 Jan-16 Apr-16 Jul-16 Oct-16 came from the sale of oil the production volumes above other oilfields (Chart 4.2.3).

Chart 4.2.2. Chart 4.2.3. The mid-2016 production in the US the volume of daily oil reserves in Agency forecasts this figure to Structure of SOFAZ’s revenues Distribution structure of the inflows from the sales of was 700 thousand barrels per day storehouses is expected to grow fluctuate between $55-$61 per in 2016 (USD million) profit oil and gas by fields, 2016 (USD million) lower than in the beginning of 2015. by 0.4 million barrels during the barrel, while the World Bank and Socio-political instability in Nigeria first half of the year, it is projected the IMF expect the price to settle Azeri-Chirag-Guneshli 5 100.2 and Venezuela led to shrinking oil to decline afterwards. The OPEC around $55 and $52, respectively. Revenues from profit 5 189.1 oil and gas sales production in these countries and decision has already affected At the same time, risks that could Shahdeniz 64.0 further decelerated the increase in prices and no significant production bring the prices down again remain supply levels. Most importantly, the cuts are expected further on. The salient. If the OPEC decision is Revenues from the Balakhani-Sabunchu-Ramana 8.0 management of the 688.5 decision taken in November 2016 by strong shale oil sector potential in not complied with, markets may Fund’s assets Binagadi 5.6 the OPEC and some non-member the US means that any further price respond in a negative way. The countries, including Azerbaijan and hike would bring about growing ongoing slowdown in China’s Kurovdag 4.5 Russia, to decrease their combined production there which in turn would growth creates a risk for the Transit fees 11.3 Surakhany 3.1 daily production by 1.2 million again push the prices downward. demand to fail reaching the barrels, contributed to a 9-dollar expected levels. Other potential Zig-Hovsan 1.4 spike in the oil price in December. Goldman Sachs projects the price risks involve US dollar appreciation Acreage fees 2.1 of Brent oil to reach $59 in 2017 and new political controversies Kursenghi-Qarabaghlyı 1.2 The majority of analysts predict provided the OPEC agreement is arising between the OPEC member Qum-Deniz and Bahar 0.7 oil prices to stabilize in 2017. While fulfilled. The International Energy states. Bonus payments 0.1 Neftchalla-Khylly 0.4

Oil price dynamics in the global markets

After a prolonged period of complex and intricate factors these two countries combined the plummeting oil prices in explained below. now exceeds the levels of early the global markets that took 2013 by 2.2 million barrels. On off in mid-2014 and continued On one hand, sluggish global the other hand, the period of throughout 2015, in 2016 the growth rates resulted in a cheap oil prices had resulted Revenues from the asset prices registered a gradual lower than predicted increase in significantly diminishing management increase. Although this process in the demand for oil and oil investment in oil extraction underwent several interruptions, products. Major increases in (projects that could have and the average annual price oil production were observed increased daily production by In 2016, SOFAZ’s assets were USD 688.5 million, or AZN while the same indicator per barrel (USD 43.55) was still in Iraq where the investments up to 0.5 million barrels, were invested in fixed income, 1 068.8 million. The average for the investment portfolio much lower than in the previous started to pay off thanks to a suspended), and exerted a equities, real estate and annual rate of return from amounted to 1.92%. year, there was an obvious relative political stability, and negative impact on the US gold. SOFAZ’s revenues from the management of SOFAZ’s upward trend. in Iran due to the lifting of the shale oil production which was asset management totaled assets constituted 2.0%, Such price dynamics can be sanctions against this country unprofitable given the prevailing explained by the presence of in late 2015. Daily production in $40 per barrel environment.

34 35 04 NATIONAL ECONOMY AND SOFAZ

Bonus payments Amount, million

Transferor party Date USD AZN In the reference year, SOFAZ’s to AZN 82.1 thousand or USD revenues from bonuses paid by 51.3 thousand. Bonus payment Table 4.2.2. investors for signing and fulfilling inflows are presented in the SOFAZ’s proceeds from 13.01.2016 0.8 1.3 oil and gas contracts amounted Table 4.2.1. the transit fees in 2016 08.02.2016 1.0 1.6

14.03.2016 0.9 1.5

Table 4.2.1. 15.04.2016 1.0 1.5 SOFAZ’s proceeds from bonus payments in 2016 Amount, thousand 17.05.2016 0.9 1.4

16.06.2016 1.0 1.5 Transferor party Oilfield Date USD AZN Azerbaijan International Operational Company 13.07.2016 1.0 1.6

BP Exploration (Azerbaijan) Limited Shahdeniz 27.01.2016 17.748 28.5 12.08.2016 1.0 1.6

15.09.2016 0.9 1.5

12.10.2016 1.0 1.6 LUKOIL OVERSEAS Shahdeniz Limited Shahdeniz 29.01.2016 6.156 9.8 14.11.2016 1.0 1.7

15.12.2016 0.8 1.2 TURKISH PETROLEUM OVERSEAS Shahdeniz 29.01.2016 11.697 18.7 Company Limited Total 11.3 18.0

Petronas Shahdeniz 29.01.2016 9.542 15.3 Acreage fees

In 2016, a sum of USD 2.1 million (AZN production sharing agreement over the Shafag-Asiman field in the NIKO Shahdeniz 04.02.2016 6.156 9.8 3.3 million) of acreage fees was between SOCAR and the oil Azerbaijani sector of the Caspian transferred to SOFAZ in accordance company co-owned by SOCAR and Sea. Acreage fees per company are with the offshore exploration and BP Exploration Limited (Azerbaijan) represented in the Table 4.2.3. Total 51.299 82.1

Table 4.2.3. Proceeds from acreage fees in 2016 Amount, million

Transferor party Oilfield Date USD AZN Transit fees

In 2016, another revenue inflow was USD 11.3 million of transit fees were BP Exploration (Azerbaijan) Shafaq-Asiman 01.07.2016 2.1 3.3 generated from the transportation transferred by different companies of oil and gas through the territory to SOFAZ’s budget. Detailed of Azerbaijan (transit fees). The information on this income item is Total 2.1 3.3 amount of AZN 18.0 million,or provided in the Table 4.2.2.

36 37 04 NATIONAL ECONOMY AND SOFAZ

4.3. SOFAZ’s expenditures

11 350 In 2016, SOFAZ’s expenditures accrued to the annual transfer administrative expenses at Chart 4.3.2. Chart 4.3.3. 9 905 were equal to AZN 9 022.1 million to the state budget, followed (0.2% or AZN 20.1 million). The SOFAZ’s expenditures, Transfer to the state budget 9 337 9 000 2001-2016 by years (AZN million) (USD 5 442.1 million). The biggest by expenditures on the SOFAZ- breakdown of the SOFAZ’s 8 130 share of the total expenditures funded state projects (15.4% or expenditures is provided in Chart 7 615 (84.4% or AZN 7 615.0 million) AZN 1 387.0 million) and SOFAZ’s 4.3.1. 5 915 4 915

3 800

10.1% Chart 4.3.1. Projects and other 585 585 Structure of the SOFAZ expenditures 100 130 150 expenditures in 2016, (AZN million) 89.9% Transfer to the state budget 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016

Transfer to the state budget 7 615.0 Transfers of SOFAZ to state budget total SOFAZ budgetary expenditures started in 2003 and accumulated to (Chart 4.3.2.). In 2016, the transfer Financing of the South Gas Corridor project 797.4 AZN 71.5 billion within the following from SOFAZ to the state budget 13 years. Throughout 2001-2016 the comprised 43.5% and 42.9% of Financing of the Star project 331.8 overall transfer from SOFAZ to the the state budget revenues and state budget equaled 89.9% of the expenditures, respectively.

Improvement of social conditions of refugees and internally displaced people 90.0

Samur-Absheron irrigation system 70.0 Chart 4.3.4. Chart 4.3.5. Transfer from SOFAZ Transfer from SOFAZ as a share of the state as a share of the state New Baku-Tbilisi-Kars railway construction project 66.2 budget revenues budget expenditures

2016 43.5% 2016 42.9%

Education of the Azerbaijani youth abroad 31.6 2015 46.5% 2015 45.7%

2014 50.7% 2014 49.9% Adminstrative expenses 20.1 2013 58.2% 2013 59.3%

2012 57.3% 2012 56.9%

2011 57.3% 2011 58.5% Transfer to the state budget 2010 51.9% 2010 50.3% 2009 47.6% 2009 46.8%

The policy of reducing the before. The breakdown of the 2008 35.3% 2008 35.6% transfer amounts to the state budget transfers throughout the budget continued in the years 2001-2016, as well as the 2007 9.7% 2007 9.7% reference year. share of the transfer in the overall 2006 15.1% 2006 15.4% state budgetary incomes and Thus, the transfers constituted expenditures are demonstrated 2005 7.3% 2005 7.0% AZN 7 615.0 million, 6.3% or AZN in the Сharts 4.3.3., 4.3.4. and 2004 8.6% 2004 8.7% 515 million lower than a year 4.3.5. 2003 8.2% 2003 8.1%

38 39 04 NATIONAL ECONOMY AND SOFAZ

FINANCING SOCIAL AND INFRASTRUCTURE Table 4.3.1. Aggregate results of the works completed within the framework of the project and financed by SOFAZ, in 2001-2016 (according to quarterly PROJECTS statements by SDFDP) Share in the overall volume SOFAZ plays a significant role in Works done Overall volume for Azerbaijan financing social and infrastructure projects of strategic national VAT paid from the assets allocated for the project* AZN 360.0 mln. 2% importance. Total surface area of the apartments completed and added 2.9 mln. m2 5% into the housing stock** The improvement of the socioeconomic conditions of refugees and internally displaced persons High schools 75 5% Transmission lines 1600 km 8% The sponsoring of “The State since 2001 (Chart 4.3.6). More Program on the improvement specifically, in the reference Elektric sub-stations 29 22% of the socioeconomic year, the amount allocated conditions of refugees and to the improvement of the Small and large high voltage electric transformers 734 24% internally displaced persons” socioeconomic conditions Water pipelines 860 km 25% was continued in 2016 as well. of refugees and internally Overall, AZN 1 997.8 million has displaced persons constituted Sewerage lines 76 km 6% been spent on this program AZN 90 million. Road surface 764 km 5%

Irrigation system 11 300 ha 1%

Chart 4.3.6. * SOFAZ calculations; ** Source: the webpage of the State Committee of the Republıc of Azerbaijan on Deals of Refugees Expenditures on the improvement of the socioeconomic 300.0 300.0 300.0 and Internally Displaced Persons conditions of refugees and internally displaced persons by year ( 2001-2016, AZN million) Chart 4.3.7. Poverty rate among the refugees and IDPs (%) 154.1 145.0 140.0 150.0 110.0 104.9 2016 12% 89.9 90.0 2015 12% 37.8 40.4 20.0 0.7 15.0 2014 10%

2013 15%

2012 15% 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2011 18%

2010 23%

2009 25% Aforementioned funds were 75 schools, 6 music colleges, 54 sewerage lines were built within the allocated for the construction of community centres, 62 adminis- framework of the program; 734 high 2008 30% 71 residential districts of private trative buildings, 59 kindergartens, voltage electric transformers, 29 2007 41% houses, 168 houses and 15 resi- 16 medical centres, 5 hospitals, an electric sub-stations, 235 artesian dential blocks of multi-storeyed Olympic complex as well as 48 wells, 205 water reservoirs and 82 2006 57% buildings that in total allow for the communication junctions, 764 km pumping stations were completed 2005 72% settlement of 31,304 families, as of highways, 860 km of water pipe- and made ready for use and an Source: State Committee of the 2004 74% well as a large number of socio-in- lines, 1 592 km of transmission lines, irrigation system covering 11 300 Republic of Azerbaijan on deals of the Refugees and frastructural objects. In addition, 423 km of gas pipelines, 76 km of hectares was created. 2003 75% Internally Displaced Persons

40 41 04 NATIONAL ECONOMY AND SOFAZ

Reconstruction of the Samur- Absheron irrigation system Chart 4.3.8. and master’s students, respectively). The project on the reconstruction are already over. They included thousand hectares more arable Distribution of the Moreover, the Program has also of the Samur-Absheron irrigation the construction of such facilities again. The newly irrigated land students by study areas financed 692 students doing system aims at creating a reliable as the Takhtakorpu water will create plentiful opportunities doctoral or higher medical studies. source of water supply for the reservoir, Velvelichay-Takhtakorpu for agricultural development. Most of the undergraduate level cities of Baku and Sumgayit, pre- and Takhtakorpu-Jeyranbatan students have studied economics vent energy losses incurred from channels which were officially The second stage plan envisages and management (320 students), water transportation and use launched on 28 September the construction of water intake 6.6% medicine (238 students), industry this spare capacity to produce 2013 with the participation of facilities and water transmission 5.1% (191 students) information and 25 MWt of energy, as well as to the President of the Republic channels (first of all, at the rivers communication technologies (174 boost the irrigation and meliora- of Azerbaijan. According to Qusarchay, Qudyalchay and 4.7% students). At the graduate level, tion capacity of Azerbaijan. The the 12.11.2014 Act of the State Jaqajuq), as well as construction economics and management have project, since its initiation in 2006, Commision created with the works and consultancy services 32.2% been mostly prioritized (722 people), has been funded by SOFAZ. The Order №019Ü of the Azerbaijan regarding the aforementioned 5.6% followed by industry (138) and law extention of building works on Melioration and Waterworks Open works, within the framework of (120). 128 of the state program the Takhtakorpu water reser- Joint-Stock Company dating back improvement of water supply for participants have been financed voir, Velvelichay-Takhtakorpu to 08.05.2014, the Takhtakorpu the lands already irrigated and two times, while there were 6

and Takhtakorpu-Jeyranbatan water reservoir and hydroelectric commissioning of newly irrigated 10.3% students who have been financed water channels which are part power plant, the Velvelichay- lands in the Shabran, Siyazan and for their studies for three times of the Samur-Absheron project, Takhtakorpu and Takhtakorpu- Khizi districts. within the framework of the program. have been included in the action Jeyranbatan water channels The biggest share of the program plan for the “State Program on were put in commission. During Throughout the years 2006-2016, participants are students in Great Ensuring Reliable Supply of the the second stage of the project, AZN 1 309.6 million (USD 1 570.7 Britain (29.1%), followed by Turkey Food Projects for the Population the Takhtakorpu water reservoir, million) have been transferred 9.1% (22.1%), Germany (12.4%) Canada of Azerbaijan in the years 2008- the Velvelichay-Takhtakorpu and from SOFAZ with the purpose of (7.2%), Netherlands (5.2%) and Russia 2015”. Takhtakorpu-Jeyranbatan water financing the “Reconstruction of (3.8%). For the purposes of financing 26.4% channels, once launched, are the Samur-Absheron irrigation the State Program, SOFAZ has The project has been fulfilled expected to improve the irrigation system” project, including AZN allocated AZN 188.4 million during in two stages, and the works of 150 thousand hectares of 70.0 million (USD 43.4 million) in the period of 2008-2016. envisaged for the first stage of it cultivated land and to make 30 the reference year.

Law Industry Economics and development DEVELOPMENT OF THE HUMAN CAPITAL Services Information and communication technologies Others Sciences Medicine Financing the “State Program on Education of Azerbaijani Youth abroad in the years 2007-2015”

The Fund finances the “State of the Ministry of Education, AZN As of the end of the last year, A praiseworthy fact is that 95% to make them more lasting and and 1 898 participants are still Program on Education of 15.5 million went to cover the living SOFAZ had financed the education of the graduates are employed sustainable. Some of the former to graduate. The last graduates Azerbaijani Youth Abroad in the expenses, AZN 13.9 million - to pay of 3 302 students within the according to the specialties, that students teach at the leading are projected to study abroad years 2007-2015” that aims at tuition fees, approximately AZN 0.9 framework of the State Program, is a sign of a correct allocation universities of Azerbaijan or share until 2021. It means that the full fulfilling the idea of transforming million to pay transport exports, AZN 1404 of whom have already of the professions. Further their knowledge via various online positive effects will be felt only in black gold into human capital. Out 0.5 million were spent on medical graduated. 79.0% of the students academic contribution by the course platforms, thus reaching the future. The beneficiaries of the of AZN 31.6 million allocated by insurance while AZN 0.8 million - on have been funded to study at Program participants helps to not only to Azerbaijani but to the program are set to exert lasting SOFAZ for the education program in visa and registration fees and some undergraduate or master’s levels (of spread further their knowledge global audience. The Program influence on the socio-economic 2016 in accordance with the orders other expenses. which 1180 and 1430 were bachelors and multiply the Program effects has not finished yet, it is ongoing, development of Azerbaijan.

42 43 04 NATIONAL ECONOMY AND SOFAZ

Financing the share of the Republic of Azerbaijan in the сharter capital of the “South Gas Corridor” Funding of the Azerbaijan’s Closed Joint Stock Company share in the STAR project

In accordance with the Decree and the Trans-Adriatic Pipeline. equaled AZN 1 530.3 million (USD The funding of the project and management of the Company was increased from of the President of the Republic According to the paragraph 2.1. 1 232.1 million). by SOFAZ is fulfilled in Company’s state-owned USD 1 900 million to of Azerbaijan dated 25.02.2014, of the aforementioned Decree, accordance with the Executive shares are entrusted to the USD 2 412.0 million, while the the “South Gas Corridor” Closed the Fund is responsible for the In compliance with the decisions Order №2698 of the President Ministry of Economy of the value of the state-owned 40% Joint-stock Company was financing of the company’s of the Supervisory Board dated of the Republic of Azerbaijan Republic of Azerbaijan, while share of the Company was established with its charter state-owned shares, while their 28.04.2014, 15.07.2014, 10.09.2014 dated 04.02.2013 on the the dividends on these shares increased up to USD 964.8 capital of USD 100 million, ownership and management and 21.11.2014, the SGC CJSC additional measures aimed at are transferred to SOFAZ. million. 51% of which is owned by the are vested to the Ministry of issued corporate bonds worth supporting the participation Azerbaijani government and Economy. In 2016, the Fund USD 2 516 995 800 in order to of the Azerbaijani side in The Executive Order №1804 Since the start of the funding the remaining 49% - by SOCAR. transferred AZN 797.4 million maintain financing the Project the “SOCAR Turkey Ege” Oil of the President of the up to the end of 2016, SOFAZ The company’s purpose is to (USD 495.2 million) to the execution. The bonds had the Refinery Plant (STAR) project. Republic of Azerbaijan transferred the amount of facilitate the management of Ministry of Economy in order to following characteristics: In accordance with the dated 24.02.2016 “On USD 960.2 million (AZN 927.9 such projects as the second finance the state-owned shares mentioned Order, a joint- additional measures aimed at million) via Treasury to the stage of exploitation works of the Company. During the • 10 years’ period of validity; stock company (hereafter supporting the participation Ministry of Economy in order at the “Shah Deniz” gas- years of 2014-2016, the overall • Annual rate of return: 6-month - Company) with the charter of the Azerbaijani side in the to finance the Azerbaijani condensate field, the expansion amount of money allocated LIBOR+1%; capital of USD 1 900 million STAR project” introduced share in the project. In the of the South Caucasus by the Fund for financing the • Accumulation of returns during was established, the financing certain changes to the reference year, the respective Pipeline, the construction of Azerbaijani share in the South 7 years with later payment (7 of its state-owned shares previous Order №2698, expenditure item constituted the Trans-Anatolian Pipeline Gas Corridor (SGC) project, years’ period of delay). (40% of the total) having been according to which the USD 200.2 million (AZN 331.8 assigned to SOFAZ. Ownership charter capital of the million).

Funding of the New Baku-Tbilisi-Kars Railway construction project

The main purpose of the Azerbaijan, Georgia and In 2016, SOFAZ allocated project is to consolidate the Turkey. The project envisages USD 41.9 million (AZN 66.2 Trans European and Trans building a Kars-Akhalkalaki million) to finance this project. Asian railway networks, and railway line, 76 km of which will Throughout the years 2007- ensure efficient transportation pass through Turkey and 26 2016, SOFAZ spent in total USD of cargo and passengers km through Georgia, as well 630.0 million (AZN 551.9 million) between Europe and Asia as restoring and rebuilding on the railway construction. by building a railway line the 160 km of Georgia’s that would pass through Marabda-Akhalkalaki railway.

44 45 Formula 1 European Grand Prix His result was 1:32:52.366. Scuderia Hermann Tilke, the architect of the Ferrari’s Sebastian Vettel came in newest Formula 1 tracks, designed Formula 1 European Grand Prix took second, followed by Force India’s the layout of the circuit. place on 17-19 June, 2016 in Baku - the Sergio Perez. capital of Azerbaijan. The length of the widest part of the The Baku City Circuit is a motor track is 13m, and the narrowest width Overall 22 pilots competed in the racing circuit constructed in the is 7.6m between the 7th and 8th turns, race. German pilot Nico Rosberg from centre of the city. Baku City Circuit which are situated along Mercedes AMG F1 team has won the is the second longest F1 track, with a Icheri Sheher. Formula 1 Grand Prix of Europe in Baku. length 6003 kilometres. 05 INVESTMENT REPORT

F1 Grand Prix June 17-19, 2016, Baku

5 INVESTMENT REPORT

5.1. Investment Strategy SOFAZ’s investment strategy is aimed at maximizing long-term risk adjusted returns.

Broad diversification among investment decisions. SOFAZ’s other purposes, it outlines the asset classes and across investment portfolio is permissible asset classes, the countries, along with managed in accordance with currencies, minimum monitoring and analysis of the “Rules on managing the requirements for the Fund’s macroeconomic environment foreign currency assets of the external managers, and serves this strategic goal State Oil Fund of the Republic defines the credit quality and assures the persistence of Azerbaijan” (“Investment limits for the Fund’s of stable investment Guidelines”), approved by counterparties (custodian performance. Presidential Decree No. 511 banks, correspondent banks, of 19 June 2001 and the etc.). Government has laid down Investment Policy approved general principles and by Presidential Decrees on an Investment Policy defines guidelines for the efficient annual basis. the objectives, forecasted management of the Fund’s size, currency composition, assets, in order to set up the “Investment Guidelines” sets strategic asset allocation, legal framework for the Fund’s the general principles of benchmarks and risk limits investment mandate and to SOFAZ’s asset management for the Fund’s investment ensure the transparency in its framework. Along with the portfolio.

48 49 05 INVESTMENT REPORT

In line with the long-term • 70% - Debt obligations and and money market securities Table 5.1.2. objectives, asset class money market instruments; while 12.2%, 3.4% and 4.4% Investment Forms composition of the Fund’s • 15% - Equities; were invested in equities, investment portfolio is • 10% - Real estate; gold, and real estate, Portfolio asset Strategy reviewed and approved • 5% - Gold. respectively. Global asset classes classes employed Implemenation methods annually. According to the 2016 Investment Policy, asset As of December 2016, 80.0% allocation of the investment of the investment portfolio portfolio is defined as below: comprised of fixed income Exposure through direct MSCI World Index, MSCI Europe ex UK, Public Equity and indirect S&P 100, strategic stake in VTB Bank ownership of global equities Table 5.1.1. Target Asset allocation Traditional

Exposure through Sovereign, supranational, agency and Fixed Income bonds and corporate investment grade bonds and money market money market instruments Portfolio as of Portfolio as of Target Portfolio instruments 31.12.2015 31.12.2016 31.12.2016

Fixed Income 82.1% Fixed Income 80.0% Fixed Income ≥ 70% Exposure Commitments to IFC AMC managed funds, Equities 10.2% Equities 12.2% Equities ≤ 15% Private Equity through private Private Equity Separately Managed Mandate equity funds with Neuberger Berman and EBRD EPF Fund. Real Estate 4.6% Real Estate 4.4% Real Estate ≤ 10% Gold 3.1% Gold 3.4% Gold ≤ 5%

Prime office space in Moscow, London, Paris, Seoul, Tokyo, and Milan; Exposure Co-investment in “Junghof Plaza” in Frankfurt, through direct with PGIM’s “European Value Partners”; 3-month LIBOR (3-month benchmark for the public equity Alternative Real Estate property EURIBOR for assets portfolio. acquisitions and Commitments to real estate funds making real estate funds denominated in EUR) is selected commercial investments in Asia-Pacific, as the benchmark for the fixed Table 5.1.2. provides a summary Europe and United States, as well as logistics income and money market snapshot of SOFAZ’s current investments in Japan. instruments portfolio, while investment approach and its the MSCI World Index is the implementation to the portfolio:

Exposure Gold through physical Investments through gold bars purchase

50 51 05 INVESTMENT REPORT

Internal Portfolio Management External managers

One of the unstated missions Fund puts special emphasis the field. At the end of the As of December 2016, 8.5% The following external of assets). of SOFAZ is to promote and to on bringing all asset classes year under review, 91.5% of of SOFAZ’s investment managers were responsible For equity portfolio: enhance asset management under internal management the investment portfolio was portfolio was managed by for managing the portion of • UBS Asset Management industry standards in as it builds extensive managed internally. external managers. Benefits SOFAZ assets: – manages USD 1 274 mln. Azerbaijan. Therefore, the knowledge and expertise in brought by external For fixed income portfolio: (3.9% of assets); managers include market • World Bank – the World • State Street Global expertise, specific industry Bank Treasury manages Advisors (SSgA) – experience and regional USD 226 mln. (0.7% of manages USD 1 215 mln. presence thereby adding assets); (3.7% of assets). value to the investment • Deutsche Bank Advisors – Chart 5.1.1. portfolio. manages USD 102 mln. (0.3% SOFAZ’s investment portfolio breakdown by geographic regions

5.2. SOFAZ Investment portfolio GLOBAL ECONOMY REVIEW

Global growth divergence continued

The year began at a low start, having dwindled for a long activity rebounded with growth rebalancing itself period of time and hitting strongly in the United in emerging and developed the 12-year bottom at the States (1.6%) despite a countries, the FED gradually beginning of the year with the weak first half. Output normalizing its monetary decision to limit production, remains below potential in policy by rising interest which will be effective from the euro area (1.8%), while rates once in 2016 and ECB’s January 2017. the Japanese growth rate announcement of tapering (1.0%) outperformed the the QE in 2017, major political Contrary to 2015, when estimations. The picture events, namely the United the global growth missed for emerging markets and Kingdom voting to leave the the expectations, the developing economies EU and Americans voting global growth in 2016 (EMDE) remains much more Europe Asia North America Australia & Oceania to elect Donald Trump as was recorded at 3.1% (IMF, diverse. The growth rate in president, shifting the market World Bank), broadly in line China was stronger than International Financial Middle East South America Organizations 3.07% sentiment shaped the year of with projections. Among expected (6.7%), supported 2016. Oil price recovered after advanced economies, by continued policy stimulus,

52 53 05 INVESTMENT REPORT

Chart 5.2.2. Inflation rates in major economies (2011-2016, percentages)

however still big concerns about with the bottoming out the inflation rate (CPI 0.2%); slowdown remained. On the commodity prices, but core however, have failed to lift the other hand, Russia ended year inflation rates have remained inflation to the target level. In with -0.2% growth rate beating broadly unchanged and the US, despite the FED trying the previous expectations of generally below the targets. In to be responsive and not as further significant economic the Euro Area, negative policy hawkish as expected due to contraction. interest rates and extensive global market shocks, the unconventional measures inflation was approaching Headline inflation rates implemented by the ECB have target of 2.0%, leading to have recovered in advanced helped to support the economic the implementation of more economies in recent months activity and somewhat recover cautious pace of hikes.

Chart 5.2.1. GDP growth rate in major economies (2011-2016, percentages) Jun 2011 Mar 2011 Sep 2011 Jun 2013 Jun 2012 Dec 2011 Jun 2016 Jun 2015 Jun 2014 Mar 2013 Mar 2012 Mar 2016 Mar Mar 2015 Sep 2013 Sep 2012 Mar 2014 Sep 2016 Sep 2015 Sep 2014 Dec 2013 Dec 2012 Dec 2016 Dec 2015 Dec 2014

US Eurozone UK Japan China Source: Bloomberg

Policy Reaction – Major players

The low bond yields impact was investors to go even further the monetary policy in US and getting stronger, influencing all along the curves, increasing Europe diverged even more, investors. The responsive moves durations and risks. Additionally, with significant widening in the by ECB, as well as BoJ stepping the markets were shocked with short term rates. into negative area with shocks unexpected Brexit decision Mar 2011 Sep 2011 Mar 2012 Sep 2012 Mar 2013 Sep 2013 Mar2014 Sep 2014 Mar 2015 Sep 2015 Mar 2016 Sep 2016 on credit markets cleared that and further surprise proceeded Being consistent with the year would not be good for with Bank of England forced previously declared steps, the sovereign bonds, pressuring to act responsively to the key interest rates were lowered yields across different countries environment created by the by the ECB again on March 16, and pushing most developed decision and to ease the policy pushing marginal rate to 0.25%, market yields into the negative rate. On the other side of the sticking the repo rate to 0%, zone, even Swiss curve all Atlantic, the Fed proceeded and diving even further into US Eurozone UK Japan China (RHS) Source: Bloomberg below zero. This pushed with a further hike. Therefore, negative area with depositing

54 55 05 INVESTMENT REPORT

Chart 5.2.3. Chart 5.2.4. Central Banks’ benchmark interest 10 Year generic yield (percentages) rates (2008-2016, percentages) 3

2.5 8 2 6 1.5 4 1 2 0.5 0 0 -2 -0.5 Jan-2011 Sep-2011 Jan-2012 Jan-2013 May-2011 SeP-2016 Jan-2016 Jan-2015 Sep-2012 Sep-2013 Jan-2014 Sep-2015 Sep-2014 Jan-2010 Sep-2010 May-2012 May-2013 May-2016 May-2015 May-2014 May-2010 Jan-2009 Jan-2008 Sep-2009 Sep-2008 May-2009 May-2008 Jul-2016 Apr-2016 Jun-2016 Oct-2016 Mar-2016 Feb-2016 Jan-2016 Nov-2016 Sep-2016 Aug-2016 Dec-2016 ECB FED BoJ PBOC BOE Source: Bloomberg May-2016

Germany France Japan UK USA Italy Source: Bloomberg

At the beginning of the about the capability of China lending rates unchanged at year, PBOC announced an to make a soft landing. To 1.50% and 4.35%, respectively. rate set at -0.4%. Additionally, of the referendum, almost A different scenario was in accelerated depreciation support the declared policy, Main source of concern the monthly asset purchase immediately imposing the practice in the US during 2016. of Yuan to prevent further PBOC implemented a further remained as China continued program was increased by GBP 60 Billion sovereign and decline in the growth rates. 50bps cut in the reserve to rely on increasing leverage 33% to EUR 80 Billion monthly, GBP 10 Billion Corporate Despite the market shocks However, these measures requirement rate bringing it to to sustain high level of growth pushing the yields further into bond purchase program, with during the whole year, the FED only served to fuel concerns 17%, but left the deposit and and economic activity. negative territory. Moreover, a subsequent rate cut to implemented the hike by the the procedures pressured 0.25%. All of the measures in end of the year, with Fed funds the yields on Corporate place with Brexit uncertainty target rate linked at 0.5%-0.75%. Fixed income securities as affected the Sterling and Additionally, the US election Fixed Income the program extended the forced it to hit its lowest intensified the sell-off in US Markets types of securities eligible for level in decades. Despite Treasuries, with US 10-year, purchase. Backed by promising the decline in Sterling, the which traded at 1.85% on the economic indicators and upon preventive measures absorbed early November, rising 75bp As a result of the Brexit, the respectively by pressuring USD 12 Trillion. Additionally, accomplishing certain targets the negative impact on by the mid December. It was investors turned more risk biggest share of EURO the significant tightening and in order to prevent any general economy and UK expected that Donald Trump averse and pushed the 10 Sovereign debt to trade in the European Sovereign uncertainties in the market, the completed the year with would push through a fiscal year Bund to the all-time below zero level (The Spreads took place with ECB announced in December no significant declines in stimulus in the form of tax cuts low level of -0.2% by mid- negative yielding share France and Spain returning 2016 the reduction of the APP in economic activity. However, and infrastructure spending. 2016. Uncertainty over the surged to 56% of all EUR to their historical levels with the March of the following year. the vague future of single In sum, the Fed has turned shape of the U.K’s economic Sovereign Credit at Q3). The respect to Bund. But at Q4 market and uncertainty more hawkish on policy, while relationship with Europe was amount of EUR Sovereign the US election and Italian Brexit Surprise forced the Bank regarding “Article 50” built up not seeming to share equity expected to drag the growth, Negative Yield Debt was Referendum changed the of England to act quickly in significant risks, the effects markets’ optimism about with business investment in EUR 3.3 Trillion in Q3, more future market expectations, order to prevent the negative of which will potentially be Trump’s anticipated supply-side particular being crimped. than a quarter of the global slightly pushing the impact created as a result material. reforms. Market participants replied negative-yielding debt of sovereign yields up.

56 57 05 INVESTMENT REPORT

Chart 5.2.5. FX and oil Germany sovereign yield curve (percentages) 2 90 The whole year was and regaining strength indicators, the Dollar 1,5 70 abundant with increasing of populism. Despite the continued its dominance in 50 uncertainty in the global relatively weak performance the world currency markets, 1 30 framework. Major sources of USD during the first half with significant gains, 0,5 of the turmoil were the of the year due to delayed specifically after the US 10 0 major political events hikes and subdued growth presidential elections. -10 -0,5 -30 Chart 5.2.8. -1 -50 G10 Currency performance in 2016 against USD (percentages) -1,5 -70 New British Swedish Danish Swiss -2 -90 Euro Australian Zealand Norwegian Japanese Canadian Pound Krona Krone Franc Dollar Dollar Krone Yen Dollar M M M Y Y Y Y Y Y Y Y Y Y Y Y Y Y 5%

Source: Bloomberg Difference bps (rhs) 31.12.16 01.01.16 0% Chart 5.2.6. 10 year yield spreads against Germany government bonds (percentages) -5%

4

-10%

2 -15%

0 -20% Jan-16 Feb-16 Mar-16 Apr-16 May-16 Jun-16 Jul-16 Aug-16 Sep-16 Oct-16 Nov-16 Dec-16 Source: Bloomberg Source: Bloomberg France Italy Spain Portugal

At the same time, the increase in the US 10-year interest rate by The worst performer against allow the oil prices to free Clearly, under those market the end of the year pushed the Chart 5.2.7. the USD during the year was fall, a lot of concerns about conditions, OPEC may not rise in European rates, especially US sovereign yield curve (percentages) the British Pound, which the viability of the group have been controlling the oil as the Italian referendum did not end with a downfall in Italian came as no surprise after a came into place. However, market the way it once did 3.5 40 treasuries, despite the market significant drop following the on November 30, 2016, and expected to proceed, expectations. In addition, Italian 3.0 Brexit vote. GBP was followed OPEC regained its place but perception of its death Banking sector struggled under 30 by the Swedish Krona, which as major market player by was greatly exaggerated. 2.5 the weight of the bad loans, suffered as a result of the very agreeing to reduce the which forced the government 2.0 accommodative monetary output for 1.2 million barrels 2016 closed with a significant to take action. Nevertheless, 20 policy, and Euro, while per day. Despite the OPEC’s regains in the oil prices with 1.5 the country’s banking shares Canadian dollar and Japanese incapability to initially make approximately 50% gain for remained deeply under water 1.0 Yen ended the year on a better a decision, they finally Brent and close to 40% gain for the year. As a result of all the 10 note, outperforming all the reached an agreement to for WTI. The year ended with turmoil, the 10-year Italian BTPs 0.5 rose slightly above 60bp over the other G10 currencies. limit production, which had a oil prices stable above the last quarter, while the Bunds and 0 0 significant impact on market 50 USD/b, which was actually 1 M 3 M 6 M 1 Y 2 Y 3 Y 5 Y 7 Y 10 Y 30 Y comparable French treasuries When the OPEC decided expectations and raised the consistent with OPEC’s plans. rose 33bp and 50bp, respectively. not to cut the output and oil prices by the end of year. Source: Bloomberg Difference bps (rhs) 31.12.16 01.01.16

58 59 05 INVESTMENT REPORT

Chart 5.2.9. Chart 5.2.11. Oil prices in 2016 (USD) SOFAZ continued Breakdown of fixed income portfolio by geographical diversification geographical distribution (percentages) of fixed income portfolio. The 44.4% Fund slightly underweighted Europe its exposure to Europe 24.4% (44.4%), whereas the North America exposure to North America 22.6% was maintained almost the Asia

same with a slight increase 4.5% from approximately 23.2% Australia & Oceania

in 2015 to 24.4% in 2016. International Financial 3.8% Holdings in other regions Organizations 0.2% remained relatively stable. South America

0.1% Middle East Jul-2016 Apr-2016 Jun-2016 Oct-2016 Mar-2016 Feb-2016 Jan-2016 Nov-2016 Sep-2016 Aug-2016 Dec-2016 May-2016

31.12.16 30.06.16 31.12.15 Source: Bloomberg Brent WTI

SOFAZ’s Fixed Income Investments The portion of fixed coupon this strategy was consistent considered to be short, for securities was decreased to with market expectation and the purpose of protecting it In 2016, SOFAZ’s exposure to continued to increase its papers was decreased even 41.40% in 2016 from 48.71% in the designed both to benefit from from adverse movements in government agencies and holdings at financial bonds further due to lower money- previous year and the overall potential rate hikes, increase the interest rates. Additionally, international organizations to gain additional pick up, market yields and lack of fraction of floating rate notes in yields and widening spreads the fixed income portfolio is increased around 3.3% particularly in Euro issued opportunities in Euro. Coming and money market instruments in the bond markets. However, consistent with the previous well compared to the previous securities. Exposure to the to the sovereign debt, slight (including deposit and cash) the duration in the overall diversification across industries year. Moreover, the Fund short-term commercial reduction may be observed. was increased. The aim of fixed income portfolio is still and sectors.

Chart 5.2.10 Chart 5.2.12. Breakdown of fixed income portfolio by product types (percentages) Breakdown of fixed income portfolio by security type (percentages)

35.0% Corporate bonds

23.2% Financial bonds

16.0% Agencies and international organizations

12.7% Deposit and cash 19.34% 39.27% 41.4% 6.6% Short-term commercial paper(money markets) Money Market Floating Fixed

6.5% Sovereign debt securities

0% 5% 10% 15% 20% 25% 30% 35% 40% 45%

31.12.16 30.06.16 31.12.15

60 61 05 INVESTMENT REPORT

EQUITY INVESTMENTS

Public Equity market review

Overall, 2016 was a strong year UK’s benchmark FTSE 100 index to show its impact. 100 index, generated the local to -6.60% (+11.57% in USD terms). equity portfolio in for global equities. MSCI World posted an extraordinary all-time return of 11.32% throughout the The local return of the portfolio 2015, the results measured index, the gauge of the stock high of more than 14.43% at the The leading Japanese market year. SOFAZ continues to hold tracking MSCI Europe ex-UK in base currencies (given market performance of developed end of the year. Worth to mention index, Nikkei 225 posted an annual an equity stake in VTB bank, a index was 2.75% (+2.76% in EURO in parentheses) should be countries posted 7.51% total return that Brexit vote caused Sterling return of 0.42%. state-controlled Russian bank. terms) in 2016. If compared to considered. in the previous year. The biggest to devalue against USD, which In 2016, its local return equaled the performance results of the contributor to such a bold return was also a stimulus to British stock While most of the stock markets was the United States, whose market and exports. rallied during the year, some flagship S&P 500 index ended countries ended the year with PRIVATE EQUITY 2016 with the return of 9.54%. With During 2016, STOXX Europe 600 losses. Among these Italy, whose this, S&P 500 has finished four out Index indicated a loss of 1.20%. In FTSE MIB lost 10.20% in the course of five previous years in a positive terms of size, midcaps (+3.53%) of 2016, had troubles with its Private Equity market territory. Among the sectors of significantly outperformed large banking sector. Another country review 2016 the US economy, energy (+23.65%), caps (+0.58%) and small caps was China, whose benchmark financials (+20.14%) and telecom (-0.79%). The banking sector index Shanghai Composite closed (+17.81%) were the biggest winners. particularly suffered in 2016, as the the year with a loss of 12.31%. Private Capital markets unrealized value, total Private 9,719 financings with a record Healthcare was the only sector that negative interest rate policy from had another healthy year of Equity AUM currently stands aggregate value of USD 134 finished the year with losses (-4.36%). the European Central Bank started capital raising with USD 347 at USD 2.49 trillion. Given 984 billion. Dry powder levels bln. aggregate capital raised market exits valued at some increased by 8.6% and stood by 830 Private Equity funds USD 328 billion, buyout funds at USD 820 bln. increasing the Chart 5.2.13. throughout the year. Combined exit value dropped from 2015. competition over deals in the MSCI World Index (2006-2016, index points) with an increase in the Venture capitalists engaged in market among funds.

Private Equity portfolio

Currently, SOFAZ has a Caribbean. The fund makes markets. To date, the fund has commitment to three funds investments mostly in Argentina, USD 418 million in commitments. managed by IFC Asset Brazil, Chile, Colombia, Cote SOFAZ’s commitment in IFC Management Company, Private D’Ivoire, Dominican Republic, Catalyst Fund is USD 50 million, Equity Separately Managed Kenya, Mexico, Nigeria, Trinidad representing 12% stake as a Mandate with Neuberger and Tobago, and Uganda. Limited Partner. Source: Bloomberg Berman and EBRD EPF Fund. SOFAZ’s commitment in The description of each fund is ALAC Fund is USD 100 million, • IFC Global Infrastructure Fund outlined below: representing 10% stake as a was established in 2013 and Public Equity Portfolio Limited Partner. makes equity and equity- • IFC African, Latin American, and related investments in the By the end of 2016, SOFAZ had a local return of 4.96% (+5.63% in The return of the portfolio Caribbean Fund (ALAC) is a USD • IFC Catalyst Fund was infrastructure sector in global increased its public equity USD terms). The Fund mitigates tracking MSCI World accounted 1 billion fund established in 2010 established in 2012 as a fund of emerging markets. To date, the portfolio to 9.20% of total AUM, portfolio volatility by investing for 9.54% local return (+7.72% and makes equity and equity- funds and makes investments fund has commitments of USD compared to 7.70% in 2015. the largest proportion of the in USD terms) in 2016. SOFAZ’s related investments across all in selected renewable energy 1.2 billion and SOFAZ’s portion in Throughout the year, public equity portfolio into the well internally managed portfolio, industry sectors in Sub-Saharan and resource efficiency-focused it is USD 200 million representing equity investments generated diversified MSCI World index. which is benchmarked to S&P Africa, Latin America, and the private equity funds in emerging 16.67% stake as a Limited Partner.

62 63 05 INVESTMENT REPORT

Real Estate Market highlights

• As of 2015, SOFAZ has and co-investments in the to participate in the EBRD’s Throughout the year, global real 6% below 2015, which was the Since 2010, annual all initiated a Private Equity Developed Markets, primarily direct equity investment estate markets experienced third most active year on record. property rental growth in the Separately Managed Mandate in North America and Western strategy. The focus is mainly several shocks. Financial market top eight* was 4.6% per year, with Neuberger Berman, a Europe through the mandate. on EBRD investment regions, volatility and concerns about Leasing markets maintained a compared to a more modest prominent US based asset such as Central and Eastern growth in China weighed on healthy pace in 2016. For the 3% per year for all global manager, with USD 200 mln. • In 2016, SOFAZ committed Europe, Mediterranean, Central sentiment and activity during full year, leasing volumes were markets. total commitment. SOFAZ EUR 100 million to EBRD Equity Asia etc. SOFAZ’s portion in it the early part of the year, down modestly by only 3% on will be investing in Buyout, Participation Fund, which represents 28.57% stake as a before political events in the the robust levels of 2015. While global leasing volumes Mezzanine, Growth funds enables institutional investors Limited Partner. form of “Brexit” in the UK and are forecasted to be broadly the U.S. presidential election At year-end the global office stable on 2016 levels, new surprised markets in the latter vacancy rate fell to 11.9% for the deliveries are expected to part. first time in this cycle, reaching peak in 2017 and the global Chart 5.2.14. Investment to its lowest level since Q3 2008. office vacancy rate to trend Breakdown of private equity funds by sectors the new, semi- 2016 commercial real estate Vacancies continued their slowly upwards over the next investment transaction volumes downward trend in the Americas, 12 months. Prime rental growth 2.7% submersible 4.1% 1.1% Industrials came in ahead of initial but we also witnessed surprise is set to soften further to 3.3% drilling rig 2% Banking expectations at USD 661 billion, falls in Europe and Asia Pacific. around 2% for the full year. 4.6% Technology & Software In 2016, the Fund invested 0.9% Energy 2.9% 28.9% USD 97.7 million (AZN 153.0 Infrastructure million) in the charter capital Chart 5.2.16. Non-banking financial institutions 2016 YOY Change in Transaction Volume of 14.2% of the Azerbaijan Rigs LLC, Renewable energy global commercial real estate formed with the participation Housing & Hotels of State Oil Fund (90%) and Oil & Gas State Oil Company (10%). Cleantech and resource efficiency The maximum budget limit Health & Education of the project is USD 1 116.7 Other million. The charter capital 13.3% 22% is formed by periodic capital contributions from SOFAZ and SOCAR in order to fulfil payments to the contractors. Chart 5.2.15. According to the Engineering Breakdown of private equity funds by regions Procurement Construction and Management Contract 1.4% 0.7% 4.5% dated 24 June, 2013 Caspian Drilling Company LLC is a 8.3% project contractor, which was founded by State Oil Latin America and Carribean Company and is the owner of existing drilling rigs in the 42.5% Africa 17.3% Caspian Sea. The project is Asia and the expected to be completed in Pasific 7 months. Global North America

China Source: Real Capital Analytics Middle East & North Africa

25.2%

64 Note: Top eight markets refers to New York, London, Tokyo, Los Angeles, Paris, San Francisco, 65 Washington DC, and Hong Kong. 05 INVESTMENT REPORT

Chart 5.2.17. All property rental growth: top eight* vs global

Top Eight Markets Global Average Source: PGIM Real Estate

CURRENT REAL ESTATE PORTFOLIO Investments in 2016 Indirect Investments Direct Investments Consistent with its real The Fund was established 2015 with the size of EUR Palazzo Turati. On May addition to an exhibition hall on estate strategy of building in 2014 with the size of EUR 457 million and makes real 2016, SOFAZ has reached an the ground floor. The net leasable a diversified risk adjusted 445 million and makes real estate investments mostly agreement to acquire Palazzo area of this prime asset is 10 360 portfolio across geographies, estate investments mostly in in Germany and France. Turati, an office property in Milan square meters. The historical real estate types, and UK, Germany, France, Italy. SOFAZ’s committment in EVP for EUR 97 million. Palazzo Turati building is dated 1880 and is part investment strategies, SOFAZ SOFAZ’s committment in is EUR 100 million as a Limited is located at Via Meravigli 7 in the of Milan’s cultural heritage. The made investments to the PEVAV is EUR 100 million as a Partner. historical center of Milan, just a building has recently undergone following private real estate Limited Partner. step away from Piazza Cordusio, major restoration works. The funds: • Blackstone’s “Black Stone and 500 m from Duomo. property is leased in its entirety • PGIM’s European Value Real Estate Partners Europe to Milan Chamber of Commerce. • AXA’s Pan European Value Partners fund (EVP). The V” (BREP EUROPE V). The The building has six floors above This is the first property Added Venture fund (PEVAV). Fund was established in Fund was established in 2016 the ground for office use, in acquisition of SOFAZ in Italy.

66 Note: Top eight markets refers to New York, London, Tokyo, Los Angeles, Paris, San Francisco, 67 Washington DC, and Hong Kong. 05 INVESTMENT REPORT

with the target size of EUR 7.5 commitment in PREP is USD 100 target size of USD 1 billion Moscow. As a result of this valuation results and valuation Appraisal, KRW 496 350 000 000 billion and makes commercial million as a Limited Partner; and makes logistics real program, net operating companies are as below: • Kirarito Ginza, Daiwa Real real estate investments across estate investments in Japan. income fell compared to 2015, • 78 St James Street, Knight Estate Appraisal, all asset class in Europe. The • PGIM’s “Asia Property Fund SOFAZ’s commitment in RJLF II associated with the loss of Frank LLP, GBP 190 315 000; JPY 54 100 000 000 fund will be investing mostly in III” (ASPF III). The Fund was is USD 100 million as a Limited rental income and capital • 8, Place Vendome, BNP Paribas • Palazzo Turati, CBRE, UK, Germany, Spain and Italy established in 2015 with the Partner. expenditure. Real Estate, EUR 175 000 000 EUR 99 000 000 starting from 2016. SOFAZ’s size of EUR 580 million and • Tverskaya 16, Cushman & commitment in BREP EUROPE V makes commercial real estate • Starwood Group’s “Starwood All six assets were independently Wakefield, RUB 4 973 000 000 is EUR 100 million as a Limited investments across all asset Global Opportunity Fund valued at the end of 2016. The • Pine Avenue Tower A, Kyungil Partner. class in Asia-Pacific. The fund XI” (SOF XI). The Fund was makes investments mostly established in 2016 with the • PAG’s “PAG Real Estate in Australia, China, Japan, target size of USD 5-6 billion Partners” (PREP). The Fund South Korea, Singapore and and makes commercial real was established in 2014 with Malaysia. SOFAZ’s commitment estate investments across all Gold investments the size of USD 1.3 billion and in ASPF III is EUR 100 million as asset class in United States makes commercial real estate a Limited Partner; and Western Europe. The fund According to the “Investment By the end of 2016, 30 175 kg of transfer the purchased gold to investments across all asset will be investing mostly in US Guidelines”, up to 5% of gold (970 146 troy ounces) was Azerbaijan and by the end of class in Asia-Pacific. The fund • E-Shang Redwood’s starting from 2017. SOFAZ’s the SOFAZ’s assets can be included into SOFAZ’s investment 2016, 30 169 kg of gold has been makes investments mostly “Redwood Japan Logistics commitment in SOF XI is invested into gold. portfolio. Starting from January transferred to Azerbaijan. in Australia, China, Hong- Fund II” (RJLF II). The Fund was USD 200 million as a Limited 11, 2013, SOFAZ began to Kong and Japan. SOFAZ’s established in 2016 with the Partner.

Co-investments 5.3. SOFAZ INVESTMENT PORTFOLIO PERFORMANCE • In 2016, SOFAZ has reached fund to make co-investment Frankfurt city centre. SOFAZ’s an agreement with PGIM’s to the property located at equity portion in the co- “European Value Partners” Junghof Strasse 14/16 in the investment is EUR 41 million. Performance measurement methodology

Annual earnings Returns on SOFAZ’s assets performance of the total respective (local) currency and are calculated in accordance investment portfolio, AZN, USD in USD selected as the base As of the year end, the real • London, 78 St James Street, • Tokyo, Kirarito Ginza, with the “Performance and EUR are selected as the currency (provided the impact estate portfolio consisted of six GBP 9 650 084; JPY 1 977 659 392 measurement methodology for base currencies; in this case of the currency component is assets located in London, Paris, • Paris, 8 Place Vendome, • Milan, Palazzo Turati, the investment portfolio and performance is calculated indicated). Moscow, Seoul, Tokyo and Milan. EUR 5 860 555; EUR 3 072 527. sub-portfolios of the State Oil without taking into account During 2016, gross rents • Moscow, 16 Tverskaya, Fund”, approved by the Internal currency exchange fluctuations. The following figures are mentioned below were RUB 250 606 000 RUB; In 2016, the initiated Resolution No.5 dated April 21, For calculating performance based on the performance of collected from the six respective • Seoul, Pine Avenue Tower A, redevelopment program 2009. In accordance with this of each sub-portfolio, the investment portfolio measured in investments: KRW 30 992 844 997; continued in Actor Gallery, methodology, for calculating returns are measured in the local currencies.

68 69 05 INVESTMENT REPORT

4.49% Chart 5.3.1. Chart 5.3.4 SOFAZ investment portfolio: SOFAZ rate of return 4.14% Contribution to total performance by rate of return asset class* 3.85% in 2016 4% 4.49% 3.13%

The total rate of return on SOFAZ’s investment 3.79% 3% 2.66% portfolio was 1.92%. Historical returns for the 2.58% 2.46% 0.51% 0.14% period of 10 years starting from 2007 and monthly 3.29% 2.35% 1.27% 2.22% 2.19% cumulative returns for the year of 2016 are 2% illustrated in charts 5.3.1 and 5.3.2, respectively: 2.16% 1.77% In 2016, annual returns for fixed income, equity 1.92% 1% 0% 10% 20% 30% 40% 50% 60% 70% 80% 90% 100% (public and private) and real estate investments 1.52% 1.24% *Performance of the Gold investments is not

were 1.58%, 3.65%, and 2.75%, respectively, while 0.99% included into the total performance results Fixed income Equities Real Estate 0.83% because it is treated as FX effect. their corresponding contributions to the total 0% performance of the investment portfolio (1.92%) 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 accounted for 1.27%, 0.51% and 0.14% (Chart 5.3.4.). RoR Moving average Chart 5.3.5. Cumulative monthly fixed income performance

0.30% 1.8% 1.58% 1.44% 1.6% 0.25% 1.33% 1.39% 1.27% 1.4% Chart 5.3.2. 1.14% Cumulative monthly performance 0.20% 1.2% 0.97% 0.80% 1.0% 0.15% 0.68% 2.50% 0.8% 0.55% 0.6% 1.92% 0.10% 2.00% 0.35% 0.24% 0.04% 0.05% 0.02% 1.50% 1.28% 1.13% 1.23% 1.42% 1.02% 0.00% 0.00% 1.00% 0.51% 0.50%

Monthly return Jul-16 Apr-16 Jun-16 Oct-16 Mar-16 Feb-16 Jan-16 Nov-16 Sep-16

0.50% Aug-16 Dec-16 0.23% 0.32% May-16 0.00% Cumulative return 1 month RoR 12 month Cumulative return -0.50% -0.27% -0.28% Chart 5.3.6. Jul-16 Apr-16 Jun-16 Oct-16 Mar-16

Feb-16 Cumulative monthly public equity performance Jan-16 Nov-16 Sep-16 Aug-16 Dec-16 May-16

6% 4.96% 4% 70% 4% Chart 5.3.3. Performance of asset 2% 60% 3.5% 0.34% 0.90% classes and weights of Jan-16 Feb-16 Apr-16 Jun-16 Oct-16 3.65% 50% 66.25% 3% their contributions in total 0% performance (1.92%)* Mar-16 May-16 Jul-16 Aug-16 Sep-16 Nov-16 Dec-16 40% 2.5% -2%

2.75% -1.16% -0.49% -0.90% -2.71% 30% 2% -4% Weights in total Rates of return -3.71% -3.95% performance -4.62% 20% 1.5% -6% 1.58% 7.33% 10% 26.42% 1% -6.15% -8% -7.67% 0% 0% *Performance of the Gold investments is not included into the total -10% Fixed income Equities Real Estate performance results because it is treated as FX effect.

1 month RoR 12 month Cumulative return

70 71 05 INVESTMENT REPORT

3.0% Chart 5.4.2. Contribution to equity VaR 2.5% 5.4. 2.46% RISK 2.0% MANAGEMENT 1.92% 1.5% Risk management and risk repectively, and 22 bps for the 1.36% monitoring procedures of SOFAZ MSCI Europe ex UK index mandate 1.0% include analysis across risk portfolio managed by the UBS. classes. Market risk and credit 0.5%

risk indicators, as well as other For the purpose of internal risk 0.15% relevant measures, are reported management, Value at Risk (VaR) 0.0% MSCI VTB MSCI EUR S&P100 both internally and externally. The is a common and valuable mea- World measures of assessing market risk sure of total risk. We obtain VaR include Value at Risk, tracking of the portfolio using Monte Carlo error, scenario analysis, stress and historical simulations. As of Chart 5.4.3. tests etc. 31.12.2016, the Fund’s 20 day ho- Contribution to Fixed Income VaR by product rizon 95% VaR accounted for USD types (ex FX, bps) To monitor the risk of divergen- 342 million compared to USD 329 ce of our sub-portfolio returns million at the end of the previous Financial bonds 6.21 from their passively tracked year. benchmarks, tracking errors are Corporate bonds Credit risk management 4.36 continually observed. Ex-ante The calculation of VaR and is another crucial part of tracking error limits for the equity contributions to VaR of different Sovereign debt SOFAZ’s risk procedures. securities sub-portfolios managed by UBS sub-portfolios is based on local 1.18 The Fund’s “Investment

Global Asset Management (UBS) returns, since the impact of FX Agencies Guidelines” sets restrictions and State Street Global Advisors fluctuations might considerably 0.67 on the credit ratings of issuers (SSGA) are established at the skew the results, especially those International and securities. The Chart level of 30 bps on an annual ba- of the fixed income instruments. organizations 0.35 5.4.4. represents the change sis. As of 31.12.2016, the tracking However, due to the minor impact Short-term in the composition of the errors on an annual basis were 6 of FX fluctuations on the VaR of commercialpaper 0.12 portfolio by credit rating from bps and 7 bps for the MSCI World equities, FX effect is not excluded (money markets) 2015 to 2016.

index mandate portfolios ma- from the results of the latter. Deposit 0.08 naged by the SSGA and the UBS

Chart 5.4.4. Composition of the portfolio by credit ratings 1.0% Chart 5.4.1. 31.12.2016 30.06.2016 31.12.2015 Contribution to total VaR 20.35% 0.8% by asset classes (ex FX) AAA

0.77% 27.93% 0.6% AA

34.81% 0.4% A

16.77% 0.2% 0.20% BBB 0.13% 0.09% 0.13% 0.0% Non Equity Real Estate Fixed income Gold Investment 0% 5% 10% 15% 20% 25% 30% 35% 40%

72 73 F1 Grand Prix June 17-19,2016, Baku Baku Chess Olympiad

42nd Chess Olympiad was held in Baku , in 2016, during September 1 – 14, 2016. The Olympiad, which was hosted by Azerbaijan, is considered the most popular race competition up until now. 175 countries had been registered to participate in this outstanding contest. There were 181 men’s and 142 women’s teams that competed with each other. For the number of countries participated, it is a record number in the history of the Olympiad. Azerbaijan was represented in the Olympiad by 3 men’s and 3 women’s teams.

The winners of the Olympiad in the men’s section were the team of the USA with 20 points. Ukraine also scored 20 points, but had to settle for the second place on a tie-breaker. Russia finished in the third place with 18 points.

Meanwhile in the women’s section, China took the first place with 20 points, whilst the Polish women’s team won the second place scoring 17 points, followed by Ukraine with the same match points. 06 2016 SOFAZ BUDGET EXECUTION

2016 SOFAZ 6 BUDGET EXECUTION

Revenues

In 2016, the revenues SOFAZ income in 2016. of this revenue constituted SOFAZ’s 2016 accrued to SOFAZ were 50% of the estimated level formed from sales of the In accordance with the (AZN 0.16 million). The Republic of Azerbaijan’s terms of the agreement reasons of bonus incomes budget was approved share of hydrocarbons, concluded between being under-fulfilled were fees paid to Azerbaijan SOCAR, BP Exploration the lower than forecasted for the oil and gas transit Limited and a SOCAR- amount of gas sales along by the Presidential through its territory, bonus affiliated company with the Baku-Tbilisi- payments, acreage on regulation of oil Jeykhan pipeline’s abating fees and revenues from prospecting, exploitation transport capacity. management of SOFAZ’s and production sharing Decree №719 on assets. at the Shafag-Asiman The revenues obtained offshore field in the from the transit of oil and In 2016, revenues from the Azerbaijani sector of the gas through the territory of December 29, 2015. sale of profit oil and gas Caspian Sea, USD 2.1 Azerbaijan in the reference constituted AZN 8 320.0 million or AZN 3.3 million of year amounted to USD million, or USD 5 189.1 acreage fees were paid to 11.3 million, or AZN 18.0 million. Because of higher SOFAZ. This revenue item million. Compared to the than projected oil prices was executed at 97.1%. budgetary target of AZN throughout the reference The downturn in exchange 19.3 million, the execution In 2016 SOFAZ’s budget revenues thousand to AZN 4 578 474.6 Due to the fluctuations in year, the respective rate on the day of the of aforementioned item and expenditures were projected to thousand, while total budget exchange rates of the currencies revenue article was US dollar-made payment was recorded at 93.3%. constitute AZN 6 711 564.1 thousand expenditures were increased from comprising SOFAZ’s investment overfulfilled at the level of that was lower than that and AZN 8 181 399.7 thousand AZN 8 181 399.7 thousand up to portfolio against the Azerbaijani 114.7% of what it had been projected in the budget The revenues accrued respectively. According to the AZN 10 668 933.7 thousand. manat, SOFAZ recorded foreseen (AZN 3 875.7 (1.62 manat per USD) to SOFAZ from the Law of the Republic of Azerbaijan AZN 5 356.1 million of extra- million). That is, the caused the 2.9% under- management of its asset “On changes to the Law “On the In 2016, SOFAZ’s revenues expressed budgetary revenues, while average sale price per execution of this revenue portfolio equaled USD state budget of the Republic of in manat terms constituted AZN 349.6 million of extra- barrel of oil constituted item. 688.5 million or AZN 1 068.8 Azerbaijan in 2016”” dated February AZN 9 410.2 million, which is 105.5% budgetary revenues were accrued USD 41.9 in 2016 (as million in 2016. Thus, the 23, 2016, amendments to SOFAZ’s more than the envisaged amount on gold. The overall amount of against USD 54.31 in 2015), Bonus payments to SOFAZ execution rate of this 2016 budget were approved by the (AZN 4 578.5 million). The actual SOFAZ’s extra-budgetary revenues whereas the USD 25 per made in accordance revenue item as against Order №852 of the President of the budget expenditures in 2016 in 2016 equaled AZN 5 705.7 million. barrel was forecasted in with the 5th Appendix to the figure forecasted in Republic of Azerbaijan dated March equaled AZN 9 022.1 million, 84.6% of On the other hand, the budget. the Production Sharing the budget (AZN 680.0 18, 2016. Amendments were made the estimated amount USD 876.1 million of extra- Agreement at the million) stood at 157.2%. in order to provide more precise (AZN 10 668.9 million). Compared to budgetary expenses were incurred Acreage fees paid by the Shahdeniz field in the figures of SOFAZ’s incomes and the 2015 figure (AZN 9 187.8 million) as a result of the fluctuations foreign investors for the Azerbaijani sector of the No incoming payment spendings. Thus, based on changes, SOFAZ’s expenditures decreased by in exchange rates between the usage of the hydrocarbon Caspian Sea constituted was registered in SOFAZ’s SOFAZ’s total budget revenues were 1.8%, and the overall budget surplus US dollar and the other foreign resources respresented USD 0.05 million (AZN 0.08 2016 budget on any other decreased from AZN 6 711 564.1 amounted to AZN 388.1 million. currencies held by the Fund. another source of the million). The execution rate revenue items.

78 79 06 2016 SOFAZ BUDGET EXECUTION

Extrabudgetary revenues Table 6.1. SOFAZ’s revenues in 2016 Total revenue (AZN million) The increased value of SOFAZ’s extrabudgetary revenues accrued Euro, Pound Sterling and other assets and currencies comprising its to SOFAZ’s budget, including currencies and AZN 349.6 million portfolio as expressed in Azerbaijani AZN 5 356.1 million from the rising stemming from the increasing value manat, AZN 5 705.7 million of exchange rates of the US dollar, of the gold reserves. Sources of revenue Confirmed Actual Execution rate

Net income obtained from the sales of hydrocarbons falling into Expenditures the share of Azerbaijan (excluding expenditures on transportation, customs clearance and banking SOFAZ’s budget expenditures fully executed at the 100.0% transfered AZN 797.4 million 1 services, independent surveyor 3 875.7 8 320.0 214.7 in 2016, planned to equal level (AZN 90.0 million). (USD 495.2 million) to the bank services, marketing and insurance, AZN 10 669.0 million, were account of the Ministry of as well as the shareholder incomes executed at the 84.6% level The budget for financing the Economy in 2016. Compared received by SOCAR in the capacity of investor, shareholder or partner in and amounted to AZN project on the reconstruction to the estimated sum in the different projects it is a party to) 9 022.1 million. In the reference of the Samur-Abhseron budget (AZN 2 355.3 million), year, SOFAZ’s expenditures irrigation system in 2016 was the execution rate of Acreage fees paid by investors per structure was as follows: executed at the 100% level this expenditure item 2 land they use for the exploitation of 3.4 3.3 97.1 (AZN 70.0 million). constituted 33.9%. The hydrocarbon reserves The transfer from SOFAZ’s incomplete execution of to the state budget in 2016 The “State Program on the the budget expenditures Fees from the transit of oil and gas constituted AZN 7 615.0 million, education abroad of the on this project is due to 3 through the territory of the Republic 19.3 18.0 93.3 which was 100% executed with Azerbaijani youth in the years the placement of foreign- of Azerbaijan respect to the sum estimated of 2007-2015” was financed currency denominated in the budget (AZN 7615.0 by SOFAZ at AZN 31.6 million bonds (eurobonds) in the Bonus payments made by investors million). manat, 86.3% of the sum international financial markets 4 within the framework of signing or 0.16 0.1 50.0 initially allocated for the by the SGC CJSC in March executing oil and gas contracts Within the framework of respective budget item (AZN 2016. This operation helped executing the 2016 SOFAZ’s 36.6 million). to raise USD 991.1 million in Revenues obtained from the budget, AZN 90.0 million was discounted value. The shift 5 680.0 1 068.8 157.2 management of SOFAZ’s assets spent on financing measures Financing the share of the of certain expenditures aimed at ameliorating social Republic of Azerbaijan in the on TANAP and TAP into the Total revenues 4 578.6 9 410.2 205.5 and living conditions of South Gas Corridor CJSC. In following years is another the refugees and internally order to fulfill the funding of reason of underfulfillment of Extrabudgetary revenues 5 705.7 displaced persons, thus the the company’s share directly this expenditure item. respective budget item was owned by the state, SOFAZ

80 81 06 2016 SOFAZ BUDGET EXECUTION

The opening ceremony of the Chess Olympiad September 1, 2016, Baku

SOFAZ’s input into the financing year, AZN 331.8 million were of the New Baku-Tbilisi-Kars allocated by SOFAZ to finance Railway project equaled AZN the project. The execution rate 66.2 million or USD 41.9 million, of the respective budget item in amounting to 48.1% of the 2016 equaled 100%. initially projected sum of AZN 137.6 million. SOFAZ’s administrative expenses in 2016 composed AZN 20.1 Financing the share of the million, equaling 61.5% of the Republic of Azerbaijan in the amount estimated in the budget STAR project. In the reference plan (AZN 32.7 million).

Table 6.2. Expenditure amount SOFAZ’s expenditures in 2016 (AZN million)

Execution Expenditure items Confirmed Actual rate

Financing measures aimed at ameliorating 1 social and living conditions of the refugees and 90.0 90.0 100.0 internally displaced persons

2 Transfer from SOFAZ to the state budget in 2016 7 615.0 7 615.0 100.0

Financing the project on the reconstruction of the 3 70.0 70.0 100.0 Samur-Absheron irrigation system

Financing the new Baku-Tbilisi-Kars 4 137.6 66,2 48,1 railway project

State Program on the education abroad of the 5 36.6 31.6 86.3 Azerbaijani youth in the years of 2007-2015

Financing the share of the Azerbaijan Republic 6 2 355.3 797.4 33.9 in South Gas Corridor

Financing the share of the Azerbaijan Republic in 7 construction of the “STAR” oil refinery complex in the 331.8 331.8 100.0 Turkish Republic

8 SOFAZ’s administrative expenses 32.7 20.1 61.5

Total expenses 10 669.0 9 022.1 84.6

82 83 FIFA U-17 Women’s World Cup

The third FIFA U-17 Women’s World Cup was held in 2012 from 22 September to 13 October. The cup, which was hosted in Azerbaijan, took place in New Zealand in 2008 and in Trinidad and Tobago in 2010. It is the first FIFA event that was held in Azerbaijan and the first U-17 Women World Cup that took place in Eurasia. The matches were organized in Baku and Lankaran, in which teams consisting of girls under 17 from 16 countries competed with each other. France was the winner of this Cup. One of the interesting facts was that the Azerbaijan-Columbia match was watched by 30 250 fans, which is a record attendance in the history of the tournament. 07

THE STATE OIL FUND OF Contents 7 THE REPUBLIC OF AZERBAIJAN INDEPENDENT AUDITOR’S REPORT CONSOLIDATED FINANCIAL STATEMENTS Consolidated statement of financial position 90 INTERNATIONAL FINANCIAL REPORTING STANDARDS Consolidated statement of profit or loss and other comprehensive income 91 CONSOLIDATED FINANCIAL STATEMENTS AND Consolidated statement of changes in equity 92 INDEPENDENT AUDITOR’S REPORT Consolidated statement of cash flows 94

31 December 2016 NOTES TO THE CONSOLIDATED FINANCIAL STATEMENTS 1 Introduction 96 2 Operating environment of the Fund 98 3 Summary of Significant Accounting Policies 99 4 Critical accounting estimates, and judgements in Applying Accounting Policies 110 5 Adoption of new or revised Standards and Interpretations 110 6 New Accounting Pronouncements 111 7 Cash and cash equivalents 113 8 Trading securities 116 9 Other financial assets at fair value through profit or loss 119 10 Financial assets at amortised cost 120 11 Gold bullion 122 12 Investment properties 122 13 Investments in Joint Ventures 125 14 Capital contributions 126 15 Non-current liabilities 127 16 Interest income and other investment income 128 17 Foreign currency translation differences 128 18 Fair value loss on financial assets at fair value through profit or Loss 129 19 Operating expenses 129 20 Transfers by the Fund 130 21 Income taxes 130 22 Fair value of financial instruments 131 23 Financial risk management 135 24 Commitments and contingencies 143 25 Transactions with related parties 143 26 Interests in structured entities 145 27 Events after the reporting period 146

87 INDEPENDENT AUDITOR’S REPORT To the Supervisory Board of the State Oil Fund of the Republic of Azerbaijan:

What we have Auditor’s responsibilities for the the audit of the consolidated financial Our opinion audited Basis for opinion statements

In our opinion, the consolidated The Fund’s consolidated financial state- We conducted our audit in accordance Our objectives are to obtain reasonable design audit procedures that are appro- tion of the entities or business activities financial statements present fairly, in all ments comprise: with International Standards on Auditing assurance about whether the consoli- priate in the circumstances, but not for within the Fund to express an opinion on material respects, the financial position • the consolidated statement of financial (ISAs). Our responsibilities under those dated financial statements as a whole the purpose of expressing an opinion on the consolidated financial statements. of the State Oil Fund of the Republic position as at 31 December 2016; standards are further described in the are free from material misstatement, the effectiveness of the Fund’s internal We are responsible for the direction, su- of Azerbaijan (the “SOFAZ”) and its • the consolidated statement of compre- Auditor’s Responsibilities for the Audit of whether due to fraud or error, and to control. pervision and performance of the group subsidiaries (together — the “Fund”) as hensive income for the year then ended; the Consolidated Financial Statements issue an auditor’s report that includes • Evaluate the appropriateness of ac- audit. We remain solely responsible for at 31 December 2016, and its financial • the consolidated statement of changes section of our report. our opinion. Reasonable assurance is counting policies used and the reason- our audit opinion. performance and its cash flows for in equity for the year ended; a high level of assurance, but is not a ableness of accounting estimates and the year then ended in accordance • the consolidated statement of cash We believe that the audit evidence we guarantee that an audit conducted in related disclosures made by manage- We communicate with those charged with International Financial Reporting flows for the year then ended; have obtained is sufficient and appropri- accordance with ISAs will always detect ment. with governance regarding, among Standards (IFRS). • and the notes to the consolidated ate to provide a basis for our opinion. a material misstatement when it exists. • Conclude on the appropriateness of other matters, the planned scope and financial statements, which include Misstatements can arise from fraud or management’s use of the going concern timing of the audit and significant significant accounting policies and other error and are considered material if, indi- basis of accounting and, based on the audit findings, including any significant explanatory information. vidually or in the aggregate, they could audit evidence obtained, whether a ma- deficiencies in internal control that we reasonably be expected to influence the terial uncertainty exists related to events identify during our audit. economic decisions of users taken on or conditions that may cast significant the basis of these consolidated financial doubt on the Fund’s ability to continue statements. as a going concern. • If we conclude that a material uncer- As part of an audit in accordance with tainty exists, we are required to draw ISAs, we exercise professional judgment attention in our auditor’s report to the Responsibilities of management and those and maintain professional scepticism related disclosures in the consolidated throughout the audit. We also: financial statements or, if such disclo- charged with governance for the consolidated • Identify and assess the risks of material sures are inadequate, to modify our misstatement of the consolidated finan- opinion. Our conclusions are based on 14 March 2017 Baku, Independence financial statements cial statements, whether due to fraud or the audit evidence obtained up to the the Republic of Azerbaijan error, design and perform audit pro- date of our auditor’s report. However, We are independent of the Fund in Management is responsible for the basis of accounting unless management cedures responsive to those risks, and future events or conditions may cause PriceWaterhouseCoopers Audit Azerbaijan LLC The Landmark Office Plaza III, 12th floor, accordance with the International preparation and fair presentation of the either intends to liquidate the Fund or obtain audit evidence that is sufficient the Fund to cease to continue as a going 90A, Nizami Street, Ethics Standards Board for Account- consolidated financial statements in ac- to cease operations, or has no realistic and appropriate to provide a basis for concern. AZ 1010, Baku, Azerbaijan ants’ Code of Ethics for Professional cordance with IFRS, and for such internal alternative but to do so. our opinion. The risk of not detecting a • Evaluate the overall presentation, T: +994 (12) 497 25 15, F:+994 (12) 497 74 11 www.pwc.com/az Accountants (IESBA Code). control as management determines is material misstatement resulting from structure and content of the consolidat- necessary to enable the preparation of Those charged with governance are fraud is higher than for one resulting ed financial statements, including the consolidated financial statements that responsible for overseeing the Fund’s from error, as fraud may involve collusion, disclosures, and whether the consolidat- are free from material misstatement, financial reporting process. forgery, intentional omissions, misrep- ed financial statements represent the whether due to fraud or error. resentations, or the override of internal underlying transactions and events in a control. manner that achieves fair presentation. In preparing the consolidated financial • Obtain an understanding of internal • Obtain sufficient appropriate audit ev- statements, management is respon- control relevant to the audit in order to idence regarding the financial informa- sible for assessing the Fund’s ability to continue as a going concern, disclosing, as applicable, matters related to going concern and using the going concern 07 CONSOLIDATED STATEMENT OF FINANCIAL POSITION

CONSOLIDATED STATEMENT OF FINANCIAL POSITION CONSOLIDATED STATEMENT OF PROFIT AND LOSS AND OTHER AS AT 31 DECEMBER 2016 COMPREHENSIVE INCOME FOR THE YEAR ENDED 31 DECEMBER 2016 In thousands of Azerbaijani Manats Notes 2016 2015 Assets In thousands of Azerbaijani Manats Notes 2016 2015 Non-current assets Financial assets at amortised cost 10 5.378.473 4.726.083 Interest income and other investment income 16 1.005.830 609.731 Investment properties 12 2.619.625 2.233.689 Net gain on foreign currency translation differences 17 5.320.847 22.460.879 Property and equipments 141.180 145.878 Net gain/(loss) on financial assets at fair value through 18 71.666 (280.607) Other non-current and intangible assets 11.316 4.288 profit or loss Investments in joint venture 13 787.589 631.895 Net gain on gold bullions 11 349.574 716.751 Net fair value (loss)/gain on revaluation of investment 12 (26.827) 50.380 Total non-current assets 8.938.183 7.741.833 properties Current assets Rental income 100.956 61.377 Cash and cash equivalents 7 6.218.035 3.361.406 Other operating income 17.535 706 Trading Securities 8 40.726.478 38.823.295 Total operating income 6.839.581 23.619.217 Other financial assets at fair value through profit or loss 9 737.966 396.969 Financial assets at amortised cost 10 142.206 139.828 Operating expenses 19 (56.250) (35.133) Gold bullion 11 1.968.469 1.618.895 Share of after tax results of joint venture 13 2.694 11.358 Other current assets 41.393 33.023 Profit before income tax 6.786.025 23.595.442 Income tax 21 (902) (1.162) Total current assets 49.834.547 44.373.416 Net profit for the year 6.785.123 23.594.280 TOTAL ASSETS 58.772.730 52.115.249 Equity Other comprehensive income: Contributed capital 14 27,632,157 28,292,786 Items that may be reclassified subsequently to profit or loss Foreign currency translation reserve 952,240 886,175 Translation of financial information of foreign operations 68.872 970.802 to presentation currency Retained earnings 29,658,449 22,874,134

Equity attributable to the Fund 58.242.846 52.053.095 Other comprehensive income for the year 68.872 970.802 Non-controlling interest 7.208 13.809 TOTAL COMPREHENSIVE INCOME FOR THE YEAR 6.853.995 24.565.082

Total equity 58.250.054 52.066.904 Profit is attributable to: Liabilities - The Fund 6.784.315 23.594.170 Non-current liabilities - Non-controlling interest 808 110 Borrowings of subsidiaries 472.007 - Profit for the year 6.785.123 23.594.280 Tenancy deposits 37.776 30.934 Total comprehensive income is attributable to: Other non-current liabilities 243 1.533 - The Fund 6.850.380 24.560.521

Total non-current liabilities 15 510.026 32.467 - Non-controlling interest 3.615 4.561

Current liabilities 12.650 15.878 TOTAL COMPREHENSIVE INCOME FOR THE YEAR 6.853.995 24.565.082

TOTAL LIABILITIES 522.676 48.345

TOTAL EQUITY AND LIABILITIES 58.772.730 52.115.249

Note: The notes set out on pages 96 to 146 form an integral Note: The notes set out on pages 96 to 146 form an integral part of these consolidated financial statements. part of these consolidated financial statements.

90 91 07 CONSOLIDATED STATEMENT OF FINANCIAL POSITION 9.248 (10.216) (66.174) (31.607) (69.998) (89.995) 68.872 (61.522) 970.802 (331.776) (89.998) (797.427) Total Total (35.538) (149.998) equity equity 8.341.348 (692.849) 6.785.123 7.385.505 (7.615.000) 23.594.280 29.266.974 6.853.995 24.565.082 (8.130.000) 58.250.054 52.066.904 808 2.807 ------110 ------4.451 9.248 Non- Non- 4.561 (10.216) 3.615 7.208 13.809 interest interest controlling controlling controlling controlling part of these consolidated financial statements. part of these consolidated financial statements. 66.065 - - (61.522) (66.174) (31.607) (89.998) (69.998) (89.995) (35.538) (149.998) 966.351 (331.776) Total Total (797.427) 6.784.315 (692.849) 8.341.348 8.341.348 Note: The notes set out on pages 96 to 146 form an integral 7.385.505 Note: The notes set out on pages 96 to 146 form an integral (7.615.000) (8.130.000) 23.594.170 29.266.974 24.560.521 6.850.380 58.242.846 52.053.095 ------deficit) deficit) (720.036) 23.594.170 6.784.315 6.784.315 23.594.170 22.874.134 29.658.449 / (Accumulated (Accumulated / / (Accumulated (Accumulated / Retained earnings Retained Retained earnings Retained ------Attributable to the Fund Attributable to the Fund 966.351 (80.176) 966.351 reserve reserve 66,065 66,065 886,175 952.240 Currency Currency Currency Currency translation translation translation translation ------(66.174) (61.522) (31.607) (69.998) (89.995) (89.998) (35.538) (331.776) (797.427) (149.998) capital capital (692.849) 8.341.348 7.385.505 (7.615.000) 30.067.186 27.632.157 (8.130.000) 28.292.786 Contributed Contributed Contributed Contributed 14 20 20 20 20 20 20 14 20 20 20 20 20 20 Note Note FOR THE YEARFOR ENDED DECEMBER 31 2016 - - CONSOLIDATED STATEMENT OF CHANGES IN EQUITY STATEMENT CONSOLIDATED Other comprehensive income comprehensive Other Transfer forTransfer the "Southern Gas Corridor" Profit for theyear Transfers forTransfers Program the on State “Education Azerbaijani of youth abroad” Transfers forTransfers the construction of line railway Baku-Tbilisi-Kars new Transfers forTransfers the reconstruction of system Irrigation Samur-Absheron Transfers to the State Refugees the to State Transfers Committee and Internally Displaced Peoples’ Social Fund Development Establishment GK001, of the Japansubsidiary in Budget the to State Transfers Contributions received At 1 January 2015 comprehensiveTotal income for 2015 Transfers forTransfers Program the on State “Education Azerbaijani of youth abroad” Disposal non-controlling of interest subsidiaries in Transfers to the State Budget the to State Transfers Balance at 31 December 2015 comprehensiveTotal income for 2016 Contributions received "Star" of construction for Transfers oil refinery complex Balance at 31 December 2016 Transfers forTransfers the construction of line railway Baku-Tbilisi-Kars new Transfers to the State Refugees the to State Transfers Committee and Internally Dis forTransfers the reconstruction of system Irrigation Samur-Absheron forTransfer the “Southern Gas Corridor” placed Peoples’ Social Develop ment Fund Profit for theyear income comprehensive Other In thousands of Manats Azerbaijani In thousands of Manats Azerbaijani

92 93 07 CONSOLIDATED STATEMENT OF FINANCIAL POSITION

CONSOLIDATED STATEMENT OF CASH FLOWS CONSOLIDATED STATEMENT OF CASH FLOWS FOR THE YEAR ENDED 31 DECEMBER 2016 FOR THE YEAR ENDED 31 DECEMBER 2016

In thousands of Azerbaijani Manats Notes 2016 2015 In thousands of Azerbaijani Manats Notes 2016 2015 Cash flows from Cash flows from operating activities: investing activities: Profit/(loss) before income tax expense 6.786.025 23.595.442 Purchase of property and equipment (11.409) - Adjustments to reconcile result to net cash used in Purchase of intangible assets - (10.522) operating activities Net cash used in investing activities (11.409) (10.522) Depreciation of property and equipment 5.679 5.829 Amortization of intangible assets 3.400 458 Cash flows from Unrealized (gain)/loss on change in fair value of financial (82.537) 347.336 financing activities: assets at fair value through profit or loss Contributions received 14 8.341.348 7.385.505 Net unrealized gain on foreign currency translation differences (4.980.520) (21.629.463) Transfers to the State Budget 20 (7.615.000) (8.130.000) Net gain on revaluation of gold bullion 11 (349.574) (716.751) Transfers for construction of “Star” oil refinery complex 20 (331.776) - Fair value loss/(gain) on revaluation of investment properties 12 26.827 (50.380) Transfers for the reconstruction of Samur-Absheron Irrigation Share of after tax results of joint venture 13 (2.694) (11.358) (69.998) (89.998) system Change in interest accruals (62.272) (143.493) Transfers to the State Refugees Committee and Internally 20 (89.995) (149.998) Displaced Peoples’ Social Development Fund Changes in operating assets Transfers for the construction of new Baku-Tbilisi-Kars 20 (66.174) (61.522) and liabilities: railway line Decrease/(increase) in financial assets at fair value Transfers for the State Program on “Education of Azerbaijani 8.9 1.640.113 (270.203) 20 (31.607) (35.538) through profit or loss youth abroad” Decrease in financial assets at amortised cost 10 14.166 139.386 Transfer for the “Southern Gas Corridor” 20 (797.427) (692.849) Increase in investment properties 12 (412.763) (450.590) Proceeds from non-current liabilities 477.560 17.208 Increase in investment in joint venture 13 (153.000) (300.604)

Increase in other assets (8.792) (14.908) Net cash used in financing activities (183.069) (1.757.192)

(Decrease)/increase in current liabilities (3.229) 342 Effect of exchange rate changes on cash and cash 631.180 2.358.108 equivalents Net cash from operating activities 2.420.829 501.043 Net increase in cash and cash equivalents 2.856.629 1.090.275

Income tax paid (902) (1.162) Cash and cash equivalents, beginning of the year 7 3.361.406 2.271.131

Net cash from operating activities before income tax 2.419.927 499.881 Cash and cash equivalents, end of the year 7 6.218.035 3.361.406 Operating cash flows from interest and dividend received 716.304 655.671

Note: The notes set out on pages 96 to 146 form an integral Note: The notes set out on pages 96 to 146 form an integral part of these consolidated financial statements. part of these consolidated financial statements.

94 95 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

These consolidated financial statements have Contributions into the Fund Republic or other relevant SOFAZ. been prepared in accordance with International are made in accordance with authorities of the Republic of The Regulations exclude the the Regulation of the Fund Azerbaijan due to signing of an oil following from the list of sources of Financial Reporting Standards for the year ended (“Regulation”) approved by contract and its implementation; the Fund’s contribution and assets: 31 December 2016 for the State Oil Fund of the Presidential Decree #434 dated I V. Acreage payments due to • The rental fees from the use of 29 December 2000 as amended SOCAR and/or an authorized state state property under contracts with Republic of Azerbaijan (the “SOFAZ”) and its by Presidential Decrees #849 body of the Republic of Azerbaijan foreign companies; Introduction subsidiaries (the “Fund”). and #202 on “Amending Certain from investors for the use of the • Contributions from the sale 1 Legislative Acts Regulating the contract area in connection of hydrocarbons related to the Operations of The State Oil Fund of with oil and gas exploration and participating interest or investment SOFAZ was incorporated and is domiciled in the Azerbaijan Republic. the Republic of Azerbaijan” dated development: of SOCAR in any project in which 7 February 2003 and 1 March 2005, V. Dividends and profit SOCAR is an investor, participant or respectively, and Article 2.3 of participation portions related a contracting party; and Principal Activity the “Regulations on Development to the share of the Republic of • Other proceeds generated and Implementation of the Annual Azerbaijan in connection with oil from joint activities with foreign The State Oil Fund of the Republic from agreements related to oil and legal entity, which is accountable Program of Income and Expenses and gas agreements, excluding companies. of Azerbaijan (“SOFAZ”) was gas exploration and development, and responsible to the President of (“Budget”) of the Fund” approved portion related to a participating established by Decree #240 of as well as, from SOFAZ’s own the Republic of Azerbaijan. by Presidential Decree #579 dated interest or investment of SOCAR In 2016 and 2015, the Fund was the President of the Republic of activities, for the benefit of citizens 12 September 2001 as amended in a project in which SOCAR is a party to a custody agreement Azerbaijan on the “Establishment of and future generations of the The consolidated financial state- by Presidential Decrees #849 and an investor, participant or a with the Bank of New York The State Oil Fund of the Republic Republic of Azerbaijan. ments include the financial state- #202 mentioned earlier. Pursuant contracting party; Mellon, and four investment of Azerbaijan” dated 29 December ments of SOFAZ and its direct and to the Regulations of the Fund, VI. Contibutions generated from management agreements with 1999 (the “Decree”). The purpose of In accordance with the Decree and indirect subsidiaries listed in the contributions are received from the oil and gas transported over financial institutions, namely SOFAZ is to ensure the accumulation, the Regulations (discussed below), following table and the after tax following sources: the territory of the Republic of Deutsche Asset Management effective management, and use of SOFAZ is an extra-budget state results of it’s joint venture (together a) Agreements on exploration, Azerbaijan with the use of the International GmbH (Deutsche income and other inflows generated organization, formed as a separate the “Fund”): development and production Baku-Supsa, Baku-Tbilisi-Ceyhan Bank AG), the International Bank for sharing for oil and gas fields in (“BTC”) and Baku-Tbilisi-Erzurum Reconstruction and Development the territory of the Republic of export pipelines; (IBRD – World Bank Group), State % interest Azerbaijan including the Azerbaijan VII. Contributions generated from Street Global Advisors (SSGA) and Date of Date of Sector of the Caspian Sea, as well transfer of assets from investors to Union Bank of Switzerland (UBS). Subsidiary 2016 2015 Country establishment acquisition Industry as other agreements on oil and SOCAR and/or an authorized state Under the custody agreements the gas exploration, development body within the framework of oil financial institutions hold securities SOFAZ Re Ltd. 100 100 Island of Jersey 22-May-12 - Property management and transportation entered into and gas agreements. purchased by the Fund, whereas between the State Oil Company b) Revenues generated from in accordance with the investment SOFAZ Re UK L.P. 100 100 Island of Jersey 6-Aug-12 - Property management of the Republic of Azerbaijan investment, management, sale management agreements the SOFAZ Re Min Ltd. 100 100 Island of Jersey 13-Aug-12 - Property management (“SOCAR”) or other authorized state and other disposal of the Fund’s financial institutions manage bodies and investors, including: assets (including financial assets the Fund’s investments based 78, St James`s Street 100 100 Island of Jersey 2-Oct-12 - Property management I. Contributions from the sale of and assets contributed by investors on general investment policies Unit Trust hydrocarbons related to the share within oil and gas agreements), established by the Fund. of the Republic of Azerbaijan other non-sale income or JSC Tverskaya 16 100 100 Russian Federation 29-Jun-93 21-Dec-12 Property management (net of expenditures incurred for revaluation surplus of the Fund’s SOFAZ’s registered and actual hydrocarbons transportation, assets in its reporting currency office address is 165, Heydar Aliyev SOFAZ RE Europe 100 100 Luxembourg 31-Oct-12 - Property management customs clearance and bank (Azerbaijani manats), etc.; Avenue, Baku, Azerbaijan, AZ1029. Holding Sarl costs, marketing, insurance, c) Grants and other free aids; SOFAZ RE Europe Sarl 100 100 Luxembourg 31-Oct-12 - Property management and independent surveyor fees) d) Other revenues and receipts in These consolidated financial excluding portion related to the accordance with the legislation of statements as of and for the year SCI 8 Place Vendome 100 100 France 14-Nov-12 - Property management participating interest or investment the Republic of Azerbaijan. ended 31 December 2016 are of SOCAR in a project in which authorized for issue by the Fund’s Pine Avenue Tower A 100 100 South Korea 30-Oct-11 31-Mar-14 Property management SOCAR is an investor, participant or Under the provisions of the Management on 14 March 2017. a contracting party; Fund’s Regulations approved GK001 LLC 98 98 Japan 21-Aug-15 26-Aug-15 Property management II. Price adjustments under Shah by the President of the Republic Presentation currency SOFAZ RE Fund 100 100 Luxembourg 27-May-15 - Investment management Deniz Phase I; of Azerbaijan, SOCAR or an These consolidated financial III. Bonus payments - the fees authorized state body implements statements are presented in SOFAZ PE Fund 100 100 Luxembourg 28-Sep-15 - Investment management payable by foreign oil companies the collection of the fees listed thousands of Azerbaijani Manats SOFAZ Italy 100 - Italy 19-Oct-15 - Property management to State Oil Company of Azerbaijan above and transfers them to (“AZN”), unless otherwise stated.

96 97 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

SUMMARY OF SIGNIFICANT 3 ACCOUNTING POLICIES

Basis of preparation of financial position date (non- which control ceases. These consolidated financial current) is presented. The acquisition method of statements have been prepared accounting is used to account in accordance with IFRS under Consolidated financial statements for the acquisition of subsidiaries. the historical cost convention, as Subsidiaries are those investees, Identifiable assets acquired and OPERATING modified by the initial recognition including structured entities, liabilities and contingent liabilities of financial instruments based on that the Fund controls because assumed in a business combination ENVIRONMENT OF fair value, and by the revaluation the Fund (i) has power to direct are measured at their fair values at of premises and equipment, the relevant activities of the the acquisition date, irrespective of THE FUND investment properties, gold investees that significantly affect the extent of any non-controlling 2 bullions, and financial instruments their returns, (ii) has exposure, or interest. categorised at fair value through rights, to variable returns from its Global economic environment Following the current dynamics of expenditures has a direct effect on profit or loss. The principal involvement with the investees, The Fund measures non-controlling continued to produce negative economic growth and balance of public investment. accounting policies applied in the and (iii) has the ability to use interest that represents present impacts on the Azerbaijan economy payments indicators, the Central preparation of these consolidated its power over the investees to ownership interest and entitles in 2016. Weakening global economic Bank of the Republic of Azerbaijan During the period, the monetary financial statements are set affect the amount of the investor’s the holder to a proportionate growth in major partner countries announced transition to a floating policy decisions were aimed out below. These policies have returns. The existence and effect share of net assets in the event and decrease in average oil prices exchange rate of manat at the at reduction of inflation and been consistently applied to all of substantive rights, including of liquidation on a transaction by as compared to the same period end of the year. The floating rate strengthening confidence in the the periods presented, unless substantive potential voting rights, transaction basis, either at: (a) fair of the previous year tightened regime has enabled the valuation national currency. Following the otherwise stated. (refer to Note 5 are considered when assessing value, or (b) the non-controlling the foreign currency sources and of the national currency based macroeconomic situation and for new and amended standards whether the Fund has power over interest’s proportionate share of aggregate demand in Azerbaijan. on macroeconomic fundamentals forecasts, necessary changes adopted by the Fund). another entity. For a right to be net assets of the acquiree. Non- and had a positive impact on were made to the monetary policy substantive, the holder must have controlling interests that are not During the year, the balance of protection of the strategic currency tools such as increase in the The preparation of financial a practical ability to exercise that present ownership interests are payments of Azerbaijan has been reserves. interest rate and decrease in the statements in conformity with IFRS right when decisions about the measured at fair value. influenced directly and indirectly by monetary base. At the same time, requires the use of certain critical direction of the relevant activities processes in the global and regional The dynamics of economic growth the measures were taken towards accounting estimates. It also of the investee need to be made. Goodwill is measured by deducting economy, as well as global energy was subject to the influence of improvement of the monetary policy requires management to exercise The Fund may have power over an the net assets of the acquiree from markets. Unfavorable energy market changes in the domestic demand. framework. its judgement in the process of investee even when it holds less the aggregate of the consideration conditions resulted in the balance The consumption level, which is applying the Fund’s accounting than the majority of the voting transferred for the acquiree, the of payments deficit for Azerbaijan another important component The Fund’s management observes policies. The areas involving a power in an investee. In such a amount of non-controlling interest during 2015 and 2016. Although of domestic demand, has been these developments related to higher degree of judgement case, the Fund assesses the size of in the acquiree and the fair value goal-oriented macroeconomic influenced by fluctuations of real the economic environment and or complexity, or areas where its voting rights relative to the size of an interest in the acquiree held policy applied over the last 2 years wages, cash income and interest takes precautionary measures as assumptions and estimates are and dispersion of holdings of the immediately before the acquisition (including the AZN rate arrangement) rates as well as inflation factors. it considers necessary in order significant to the consolidated other vote holders to determine date. Any negative amount had positively affected the current The aggregated demand was also to support the sustainability and financial statements are disclosed if it has de-facto power over the (“negative goodwill” or a “bargain account, however the current influenced by budget spending development of the Fund’s strategy in Note 4. investee. Protective rights of other purchase”) is recognised in profit or account is not fully adjusted yet. in 2016. The dynamics of budget in the foreseeable future. investors, such as those that relate loss, after management reassesses The Fund presents its consolidated to fundamental changes of the whether it identified all the assets statement of financial position investee’s activities or apply only in acquired and all the liabilities and separating current and non- exceptional circumstances, do not contingent liabilities assumed and current assets and liabilities. An prevent the Fund from controlling reviews the appropriateness of analysis regarding recovery or an investee. Subsidiaries are their measurement. settlement within 12 months after consolidated from the date on the statement of financial position which control is transferred to the The consideration transferred for date (current) and more than Fund (acquisition date) and are the acquiree is measured at the 12 months after the statement deconsolidated from the date on fair value of the assets given up,

98 99 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

equity instruments issued and carrying amount of non-controlling the date when control is lost, with CBAR are recognised in profit differences are recognised in other The principal average rate of liabilities incurred or assumed, interest sold as a capital the change in carrying amount or loss. Translation at year-end comprehensive income. exchange used for translating including the fair value of assets transaction in the statement of recognised in profit or loss. The rates does not apply to non- income and expenses was or liabilities from contingent changes in equity. fair value is the initial carrying monetary items that are measured When control over a foreign consideration arrangements, but amount for the purposes of at historical cost. Non-monetary operation or a subsidiary with a 1 USD 1,5973 AZN excludes acquisition related costs Joint arrangements subsequently accounting for the items measured at fair value functional currency other than the such as advisory, legal, valuation Under IFRS 11 investments in joint retained interest as an associate, in a foreign currency, including functional or presentation currency 1 EUR 1,7659 AZN and similar professional services. arrangements are classified as joint venture or financial asset. In equity investments, are translated of the Fund is lost, the exchange Transaction costs related to the either joint operations or joint addition, any amounts previously using the exchange rates at the differences recognised previously 100 KRW 0,1378 AZN acquisition of and incurred for ventures depending on the recognised in other comprehensive date when the fair value was in other comprehensive income are issuing equity instruments are contractual rights and obligations income in respect of that entity, determined. Effects of exchange reclassified to profit or loss for the 1 GBP 2,1565 AZN deducted from equity; transaction of each investor. SOFAZ has are accounted for as if the Fund rate changes on non-monetary year as part of the gain or loss on costs incurred for issuing debt as assessed the nature of its joint had directly disposed of the items measured at fair value in a disposal. On partial disposal of a 100 JPY 1,4728 AZN part of the business combination arrangements and determined related assets or liabilities. This foreign currency are recorded as subsidiary without loss of control, are deducted from the carrying them to be joint ventures. Joint may mean that amounts previously part of the fair value gain or loss. the related portion of accumulated 1 RUB 0,0240 AZN amount of the debt and all other ventures are accounted for using recognised in other comprehensive currency translation differences transaction costs associated with the equity method. income are reclassified to profit or Group companies. Loans between is reclassified to non-controlling the acquisition are expensed. loss. group entities and related foreign interest within equity. 2015: Under the equity method of exchange gains or losses are Intercompany transactions, accounting, interests in joint If the ownership interest in eliminated upon consolidation. Goodwill and fair value 1 USD 1,0237 AZN balances and unrealised gains ventures are initially recognised an associate is reduced but However, where the loan is adjustments arising on the on transactions between group at cost and adjusted thereafter significant influence is retained, between group entities that have acquisition of a foreign entity are 1 EUR 1,1355 AZN companies are eliminated; to recognise the Fund’s share of only a proportionate share of the different functional currencies, treated as assets and liabilities of unrealised losses are also the post-acquisition profits or amounts previously recognised in the foreign exchange gain or loss the foreign entity and translated 100 KRW 0,0906 AZN eliminated unless the cost cannot losses and movements in other other comprehensive income are cannot be eliminated in full and at the closing rate. Exchange be recovered. SOFAZ and all comprehensive income. When reclassified to profit or loss where is recognized in the consolidated differences arising are recognised 1 GBP 1,5666 AZN of its subsidiaries use uniform the Fund’s share of losses in a appropriate. profit or loss, unless the loan is in other comprehensive income. accounting policies consistent joint venture equals or exceeds not expected to be settled in 100 JPY 0,8455 AZN with the Fund’s policies. When its interests in the joint ventures Foreign currency translation the foreseeable future and thus At 31 December 2016, the principal necessary, amounts reported by (which includes any long-term The functional currency of each of forms part of the net investment in rates of exchange used for 1 RUB 0,0171 AZN subsidiaries have been adjusted interests that, in substance, form the Fund’s consolidated entities foreign operation. In such a case, translating foreign currency to conform with the Fund’s part of the Fund’s net investment in is the currency of the primary the foreign exchange gain or loss is balances was accounting policies. the joint ventures), the Fund does economic environment in which recognized in other comprehensive Investment property not recognise further losses, unless the entity operates. The functional income. 1 USD 1,7707 AZN Investment property is property Non-controlling interest is that it has incurred obligations or made currency of SOFAZ and the Fund’s held by the Fund to earn rental part of the net results and of the payments on behalf of the joint presentation currency, is the The results and financial position of 1 EUR 1,8644 AZN income or for capital appreciation, equity of a subsidiary attributable ventures. national currency of the Republic each group entity (the functional or both and which is not occupied to interests which are not owned, of Azerbaijan, Azerbaijani Manat currency of none of which is a 100 KRW 0,1468 AZN by the Fund. Investment property directly or indirectly, by SOFAZ. Unrealised gains on transactions (“AZN”). The consolidated financial currency of a hyperinflationary includes assets under construction Non-controlling interest forms a between the Fund and its joint statements are presented in economy) are translated into the 1 GBP 2,1745 AZN for future use as investment separate component of the Fund’s ventures are eliminated to the Azerbaijani Manat (“AZN”), which is presentation currency as follows: property. equity. extent of the Fund’s interest in the the Fund’s presentation currency. I. assets and liabilities for each 100 JPY 1,5168 AZN joint ventures. Unrealised losses statement of financial position are Investment property is initially Purchases and sales of non- are also eliminated unless the Transactions and balances. translated at the closing rate at 1 RUB 0,0293 AZN recognised at cost, including controlling interests transaction provides evidence Monetary assets and liabilities the end of the respective reporting transaction costs, and The Fund applies the economic of an impairment of the asset are translated into each entity’s period; 2015: subsequently remeasured at fair entity model to account for transferred. Accounting policies functional currency at the official II. income and expenses are value updated to reflect market transactions with owners of non- of the joint ventures have been exchange rate of the Central translated at average exchange 1 USD 1,5594 AZN conditions at the end of the controlling interest in transactions changed where necessary to Bank of the Republic of Azerbaijan rates (unless this average is not reporting period. Fair value of that do not result in a loss of ensure consistency with the (“CBAR”) at the respective end a reasonable approximation of 1 EUR 1,7046 AZN investment property is the price control. Any difference between policies adopted by the Fund. of the reporting period. Foreign the cumulative effect of the rates that would be received from the purchase consideration and exchange gains and losses prevailing on the transaction 100 KRW 0,1328 AZN sale of the asset in an orderly the carrying amount of non- Disposals of subsidiaries, resulting from the settlement of dates, in which case income transaction, without deduction of controlling interest acquired is associates or joint ventures the transactions and from the and expenses are translated at 1 GBP 2,3133 AZN any transaction costs. The best recorded as a capital transaction When the Fund ceases to have translation of monetary assets the dates of the transactions); evidence of fair value is given by directly in equity. The Fund control or significant influence, and liabilities into each entity’s III. components of equity are 100 JPY 1,2946 AZN current prices in an active market recognises the difference between any retained interest in the entity functional currency at year-end translated at the historic rate; and for similar property in the same sales consideration and the is remeasured to its fair value at official exchange rates of the IV. all resulting exchange 1 RUB 0,0216 AZN location and condition.

100 101 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

In the absence of current prices Classification of financial assets selling it in the near term. Financial is presented as finance income in bankruptcy or a financial adjusting the allowance account in an active market, the Fund Financial assets have the assets other than loans and profit or loss for the year. Dividends reorganisation; through profit or loss for the year. considers information from a following categories: (a) loans and receivables are permitted to be are included in finance income • there is adverse change in Uncollectible assets are written off variety of sources, including: receivables; (b) available-for-sale reclassified out of the fair value when the Fund’s right to receive the the payment status of the against the related impairment loss financial assets; (c) financial assets through profit or loss category dividend payment is established counterparty as a result of provision after all the necessary (a) current prices in an active held to maturity and (d) financial only in rare circumstances arising and it is probable that the changes in the national or local procedures to recover the asset market for properties of a assets at fair value through profit from a single event that is unusual dividends will be collected. All other economic conditions that impact have been completed and the different nature, condition or or loss. Financial assets at fair and highly unlikely to reoccur in elements of the changes in the the counterparty; or amount of the loss has been location, adjusted to reflect those value through profit or loss have the near term. Financial assets fair value and gains or losses on • the value of collateral, if any, determined. Subsequent recoveries differences; two sub-categories: (i) assets that would meet the definition derecognition are recorded in profit significantly decreases as a result of amounts previously written off (b) recent prices of similar designated as such upon initial of loans and receivables may be or loss for the year as gains less of deteriorating market conditions. are credited to the impairment loss properties on less active markets, recognition, and (ii) those classified reclassified if the Fund has the losses from trading investments in account within the profit or loss for with adjustments to reflect any as held for trading. intention and ability to hold these the period in which they arise. If the terms of an impaired financial the year. changes in economic conditions financial assets for the foreseeable asset held at amortised cost since the date of the transactions Loans and receivables are future or until maturity. Trade and other receivables are renegotiated or otherwise Borrowings that occurred at those prices; and unquoted non-derivative financial Trade and other receivables are modified because of financial Borrowings are recognised (c) discounted cash flow assets with fixed or determinable Certain derivative instruments recognised initially at fair value difficulties of the counterparty, initially at fair value, net of projections based on reliable payments other than those that embedded in other financial and are subsequently carried at impairment is measured using transaction costs incurred and are estimates of future cash flows, the Fund intends to sell in the instruments are treated as amortised cost using the effective the original effective interest rate subsequently carried at amortised supported by the terms of any near term. The Fund’s loans and separate derivative instruments interest method. before the modification of terms. cost using the effective interest existing lease and other contracts receivables comprise of ‘cash and when their risks and characteristics The renegotiated asset is then method. and (when possible) by external cash equivalents’ in the statement are not closely related to those of Impairment of financial assets derecognized and a new asset evidence such as current market of financial position. the host contract. carried at amortised cost is recognized at its fair value Income taxes rents for similar properties in the Impairment losses are recognised only if the risks and rewards of Income taxes have been provided same location and condition, and Held-to-maturity assets include Other financial assets at fair value in profit or loss when incurred as a the asset substantially changed. for in the financial statements using discount rates that reflect quoted non-derivative financial through profit or loss are financial result of one or more events (“loss This is normally evidenced by a in accordance with legislation current market assessments of assets with fixed or determinable assets designated irrevocably, events”) that occurred after the substantial difference between the enacted or substantively enacted the uncertainty in the amount and payments and fixed maturities at initial recognition, into this initial recognition of the financial present values of the original cash by the end of the reporting period. timing of the cash flows. that the Fund has both the category. Management designates asset and which have an impact flows and the new expected cash The income tax charge comprises intention and ability to hold to financial assets into this category on the amount or timing of the flows. current tax and deferred tax and Market value of the Fund’s maturity. Management determines only if (a) such classification estimated future cash flows of the is recognised in profit or loss for investment property is the classification of investment eliminates or significantly reduces financial asset or group of financial Impairment losses are always the year, except if it is recognised determined based on reports of securities held to maturity at their an accounting mismatch that assets that can be reliably recognised through an allowance in other comprehensive income independent appraisers, who initial recognition and reassesses would otherwise arise from estimated. If the Fund determines account to write down the asset’s or directly in equity because it hold recognised and relevant the appropriateness of that measuring assets or liabilities or that no objective evidence exists carrying amount to the present relates to transactions that are professional qualifications and classification at the end of each recognising the gains and losses that impairment was incurred for value of expected cash flows also recognised, in the same who have recent experience in reporting period. on them on different bases; or (b) a an individually assessed financial (which exclude future credit losses or a different period, in other the valuation of property in the group of financial assets, financial asset, whether significant or not, that have not been incurred) comprehensive income or directly same location and category. Held-for-trading investments are liabilities or both is managed and it includes the asset in a group of discounted at the original effective in equity. financial assets which are either its performance is evaluated on a financial assets with similar credit interest rate of the asset. The Earned rental income is recorded acquired for generating a profit fair value basis, in accordance with risk characteristics, and collectively calculation of the present value Current tax is the amount expected in profit or loss for the year within from short-term fluctuations in a documented risk management assesses them for impairment. of the estimated future cash flows to be paid to, or recovered from, rental income. Gains and losses price or trader’s margin, or are or investment strategy, and of a collateralised financial asset the taxation authorities in respect resulting from changes in the fair securities included in a portfolio information on that basis is The primary factors that the Fund reflects the cash flows that may of taxable profits or losses for the value of investment property are in which a pattern of short-term regularly provided to and reviewed considers in determining whether result from foreclosure less costs for current and prior periods. Taxable recorded in profit or loss for the trading exists. The Fund classifies by the Fund’s key management a financial asset is impaired are obtaining and selling the collateral, profits or losses are based on year and presented separately. securities into trading investments personnel. Recognition and its overdue status and realisability whether or not foreclosure is estimates if financial statements if it has an intention to sell measurement of this category of of related collateral, if any. The probable. are authorised prior to filing Subsequent expenditure is them within a short period after financial assets is consistent with following other principal criteria relevant tax returns. Taxes other capitalised to the asset’s purchase, i.e. within 3-6 months. the accounting policy for trading are also used to determine whether If, in a subsequent period, the than on income are recorded within carrying amount only when it is The Fund’s held-for-trading assets investments. there is objective evidence that an amount of the impairment loss operating expenses. probable that future economic comprise of ‘trading securities’. impairment loss has occurred: decreases and the decrease can benefits associated with the be related objectively to an event Deferred income tax is provided expenditure will flow to the Fund The Fund may choose to reclassify Trading investments • the counterparty experiences occurring after the impairment using the balance sheet liability and the cost can be measured a non-derivative trading financial Trading investments are carried a significant financial difficulty was recognised (such as an method for tax loss carry forwards reliably. All other repairs and asset out of the fair value through at fair value. Interest earned on as evidenced by its financial improvement in the debtor’s credit and temporary differences arising maintenance costs are expensed profit or loss category if the asset trading investments calculated information that the Fund obtains; rating), the previously recognised between the tax bases of assets when incurred. is no longer held for the purpose of using the effective interest method • the counterparty considers impairment loss is reversed by and liabilities and their carrying

102 103 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

amounts for financial reporting Dividends acquirer’s previously held equity during the ‘measurement period’ are recognised, to reflect new at fair value or amortised cost as purposes. In accordance with Dividends are recorded as a interest in the acquiree (if any) (which cannot exceed one year information obtained about facts described below. the initial recognition exemption, liability and deducted from equity over the net of the acquisition- from the acquisition date) about and circumstances that existed at Fair value is the price that would deferred taxes are not recorded in the period in which they are date amounts of the identifiable facts and circumstances that the acquisition date that, if known, be received to sell an asset or paid for temporary differences on declared and approved. assets acquired and the liabilities existed at the acquisition date. would have affected the amounts to transfer a liability in an orderly initial recognition of an asset or assumed. If, after reassessment, recognised at that date. transaction between market a liability in a transaction other Business combinations the net of the acquisition-date The subsequent accounting for participants at the measurement than a business combination if Acquisitions of businesses are amounts of the identifiable changes in the fair value of the Goodwill arising on an acquisition date. The best evidence of fair the transaction, when initially accounted for using the acquisition assets acquired and liabilities contingent consideration that of a business is carried at cost value is price in an active market. recorded, affects neither method. The consideration assumed exceeds the sum of the do not qualify as measurement as established at the date An active market is one in which accounting nor taxable profit. transferred in a business consideration transferred, the period adjustments depends on of acquisition of the business transactions for the asset or Deferred tax balances are combination is measured at fair amount of any non-controlling how the contingent consideration (see above) less accumulated liability take place with sufficient measured at tax rates enacted or value, which is calculated as the interest in the acquiree and the fair is classified. Contingent impairment losses, if any. For the frequency and volume to provide substantively enacted at the end sum of the acquisition-date fair value of the acquirer’s previously consideration that is classified purposes of impairment testing, pricing information on an ongoing of the reporting period, which are values of the assets transferred held interest in the acquiree (if as equity is not remeasured at goodwill is allocated to each of the basis. expected to apply to the period by the Fund, liabilities incurred any), the excess is recognised subsequent reporting dates Fund’s cash-generating units (or when the temporary differences by the Fund to the former owners immediately in profit or loss as a and its subsequent settlement groups of cash-generating units) Fair value of financial instruments will reverse or the tax loss carry of the acquiree and the equity bargain purchase gain. is accounted for within equity. that is expected to benefit from traded in an active market is forwards will be utilised. interests issued by the Fund Contingent consideration that is the synergies of the combination measured as the product of the in exchange for control of the Non-controlling interest that classified as an asset or a liability quoted price for the individual Deferred tax assets for deductible acquiree. Acquisition-related costs are present ownership interests is remeasured at subsequent A cash-generating unit to which asset or liability and the quantity temporary differences and tax loss are generally recognised in profit and entitle their holders to a reporting dates in accordance goodwill has been allocated is held by the entity. This is the case carry forwards are recorded only or loss as incurred. proportionate share of the entity’s with IAS 39 Financial Instruments: tested for impairment annually, even if a market’s normal daily to the extent that it is probable equity in the event of liquidation Recognition and Measurement, or more frequently when there trading volume is not sufficient that the temporary difference At the acquisition date, the may be initially measured either at or IAS 37 Provisions, Contingent is indication that the unit may to absorb the quantity held and will reverse in the future and identifiable assets acquired fair value or at the non-controlling Liabilities and Contingent be impaired. If the recoverable placing orders to sell the position there is sufficient future taxable and the liabilities assumed are interest’s proportionate share of Assets, as appropriate, with the amount of the cash-generating in a single transaction might affect profit available against which the recognised at their fair value, the recognised amounts of the corresponding gain or loss being unit is less than its carrying amount, the quoted price. deductions can be utilised. except that: acquiree’s identifiable net assets. recognised in profit or loss. the impairment loss is allocated The choice of measurement basis first to reduce the carrying amount Valuation techniques such as Deferred income tax assets and • Deferred tax assets or liabilities is made on a transaction-by- When a business combination of any goodwill allocated to the discounted cash flow models liabilities are offset when there are recognised and measured in transaction basis. Other types is achieved in stages, the Fund’s unit and then to the other assets or models based on recent is a legally enforceable right to accordance with IAS 12 Income of non-controlling interest are previously held equity interest of the unit pro rata based on the arm’s length transactions or offset current tax assets against Taxes measured at fair value or, when in the acquiree is remeasured carrying amount of each asset in consideration of financial data of current tax liabilities and when • Liabilities or equity instruments applicable, on the basis specified to its acquisition date fair value the unit. Any impairment loss for the investees, are used to measure the deferred income taxes assets related to share-based payment in another IFRS. and the resulting gain or loss, goodwill is recognised directly in fair value of certain financial and liabilities relate to income arrangements of the acquiree if any, is recognised in profit profit or loss in the consolidated instruments for which external taxes levied by the same taxation or share-based payment When the consideration or loss. Amounts arising from statement of profit or loss and market pricing information is not authority on either the same arrangements of the Fund transferred by the Fund in a interests in the acquiree prior to other comprehensive income. available. Fair value measurements taxable entity or different taxable entered into to replace share- business combination includes the acquisition date that have An impairment loss recognised are analysed by level in the fair entities where there is an intention based payment arrangements assets or liabilities resulting previously been recognised in for goodwill is not reversed in value hierarchy as follows: (i) to settle the balances on a net of the acquiree are measured in from a contingent consideration other comprehensive income subsequent periods. level one are measurements basis. Deferred tax assets and accordance with IFRS 2 Share- arrangement, the contingent are reclassified to profit or loss at quoted prices (unadjusted) liabilities are netted only within based Payment at the acquisition consideration is measured at where such treatment would be On disposal of the relevant cash- in active markets for identical the individual companies of the date; and. its acquisition-date fair value appropriate if that interest were generating unit, the attributable assets or liabilities, (ii) level two Fund. • Assets (or disposal groups) that and included as part of the disposed of. amount of goodwill is included in measurements are valuations are classified as held for sale consideration transferred in a the determination of the profit or techniques with all material The Fund controls the reversal of in accordance with IFRS 5 Non- business combination. If the initial accounting for loss on disposal. inputs observable for the asset or temporary differences relating to current Assets Held for Sale and a business combination is liability, either directly (that is, as taxes chargeable on dividends Discontinued Operations are Changes in the fair value of incomplete by the end of the The Fund’s policy for goodwill prices) or indirectly (that is, derived from subsidiaries or on gains measured in accordance with that the contingent consideration reporting period in which the arising on the acquisition of an from prices), and (iii) level three upon their disposal. The Fund Standard. that qualify as measurement combination occurs, the Fund associate or joint ventures is measurements are valuations not does not recognise deferred period adjustments are adjusted reports provisional amounts for described below. based on solely observable market tax liabilities on such temporary Goodwill is measured as the excess retrospectively, with corresponding the items for which the accounting data (that is, the measurement differences except to the extent of the sum of the consideration adjustments against goodwill. is incomplete. Those provisional Financial instruments - key requires significant unobservable that Management expects the transferred, the amount of any Measurement period adjustments amounts are adjusted during the measurement terms inputs). Transfers between levels temporary differences to reverse non-controlling interest in the are adjustments that arise from measurement period (see above), Depending on their classification of the fair value hierarchy are in the foreseeable future. acquiree, and the fair value of the additional information obtained or additional assets or liabilities financial instruments are carried deemed to have occurred at the

104 105 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

end of the reporting period. Refer of the financial instrument or a determine the fair value of deposits are carried at amortised when incurred. Costs of replacing estimated costs of disposal, if the to Note 22. shorter period, if appropriate, to investments that are not traded cost plus interest, if any. major parts or components of asset were already of the age the net carrying amount of the in an active market. Differences premises and equipment items are and in the condition expected Transaction costs are incremental financial instrument. The effective may arise between the fair value Gold bullion capitalised, and the replaced part at the end of its useful life. The costs that are directly attributable interest rate discounts cash flows at initial recognition, which is The Fund is involved in purchase is retired. assets’ residual values and useful to the acquisition, issue or disposal of variable interest instruments to considered to be the transaction of gold bullion for investment lives are reviewed, and adjusted of a financial instrument. An the next interest repricing date, price, and the amount determined purposes with the intention of At the end of each reporting if appropriate, at the end of each incremental cost is one that would except for the premium or discount at initial recognition using a diversification of the investment period management assesses reporting period. not have been incurred if the which reflects the credit spread valuation technique with level 3 portfolio with the ability to sell whether there is any indication transaction had not taken place. over the floating rate specified in inputs. Any such differences are the gold in the future. The gold of impairment of premises and Intangible assets Transaction costs include fees the instrument, or other variables initially recognised within assets bullion is initially recognized equipment. If any such indication Intangible assets acquired and commissions paid to agents that are not reset to market rates. or liabilities and are subsequently and subsequently measured at exists, management estimates separately are measured on initial (including employees acting as Such premiums or discounts amortised on a straight line basis fair value with gains or losses the recoverable amount, which recognition at cost. Following selling agents), advisors, brokers are amortised over the whole over the term of the investments. recognised in profit or loss. is determined as the higher of initial recognition, intangible and dealers, levies by regulatory expected life of the instrument. The The differences are immediately an asset’s fair value less costs assets are carried at cost less agencies and securities exchanges, present value calculation includes recognised in profit or loss if the Premises and equipment to sell and its value in use. The any accumulated amortization and transfer taxes and duties. all fees paid or received between valuation uses only level 1 or level The Fund’s premises and carrying amount is reduced to and any accumulated impairment Transaction costs do not include parties to the contract that are 2 inputs. equipment are tangible assets the recoverable amount and the losses. The useful lives of debt premiums or discounts, an integral part of the effective held for administrative purposes impairment loss is recognised in intangible assets are assessed financing costs or internal interest rate. Derecognition of financial assets with an expected useful life of profit or loss for the year to the to be either finite or indefinite. administrative or holding costs. The Fund derecognises financial more than one accounting period. extent it exceeds the previous Intangible assets with finite lives Initial recognition of financial assets when (a) the assets are Premises and equipment are revaluation surplus in equity. An are amortized over their useful Amortised cost is the amount at instruments redeemed or the rights to cash stated at cost less accumulated impairment loss recognised for economic lives (5 years) and which the financial instrument was Trading securities and other flows from the assets otherwise depreciation and provision for an asset in prior years is reversed assessed for impairment whenever recognised at initial recognition financial instruments at fair expired or (b) the Fund has impairment, where required. if there has been a change in the there is an indication that the less any principal repayments, value through profit or loss are transferred the rights to the cash estimates used to determine the intangible asset may be impaired. plus accrued interest, and for initially recorded at fair value. All flows from the financial assets or Premises are subject to asset’s value in use or fair value Amortization periods and methods financial assets less any write- other financial instruments are entered into a qualifying pass- revaluation with sufficient less costs to sell. for intangible assets with definite down for incurred impairment initially recorded at fair value through arrangement while (i) also regularity to ensure that the useful lives are reviewed at least losses. Accrued interest includes plus transaction costs. Fair value transferring substantially all risks carrying amount does not differ Gains and losses on disposals at each financial year-end. amortisation of transaction costs at initial recognition is best and rewards of ownership of the materially from that which would determined by comparing deferred at initial recognition evidenced by the transaction assets or (ii) neither transferring be determined using fair value at proceeds with carrying amount Derecognition of intangible and of any premium or discount price. A gain or loss on initial nor retaining substantially all risks the end of the reporting period. are recognised in profit or loss for assets to maturity amount using the recognition is only recorded if there and rewards of ownership, but not Increases in the carrying amount the year (within other operating An intangible asset is effective interest method. Accrued is a difference between fair value retaining control. Control is retained arising on revaluation are credited income or expenses). derecognised on disposal, or when interest income and accrued and transaction price which can if the counterparty does not have to other comprehensive income no future economic benefits are interest expense, including both be evidenced by other observable the practical ability to sell the asset and increase the revaluation Depreciation expected from use or disposal. accrued coupon and amortised current market transactions in the in its entirety to an unrelated third surplus in equity. Decreases that Land and construction in progress Gains or losses arising from discount or premium (including fees same instrument or by a valuation party without needing to impose offset previous increases of the are not depreciated. Depreciation derecognition of an intangible deferred at origination, if any), are technique whose inputs include restrictions on the sale. same asset are recognised in on other items of premises and asset, measured as the difference not presented separately and are only data from observable markets. other comprehensive income equipment is calculated using the between the net disposal included in the carrying values of Derecognition of financial and decrease the previously straight-line method to allocate proceeds and the carrying amount related items in the statement of All purchases and sales of liabilities recognised revaluation surplus their cost or revalued amounts of the asset, are recognised in financial position. financial assets that require A financial liability is derecognized in equity; all other decreases to their residual values over their profit or loss when the asset is delivery within the time frame when the obligation is discharged, are charged to profit or loss estimated useful lives: derecognised. The effective interest method is established by regulation or cancelled, or expires. for the year. The revaluation Years a method of allocating interest market convention (“regular way” reserve for premises included Provisions income or interest expense over purchases and sales) are recorded Cash and cash equivalents in equity is transferred directly Building 50 Provisions are recognised when the relevant period, so as to at trade date, which is the date Cash and cash equivalents include to retained earnings when the Vehicles 7 the Fund has a present obligation achieve a constant periodic rate of on which the Fund commits to cash on hand, deposits with original revaluation surplus is realised on (legal or constructive) as a result Office equipment 4 interest (effective interest rate) on deliver a financial asset. All other maturity of three months, and the retirement or disposal of the of a past event, it is probable that the carrying amount. purchases are recognised when short-term, highly liquid investments asset. If there is no market based Furniture 5 the Fund will be required to settle the entity becomes a party to i.e. money market funds, readily evidence of fair value, fair value Other property and equipment 3 the obligation, and a reliable The effective interest rate is the contractual provisions of the convertible to known amounts is estimated using an income estimate can be made of the the rate that exactly discounts instrument. of cash and subject to low risk of approach. The residual value of an asset is amount of the obligation. estimated future cash payments changes in value, with an original the estimated amount that the or receipts (excluding future credit The Fund uses discounted cash maturity of three months or less. Costs of minor repairs and day-to- Fund would currently obtain from The amount recognised as a losses) through the expected life flow valuation techniques to Cash on hand, cash in banks and day maintenance are expensed disposal of the asset less the provision is the best estimate of

106 107 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

the consideration required to settle the Republic of Azerbaijan. Once a financial asset or a group Accounting for Cash Inflows and Where market-based valuation Management uses different the present obligation at the end Contributions/transfers received/ of similar financial assets has been Outflows parameters are absent, assumptions regarding the of the reporting period, taking into made by the Fund represent written down (or partly written As described in Note 1, the management will make a interest rates, volatility, exchange account the risks and uncertainties contributions/withdrawals and, down) as a result of an impairment Fund receives cash inflows from judgment as to its best estimate rates, the credit rating of the surrounding the obligation. When accordingly, are recognized loss, interest income is thereafter revenues generated from various of that parameter in order counterparty and valuation a provision is measured using the through net equity at the fair value recognized using the rate of oil and gas activities carried out to determine a reasonable adjustments where quoted market cash flows estimated to settle the of the consideration received/paid. interest used to discount the future in the Republic of Azerbaijan. reflection of how the market prices are not available using their present obligation, its carrying Transfers to the State Budget, as cash flows for the purpose of These cash inflows are made would be expected to price the own knowledge and capabilities, amount is the present value of well as state institutions, state- measuring the impairment loss. according to certain decrees instrument. In exercising this as well as, data obtained from it’s those cash flows (when the effect owned entities and companies of the President of the Republic judgment, a variety of tools are custodians (mainly Bank of New of the time value of money is are recognized on the date of Interest earned on assets at fair of Azerbaijan. Cash outflows for used including proxy observable York Mellon) and Bloomberg. material). payment. value is classified within interest major projects and contributions data, historical data, and income. to the State budget are also extrapolation techniques. The Measurement of fair value of Trade and other payables All transfers are made within made according to decrees of best evidence of fair value of investment properties and Trade payables are accrued when the approved budget of the Expenses are recognized on the President of the Republic of a financial instrument at initial property and equipment the counterparty has performed its Fund and transferred to the accrual basis, i.e. when they are Azerbaijan. SOFAZ believes these recognition is the transaction (building) obligations under the contract and State Treasury of the Republic of incurred. inflows and outflows of funds price unless the instrument is Fair value of investment properties are carried at amortised cost. Azerbaijan for payments to eligible represent contributed capital evidenced by comparison with as well as at the property and budgetary beneficiaries (state Offsetting and withdrawals of capital, data from observable markets. equipment (building) is determined Contingencies institutions, state-owned entities Financial assets and liabilities respectively. Accordingly, SOFAZ Any difference between the by independent professionally Contingent liabilities are not and companies) based on their are offset and the net amount recognises them as movements transaction price and the value qualified appraisers. Fair value is recognized in the statement of requests for payments. reported in the consolidated in equity in the consolidated based on a valuation technique determined using the combination financial position but are disclosed statement of financial position only statement of changes in equity. is not recognized in the statement of internal capitalization method unless the possibility of any Recognition of income when there is a legally enforceable of profit or loss and other (also known as discounted outflow in settlement is remote. A and expense right to offset the recognised Valuation of financial instruments comprehensive income on initial future cash flow method), sales contingent asset is not recognized Interest income is recognized on an amounts, and there is an intention Financial instruments that are recognition. Subsequent gains comparison method and also in the statement of financial accrual basis using the effective to either settle on a net basis, or classified at fair value through or losses are only recognized to based on the highest and best position but disclosed when an interest method. The effective to realise the asset and settle profit or loss are stated at fair the extent that it arises from a use method. inflow of economic benefits is interest method is a method of the liability simultaneously. Such value. The fair value of such change in a factor that market probable. calculating the amortized cost a right of set off (a) must not be financial instruments is the participants would consider in Staff costs and related of a financial asset or a financial contingent on a future event and estimated amount at which the setting a price. contributions Equity reserves liability (or a group of financial (b) must be legally enforceable in instrument could be exchanged Wages, salaries, contributions The reserves recorded in equity assets or financial liabilities) and of all of the following circumstances: between willing parties, other The Fund considers that the to the Azerbaijan State Social (other comprehensive income) on allocating the interest income over (i) in the normal course of business, than in a forced or liquidation accounting estimates related to Insurance Fund, paid annual the Fund’s consolidated statement the relevant period. The effective (ii) the event of default and (iii) the sale. If a quoted market price is valuation of financial instruments leave and sick leave, bonuses, of financial position include: interest rate is the rate that exactly event of insolvency or bankruptcy. available for an instrument, the where quoted markets prices are and non-monetary benefits are • ‘Foreign currency translation discounts estimated future cash fair value is calculated based on not available are a key source of accrued in the year in which the reserve’ which is used to record payments or receipts through The preparation of the Fund’s the market price. When valuation estimating uncertainty because: associated services are rendered exchange differences arising the expected life of the financial consolidated financial statements parameters are not observable in (i) they are highly susceptible to by the employees of the Fund. The from the translation of the net instrument or, when appropriate, a requires management to make the market or cannot be derived change from period to period Fund has no legal or constructive investment in foreign operations; shorter period to the net carrying estimates and judgments that from observable market prices, because it requires management obligation to make pension or • ‘Property revaluation reserve’ amount of the financial asset. affect the reported amounts of the fair value is derived through to make assumptions about similar benefit payments beyond which comprises revaluation assets and liabilities at the reporting analysis of other observable interest rates, volatility, exchange the payments to the statutory reserve of land and building; Dividend income from financial date and the reported amount of market data appropriate for each rates, the credit rating of defined contribution scheme. • ‘Other capital reserve’ assets at fair value through income and expenses during the product and pricing models which the counterparty, valuation As discussed in Note 14 and 20, in profit or loss is recognized in year ended. Management evaluates use a mathematical methodology adjustments and specific feature accordance with the Decrees and the statement of profit or loss its estimates and judgments on based on accepted financial of the transactions and (ii) the the Regulations, the Fund is an when the Fund’s right to receive an ongoing basis. Management theories. Pricing models take into impact that recognizing a change extra-budget state organization. payment is established. bases its estimates and judgments account the contract terms of the in the valuations would have All decisions regarding Other operating income including on historical experience and on securities as well as market-based on the assets reported in the contributions to and transfers from rental income is recognized on various other factors that are valuation parameters, such as interest statement of financial position as the Fund are made and approved accruals basis, i.e. when these are believed to be reasonable under rates, volatility, exchange rates and well as its profit/(loss) could be by the Decrees of the President of earned. the circumstances. the credit rating of the counterparty. material.

108 109 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

by IAS 34. The amendment to disclosure required by an IFRS Amendment to IFRS 10, IFRS IAS 19 clarifies that for post- if the information resulting from 12 and IAS 28 (issued in CRITICAL ACCOUNTING ESTIMATES, employment benefit obligations, that disclosure is not material, December 2014 and effective the decisions regarding discount even if the IFRC contains a for annual periods on or rate, existence of deep market in list of specific requirements or after 1 January 2016). The AND JUDGEMENTS IN APPLYING high-quality corporate bonds, or describes them as minimum Standard was amended to ACCOUNTING POLICIES which government bonds to use requirements. The Standard clarify that an investment 4 as a basis, should be based on also provides new guidance on entity should measure at fair the currency that the liabilities subtotals in financial statements, value through profit or loss The Fund makes estimates process of applying the accounting judgements about its exposure are denominated in, and not the in particular, such subtotals all of its subsidiaries that are and assumptions that affect policies. Judgements that have to the risks and rewards, as well country where they arise. IAS (a) should be comprised of line themselves investment entities. the amounts recognised in the the most significant effect on as about its ability to make 34 will require a cross reference items made up of amounts In addition, the exemption from consolidated financial statements, the amounts recognised in the operational decisions for the from the interim financial recognised and measured in preparing consolidated financial and the carrying amounts of consolidated financial statements structured entity in question. In statements to the location of accordance with IFRS; (b) be statements if the entity’s assets and liabilities within the and estimates that can cause many instances, elements are “information disclosed elsewhere presented and labelled in a ultimate or any intermediate next financial year. Estimates a significant adjustment to the present that, considered in in the interim financial report”. manner that makes the line items parent produces consolidated and judgements are continually carrying amount of assets and isolation, indicate control or lack of that constitute the subtotal financial statements available evaluated and are based on liabilities within the next financial control over a structured entity, but Disclosure Initiative clear and understandable; (c) for public use was amended management’s experience year include: when considered together make it Amendments to IAS 1 (issued in be consistent from period to to clarify that the exemption and other factors, including difficult to reach a clear conclusion. December 2014 and effective period; and (d) not be displayed applies regardless whether the expectations of future events that The Fund does not consolidate In cases where more arguments for annual periods on or after with more prominence than the subsidiaries are consolidated are believed to be reasonable structured entities that it does not are in place towards existence 1 January 2016). The Standard subtotals and totals required by or are measured at fair value under the circumstances. control. As it can sometimes be of control, the structured entity was amended to clarify IFRS standards. through profit or loss in Management also makes certain difficult to determine whether the is consolidated. Refer to Note 26 the concept of materiality accordance with IFRS 10 in such judgements, apart from those Fund does control a structured for further information about the and explains that an entity Investment Entities: Applying ultimate or any intermediate involving estimations, in the entity, management makes structured entitiy. need not provide a specific the Consolidation Exception parent’s financial statements.

ADOPTION OF NEW OR REVISED STANDARDS AND 5 INTERPRETATIONS NEW ACCOUNTING PRONOUNCEMENTS The following new standards and for the periods beginning on amended to clarify that change 6 interpretations became effective or after 1 January 2016). In in the manner of disposal for the Fund from 1 January 2016: this amendment, the IASB has (reclassification from “held for Certain new standards and at amortised cost, those to instruments that meet the SPPI clarified that the use of revenue- sale” to “held for distribution” or interpretations have been issued be measured subsequently requirement that are held in a Accounting for Acquisitions of based methods to calculate the vice versa) does not constitute that are mandatory for the at fair value through other portfolio where an entity both Interests in Joint Operations - depreciation of an asset is not a change to a plan of sale ore annual periods beginning on or comprehensive income (FVOCI) holds to collect assets’ cash flows Amendments to IFRS 11 (issued appropriate because revenue distribution, and does not have after 1 January 2017 or later, and and those to be measured and sells assets may be classified on 6 May 2014 and effective generated by an activity that to be accounted for as such. which the Fund has not early subsequently at fair value as FVOCI. Financial assets that for the periods beginning on includes the use of an asset The amendment to IFRS 7 adds adopted. through profit or loss (FVPL). do not contain cash flows that or after 1 January 2016). This generally reflects factors other guidance to help management are SPPI must be measured at amendment adds new guidance than the consumption of the determine whether the terms IFRS 9 “Financial Instruments: • Classification for debt FVPL (for example, derivatives). on how to account for the economic benefits embodied in of an arrangement to service Classification and Measurement” instruments is driven by the Embedded derivatives are no acquisition of an interest in a the asset. a financial asset which has (amended in July 2014 and entity’s business model for longer separated from financial joint operation that constitutes a been transferred constitute effective for annual periods managing the financial assets assets but will be included in business. Annual Improvements to IFRSs continuing involvement, for the beginning on or after 1 January and whether the contractual cash assessing the SPPI condition. 2014 (issued on 25 September purposes of disclosures required 2018). Key features of the new flows represent solely payments Clarification of Acceptable 2014 and effective for annual by IFRS 7. The amendment also standard are: of principal and interest (SPPI). • Investments in equity instruments Methods of Depreciation and periods beginning on or after 1 clarifies that the offsetting • Financial assets are required If a debt instrument is held to are always measured at fair value. Amortisation - Amendments January 2016). disclosures of IFRS 7 are not to be classified into three collect, it may be carried at However, management can make to IAS 16 and IAS 38 (issued The amendments impact specifically required for all measurement categories: those amortised cost if it also meets an irrevocable election to present on 12 May 2014 and effective 4 standards. IFRS 5 was interim periods, unless required to be measured subsequently the SPPI requirement. Debt changes in fair value in other

110 111 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

comprehensive income, provided IFRS 15, Revenue from Contracts Recognition of Deferred Tax liability arising from the advance 22 does not provide application or non-monetary. The Fund is the instrument is not held for with Customers (issued on 28 Assets for Unrealised Losses - consideration. If there are multiple guidance on the definition of currently assessing the impact of trading. If the equity instrument May 2014 and effective for the Amendments to IAS 12 (issued on payments or receipts in advance, monetary and non-monetary the new standard on its financial is held for trading, changes in fair periods beginning on or after 1 19 January 2016 and effective then the entity must determine items. An advance payment or statements. value are presented in profit or January 2018). The new standard for annual periods beginning the date of the transaction receipt of consideration generally loss. introduces the core principle on or after 1 January 2017). The for each payment or receipt of gives rise to the recognition of Unless otherwise described • Most of the requirements in that revenue must be recognised amendment has clarified the advance consideration. IFRIC a non-monetary asset or non- above, the new standards and IAS 39 for classification and when the goods or services are requirements on recognition of 22 only applies in circumstances monetary liability, however, it may interpretations are not expected measurement of financial transferred to the customer, deferred tax assets for unrealised in which an entity recognises also give rise to a monetary asset to affect significantly the Fund’s liabilities were carried forward at the transaction price. Any losses on debt instruments. The a non-monetary asset or non- or liability. An entity may need to consolidated financial statements. unchanged to IFRS 9. The key bundled goods or services that entity will have to recognise monetary liability arising from apply judgment in determining change is that an entity will be are distinct must be separately deferred tax asset for unrealised an advance consideration. IFRIC whether an item is monetary required to present the effects recognised, and any discounts losses that arise as a result of of changes in own credit risk of or rebates on the contract price discounting cash flows of debt financial liabilities designated at must generally be allocated to instruments at market interest fair value through profit or loss in the separate elements. When rates, even if it expects to hold other comprehensive income. the consideration varies for any the instrument to maturity and • IFRS 9 introduces a new model reason, minimum amounts must no tax will be payable upon for the recognition of impairment be recognised if they are not at collecting the principal amount. losses – the expected credit significant risk of reversal. Costs The economic benefit embodied losses (ECL) model. There is a incurred to secure contracts in the deferred ‘three stage’ approach which is with customers have to be tax asset arises from the based on the change in credit capitalised and amortised over ability of the holder of the debt CASH AND CASH quality of financial assets since the period when the benefits of instrument to achieve future initial recognition. In practice, the contract are consumed. The gains (unwinding of the effects EQUIVALENTS the new rules mean that entities Fund is currently assessing the of discounting) without paying 7 will have to record an immediate impact of the new standard on taxes on those gains. The Fund is Cash and cash equivalents comprise: loss equal to the 12-month its financial statements. currently assessing the impact of ECL on initial recognition of the new standard on its financial financial assets that are not Sale or Contribution of Assets statements. In thousands of Azerbaijani Manats 2016 2015 credit impaired (or lifetime ECL between an Investor and its for trade receivables). Where Associate or Joint Venture - IFRIC 22 - Foreign Currency Short-term deposits 3.758.908 1.793.488 there has been a significant Amendments to IFRS 10 and IAS Transactions and Advance Money market funds 1.970.718 1.162.216 increase in credit risk, impairment 28 (issued on 11 September 2014 Consideration (issued on 8 is measured using lifetime ECL and effective for annual periods December 2016 and effective Bank accounts 488.409 405.701 rather than 12-month ECL. The beginning on or after a date for annual periods beginning Cash on hand - 1 model includes operational to be determined by the IASB). on or after 1 January 2018). The simplifications for lease and These amendments address interpretation addresses how Total cash and cash equivalents 6.218.035 3.361.406 trade receivables. an inconsistency between to determine the date of the • Hedge accounting requirements the requirements in IFRS 10 transaction for the purpose of were amended to align and those in IAS 28 in dealing determining the exchange rate accounting more closely with the sale or contribution to use on initial recognition Money market funds their assets in short-term debt and securities. Interest and dividends with risk management. The of assets between an investor of the related asset, expense Investments in money market funds debt related instruments, such as payable to the Fund are reinvested. standard provides entities with and its associate or joint or income (or part thereof) on represent share ownership in funds, commercial paper, certificates of an accounting policy choice venture. The main consequence the derecognition of a non- payable on demand. Investments deposit, bonds bearing floating The Fund had the following between applying the hedge of the amendments is that a monetary asset or non-monetary in money market funds are highly interests, US treasury bonds, investments in the money market accounting requirements of full gain or loss is recognised liability arising from an advance liquid. Money market funds invest Eurobonds and asset-backed funds with AAA credit ratings: IFRS 9 and continuing to apply when a transaction involves a consideration in a foreign IAS 39 to all hedges because business. A partial gain or loss is currency. Under IAS 21, the date the standard currently does not recognised when a transaction of the transaction for the purpose address accounting for macro involves assets that do not of determining the exchange In thousands of Azerbaijani Manats 2016 2015 hedging. constitute a business, even rate to use on initial recognition if these assets are held by a of the related asset, expense BlackRock ICS-Institution Liquidity Funds plc 1.961.888 1.147.079 The Fund is currently assessing subsidiary. The Fund is currently or income (or part thereof) is the impact of the new standard assessing the impact of the the date on which an entity The Goldman Sachs Group, Inc 8.830 15.137 on its consolidated financial new standard on its financial initially recognises the non- statements. statements. monetary asset or non-monetary Total money market funds 1.970.718 1.162.216

112 113 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Bank accounts As at 31 December 2016, the February 2017 with credit ratings may be summarised (based Fund placed AZN 1,985,158 of BB/Ba3 (Standard & Poor’s/ on Standard and Poor’s/Fitch/ Bank accounts were denominated in the following currencies: thousand (31 December 2015: Fitch/Moody’s) and above. Moody’s ratings) as follows at 31 AZN 1,793,488 thousand) in December 2016: In thousands of Azerbaijani Manats 2016 2015 deposits with non-resident The credit quality of cash and banks maturing in January and cash equivalents balances

AZN 207.234 198.418 USD 214.597 156.559 In thousands of Cash on Short term Money Market Azerbaijani Manats Hand Bank Account Deposit Funds Total GBP 976 6.298 Neither past due nor impaired (at CNY 2.235 2.421 fair value) CHF 1.582 1.386 AAA - - - 1.970.718 1.970.718 AUD 1.482 1.062 AA - 962 - - 962 EUR 15.573 3.579 A - 61.746 - - 61.746 RUB 4.492 8.345 BBB - 213.176 - - 213.176 KRW 2.565 1.513 BB* - 5.348 3.758.908 - 3.764.256 CAD 476 355 Securities without rating** - 207.177 - - 207.177 HKD 248 225 Total cash and - 488.409 3.758.908 1.970.718 6.218.035 NOK 150 158 cash equivalents DKK 109 164 NZD 102 95 The credit quality of cash and cash equivalents balances may be sum- JPY 36.184 24.956 marised (based on Standard and SGD 229 63 Poor’s/Fitch/Moody’s ratings) as follows at 31 December 2015: SEK 97 53 ILS 37 45 In thousands of Cash on Short term Money Market TRY 41 6 Azerbaijani Manats Hand Bank Account Deposit Funds Total Total bank accounts 488.409 405.701 Neither past due nor impaired (at fair value) As at 31 December 2016 the Fund of the Republic of Azerbaijan and currencies were opened with non- AAA - - - 1.162.216 1.162.216 had AZN 207,177 thousand and the International Bank of Azerbaijan, resident banks with long-term ratings AZN 95 thousand (2015: AZN 198,371 respectively. BB/Ba3 (Standard & Poor’s/ Fitch/ AA - 26.342 - - 26.342 thousand and AZN 47 thousand) held Moody’s) and above. A - 170.924 - - 170.924 at bank accounts in the Central Bank Other accounts originated in foreign BBB - 1.424 622.141 - 623.565 BB* - 8.640 1.171.347 - 1.179.987 Deposits Securities without rating** 1 198.371 - - 198.372 The Fund’s investments in deposits comprise: Total cash and cash 1 405.701 1.793.488 1.162.216 3.361.406 In thousands of Azerbaijani Manats 2016 2015 equivalents

T.C. Ziraat Bankasi A.S. 429.025 388.396

Akbank T.A.S, Istanbul 280.168 233.744 *- AZN 5,209 thousand (2015: AZN 8,093 thousand) of this amount denotes the cash balances held by the Fund’s subsid- Turkiye Is Bankasi A.S. Istanbul 637.977 584.165 iaries, where the Fund is not directly involved in cash allocations. **- It indicates the AZN cash balances held by the Fund in the Central Bank of the Azerbaijan Republic, an institution Turkiye Garanti Bankasi AS 637.988 587.183 which is not subject to the credit risk. The International Bank of Azerbaijan 1.773.750 - Interest rate analysis of cash and cash equivalents is disclosed in Note 23. Information on related party balances is dis- Total deposits 3.758.908 1.793.488 closed in Note 25.

114 115 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Term Rate with the spread external manager Deutsche 31 December 2016 total accrued ranging from +0.17% p.a. to Bank AG. interest on these securities +1.75% p.a.,(2015: from 0.06% p.a. amounted AZN 30,657 thousand to 8.625% p.a. and USD LIBOR, Sovereign bonds (2015: AZN 35,537 thousand). GBP LIBOR, EURIBOR Australian Sovereign bonds are These securities were held in Bank Bill Short Term Rate with represented by investments in the portfolio managed both TRADING the spread ranging from +0.17% debt securities issued by various directly by the Fund as well as SECURITIES p.a. to +2.02% p.a) and mature European, Asian, Australian and the Fund’s external managers, 8 during the period from January American institutions. As at 31 Deutsche Bank AG and IBRD – 2017 to January 2022, (2015: December 2016 these securities World Bank Group. Trading securities January 2016 to December bear fixed interest ranging from 2020). As at 31 December 0.5% p.a. to 9.88% p.a ( 2015: Equity securities comprise: 2016 total accrued interest on from 0.25% p.a. to 10.7% p.a. and The carrying value of equity these securities amounted USD and GBP LIBOR with the investments consists of AZN 330,200 thousand (2015: spread ranging from +0.05% investments in the following In thousands of Azerbaijani Manats 2016 2015 AZN 264,260 thousand). These p.a. to +0.63% p.a) and mature sectors at 31 December 2016 securities were held in the during the period from January and 2015: Agency/Supranational bonds 7.469.002 5.485.835 portfolio managed both directly 2017 to July 2021,(2015: from by the Fund and the Fund’s January 2016 to July 2020). As at Corporate bonds 21.691.572 22.084.832 Sovereign bonds 3.050.224 3.310.346 Equity securities 5.404.665 4.002.867 Money Market 3.111.015 3.534.182 In thousands of Azerbaijani Manats 2016 2015 Covered Bond - 405.233

Total trading securities 40.726.478 38.823.295 Finance 1.815.876 1.352.269 Consumer 1.001.540 804.190 As at 31 December 2016 the Fund held AZN 4,988,283 thousand (USD 2,817,125 thou- sand), (2015: AZN 3,708,059 thousand (USD 2,377,875 thousand)) under asset manage- Telecommunication and information technologies 811.522 512.123 ment agreements with financial institutions (“external managers”) including cash and Industrial 449.210 392.007 cash equivalents. The management fees in 2016 to the external managers were AZN 2,464 thousand (2015: AZN 1,357 thousand). Healthcare 584.625 483.772 Energy 297.783 171.518 Materials 298.347 176.381 Utilities 145.762 109.869 Transportation - 738 Agency/Supranational bonds from +0.01% p.a. to +1.2% p.a) managers, Deutsche Bank AG These bonds are represented by and mature during the period and IBRD – World Bank Group. Total equity securities 5.404.665 4.002.867 investments in debt securities from January 2017 to January issued by international 2022 (2015: January 2016 to Corporate bonds organizations of Europe, Asia June 2020). Corporate bonds are and America. These securities represented by investments These securities were held in the As trading securities are carried bear fixed interest ranging from As at 31 December 2016 total in debt securities issued by portfolio managed both directly at their fair values based on 0.25% p.a. to 8.75% p.a. and USD accrued interest on these corporations of Europe, Asia, by the Fund as well as the Fund’s observable market data using LIBOR, EURIBOR, GBP LIBOR securities amounted AZN 32,097 Australia and America. As at 31 external managers, SSGA and bid prices from Bloomberg and with the spread ranging from thousand (2015: AZN 20,344 December 2016 these securities UBS. BONYM, the Fund does not +0.03% p.a. to +0.75% p.a. (2015: thousand). These securities were bear fixed interest ranging from analyse or monitor impairment from 0.5% p.a. to 8.75% p.a. held in the portfolio managed 0.0% p.a. to 8.875% p.a. and USD Trading securities are carried at indicators. and USD LIBOR, EURIBOR, GBP both directly by the Fund as LIBOR, GBP LIBOR, EURIBOR fair value which also reflects any LIBOR with the spread ranging well as the Fund’s external and Australian Bank Bill Short credit risk related write-downs.

116 117 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Analysis by credit quality of debt trading securities is as follows at 31 December 2016:

Agency/Su- In thousands of pranational Corporate Sovereign Money Covered OTHER FINANCIAL ASSETS AT FAIR Azerbaijani Manats Bonds Bonds Bonds Market Bond Total VALUE THROUGH PROFIT OR LOSS Neither past due nor impaired 9 (at fair value) AAA 3.393.208 178.273 683.505 529.195 - 4.784.181 In thousands of Azerbaijani Manats 2016 2015 AA 3.197.301 3.218.575 226.873 835.086 - 7.477.835 A 505.831 11.937.370 574.995 926.361 - 13.944.557 Private Equity Funds 344.171 238.590 BBB 372.662 6.337.835 1.532.081 820.373 - 9.062.951 Real Estate Funds 393.795 158.379 BB - 10.212 32.770 - - 42.982 Total other financial assets at fair value through profit or loss 737.966 396.969 Securities without rating - 9.307 - - 9.307

Total neither past due 7.469.002 21.691.572 3.050.224 3.111.015 - 35.321.813 nor impaired The Fund irrevocably designated of investment funds or other pooled EBRD EPF has been formed with Total debt 7.469.002 21.691.572 3.050.224 3.111.015 - 35.321.813 the above financial assets, which investment vehicles (“Investee the purpose of providing investors trading securities are not part of its trading book, as Funds”), and direct co-investments with the exposure to EBRD’S equity at fair value through profit or loss. primarily focused on resource effi- investments in Central and Eastern The financial assets meet the cri- ciency and developing low-emission Europe, Mediterranean, Central Asia teria for classification at fair value products and services in emerging etc. through Equity Return Swaps. through profit or loss because key markets. As of 31 December 2016 the As of 31 December 2016 the fair val- Analysis by credit quality of debt trading securities is as follows at 31 December 2015: management personnel assess per- fair value of Fund’s investment in IFC ue of Fund’s investment in EBRD EPF formance of the investments based CF was AZN 30,180 thousand (2015: was AZN 1,705 thousand (2015: nil). on their fair values in accordance AZN 16,696 thousand). with a strategy documented in the Real Estate Funds Agency/Su- investment strategy. IFC ALAC is formed with the purpose Real estate’s indirect portfolio is In thousands of pranational Corporate Sovereign Money Covered of identifying, acquiring, holding comprised of investments into seven Azerbaijani Manats Bonds Bonds Bonds Market Bond Total Private Equity Funds and disposing a portfolio of equity private real estate funds and co-in- The IFC Funds are comprised of or equity related investments in vestment: AXA Real Estate Invest- Neither past due nor impaired three independent investment the African, Latin American and ment Manager Pan European Value (at fair value) funds: IFC Global Infrastructure Caribbean regions. As of 31 De- Added Venture Ltd Partnership S.C.S AAA 827.077 4.582 106.570 - 46.233 984.462 Fund (IFC GIF), IFC Catalyst Fund cember 2016 the fair value of Fund’s (PEVAV), Pramerica European Value (IFC CF) and IFC African, Latin investment in IFC ALAC was AZN Partners Ltd Partnership S.C.S (EVP), AA 1.677.155 1.595.104 706.115 371.369 255.643 4.605.386 American and Caribbean Fund (IFC 106,340 thousand (2015: AZN 109,020 Blackstone Real Estate Partners Eu- A 1.923.103 11.726.284 759.155 1.336.831 103.357 15.848.730 ALAC). thousand). rope V S.C.S (BREP EUROPE V), PAG Real Estate Partners Ltd Partnership BBB 1.058.500 8.758.862 1.708.902 1.825.982 - 13.352.246 IFC GIF is formed with the purpose All declared dividends are reinvest- S.C.S (PREP), PGIM Asia Property BB - - 29.604 - - 29.604 of identifying, acquiring, holding ed in above mentioned funds by Fund III Ltd Partnership S.C.S (ASPF and disposing of a portfolio of eq- SOFAZ. III), Redwood Japan Logistics Fund Total neither past uity or equity related infrastructure II Ltd Partnership S.C.S (RJLF II), 5.485.835 22.084.832 3.310.346 3.534.182 405.233 34.820.428 due nor impaired investments in emerging markets. As NB Caspian Partners is a separately Starwood Global Opportunity Fund of 31 December 2016 the fair value managed Private Equity man- XI Ltd Partnership S.C.S (SOF XI) Total debt trading of Fund’s investment in IFC GIF was date formed with the purpose of and co-investment to the “Junghof 5.485.835 22.084.832 3.310.346 3.534.182 405.233 34.820.428 securities AZN 164,061 thousand (2015: AZN investing predominantly in buy-out Plaza” in Frankfurt city centre. The 112,874 thousand). funds in the developed markets. As Fund has invested into these funds The credit ratings are based on lent on the Standard & Poor’s rating of 31 December 2016 the fair value through its Luxembourg subsidiar- Standard & Poor’s ratings where scale. The debt securities are not IFC CF was formed with the purpose of Fund’s investment in NB Caspian ies-Sofaz RE Holding S.A.R.L and available, or Moody’s or Fitch rating collateralised. of investing in a portfolio of limited Partners was AZN 41,884 thousand Sofaz Re Fund S.A.R.L. converted to the nearest equiva- partnerships or equivalent interests (2015: nil).

118 119 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The PEVAV fund has been estab- BREP EUROPE V is an opportunistic RJLF II is an opportunistic fund with On 1 May 2014, 23 July 2014, 25 31 December 2016 and 2015 the car- framework (program) of the main di- lished to implement value-added real estate fund and makes invest- a focus on logicstics real estate September 2014 and 28 November rying amount of these bonds equaled rections of utilization of Oil Fund’s as- real estate strategies within tar- ments mostly in United Kingdom, investments in Japan. As of 31 2014 the Fund purchased bonds to AZN 325,809 thousand and AZN sets for 2011” approved by the Decree geted European countries including Germany, Spain and Italy. As of 31 De- December 2016 the fair value of of Southern Gas Corridor at face 299,405 thousand, respectively. The of the President of the Republic of the UK, Germany, France, Spain, cember 2016 the BREP EUROPE V has Fund’s investment in RJLF II was AZN values of USD 917,321 thousand, USD maturity date of the bonds is 31 Azerbaijan dated 28 December 2010. Italy, Netherlands, Poland and the not drawn capital from the Fund yet. 63,473 thousand (2015: nil). 1,246,355 thousand, USD 101,120 December 2027 and the coupon rate According to the program SOFAZ may Nordic/Scandinavian region. As of thousand and USD 252,200 thousand is 6-month USD LIBOR + 1.335%. The invest in the securities of oil and gas 31 December 2016 the fair value of PREP is a value driven investment SOF XI invests in commercial real respectively. As of 31 December 2016 purchase was made in accordance companies operating in the Caspian Fund’s investment in PEVAV was AZN strategy fund with primary focus on estate investments across all asset the carrying amount of these bonds with the decree #519 of the President Sea basin. As of 31 December 2016 103,422 thousand (2015: AZN 88,070 Japan, China and Australia. As of 31 class in U.S and Europe with an equaled AZN 1,693,652 thousand, of Azerbaijan Republic dated 27 the carrying amount of these bonds thousand). December 2016 the fair value of Fund’s opportunistic strategy. As of 31 AZN 2,295,732 thousand, AZN 185,845 October 2011 on “Rules on manage- equaled to AZN 557,435 thousand investment in PREP was AZN 104,260 December 2016 the SOF XI has not thousand, AZN 462,206 thousand, ment of foreign currency assets of (2015: AZN 544,214 thousand). The EVP is a real estate fund formed thousand (2015: nil). drawn capital from the Fund yet. respectively (2015: AZN 1,463,963 the State Oil Fund of the Republic of maturity date of the bonds is 31 De- to acquire real estate assets in the thousand, AZN 1,983,079 thousand, Azerbaijan”. Main aim of the bond is- cember 2024 and the coupon rate is Eurozone, targeting mainly France, ASPF III is primarily focused on invest- The Fund has made with EVP a AZN 160,530 thousand, AZN 399,403 suance is to improve and reconstruct 6-month USD LIBOR + 1%. Germany, Italy and Spain, with a ing in the key markets of Australia, Chi- co-investment to “Junghof Plaza” thousand, respectively). The maturity the Ship Construction Plant of the value-add investment profile. As of na, Japan, Malaysia and Singapore property located in the Frankfurt city dates of these bonds are 1 May 2024, Republic of Azerbaijan. The custodian service for holding 31 December 2016 the fair value of with value added strategy. As of 31 centre. As of 31 December 2016 the 23 July 2024, 25 September 2024 and securities is provided by the National Fund’s investment in EVP was AZN December 2016 the fair value of Fund’s value of the Fund’s investment in this 28 November 2024 and coupons are On 5 July 2011 the Fund purchased Depository Center of the Republic of 33,738 thousand (2015: AZN 70,309 investment in ASPF III was AZN 70,259 agreement was AZN 18,644 thou- 6-month USD LIBOR +1%. bonds of AzACG Ltd. (which is a Azerbaijan. The management of the thousand). thousand (2015: nil). sand (2015: nil) 100% owned subsidiary of State Oil Fund has the intention and ability to On 26 September 2012 the Fund Company of Azerbaijan Republic) at hold the bonds until the scheduled purchased bonds of Mercury In- face value of USD 485,000 thousand. maturity date for the purpose of vestments and Holdings Ltd. at face The purchase of the bonds was made earning of interest income over the value of USD 200,000 thousand. As of under the framework of the “The holding period.

Analysis by credit quality of financial assets at amortised cost at 31 December 2016 is as follows: In thousands of Azerbaijani Manats Corporate bonds FINANCIAL ASSETS Neither past due nor impaired AT AMORTISED COST BB 5.520.679 10 Total neither past due nor impaired 5.520.679 Financial assets at amortised cost comprise: Total financial assets at amortised cost 5.520.679

In thousands of Azerbaijani Manats 2016 2015 Analysis by credit quality of financial assets at amortised cost at 31 December Current portion of financial assets at amortised cost 142.206 139.828 2015 is as follows: Non-current portion of financial assets at amortised cost 5.378.473 4.726.083 In thousands of Azerbaijani Manats Corporate bonds Total financial assets at amortised cost 5.520.679 4.865.911 Neither past due nor impaired BBB 4.006.977 These are comprised of corporate bonds of: BB 858.934

In thousands of Azerbaijani Manats 2016 2015 Total neither past due nor impaired 4.865.911

JSC Cenub Qaz Dehlizi (Southern Gas Corridor) 4.637.435 4.006.976 Total financial assets at amortised cost 4.865.911 Azerbaijan (ACG) Ltd (AzACG Ltd) 557.435 544.214 The credit ratings are based on Stan- Standard & Poor’s rating scale. ment securities at amortised cost. Mercury Investments and Holdings Ltd. 325.809 314.721 dard & Poor’s ratings where available, Information on related party invest- or Moody’s or Fitch rating converted Refer to Note 22 for the disclosure of ments at amortised cost is disclosed Total financial assets at amortised cost 5.520.679 4.865.911 to the nearest equivalent on the the fair value of each class of invest- in Note 25.

120 121 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Investment properties consist of As at 31 December 2016 investment date of valuation. The fair values of “Gallery Actor”, mixed-use office and properties are stated at fair the properties have been primarily retail complex located in Moscow value, which has been determined derived using prices for comparable central business district at 16 Tver- based on valuations performed by properties, market information, skaya Street, “78 St James’s Street” professional valuation companies, discounted cash flow method an office complex in London, “8 the accredited independent (income approach) and the expert GOLD Place Vendome” office, retail and appraisers. The appraisers are opinion of independent accredited BULLION residential building located in Paris, recognized industry specialists in valuators who have advised on 11 “Pine Avenue Tower A” office complex valuing these types of investment current market levels. located in Seoul, South Korea, “Kirar- properties. The fair value represents In accordance with the “Rules on dated 21 December 2001, #202 ito Ginza” retail complex located in the amount at which the assets At 31 December 2016, investment Holding, Placement and Manage- dated 1 March 2005, #216 dated 10 Tokyo, Japan and “Palazzo Turati” could be exchanged between a properties carried at AZN 820,589 ment of Foreign Assets of The State February 2010 and #519 dated 27 office complex in Milan, Italy. All knowledgeable, willing buyer and thousand have been pledged to Oil Fund of the Republic of Azer- October 2011, gold bars conforming properties are leased out on a com- a knowledgeable, willing seller in third parties as collateral with re- baijan” approved by Decree #511 to the requirements of the London mercial basis. an arm’s length transaction at the spect to borrowings. Refer to Note 15. of the President of the Republic Bullion Market Association may be of Azerbaijan dated 19 June 2001 included in the Investment Portfolio as amended by Decrees #607 of the Fund. Detailed disclosure on fair value increase of investment properties: Movements of gold bullion: Effect of translation In thousands of Azerbaijani Manats 2016 2015 Fair value Change in to presenta- Fair value Investment property 2016 fair value tion currency Additions Disposals 2015 Opening balance at 1 January 1.618.895 902.144 "Gallery Actor", Tverskaya Net fair value gain/(loss) on gold bullions 349.574 716.751 145.709 (12.902) 39.316 2.655 - 116.640 16, Moscow Closing balance at 31 December 1.968.469 1.618.895 "St James Street" UT, 413.840 (57.545) (30.601) - - 501.986 London "SCI 8 Palace Vendome", 326.269 16.295 27.328 2.052 - 280.594 Paris "Kirarito Ginza" , Tokyo 820.589 22.091 117.538 - - 680.960 "Pine Avenue Tower A", 728.642 6.022 69.277 - (166) 653.509 Seoul "Palazzo Turati", Milan 184.576 (788) 12.557 172.807 - - INVESTMENT 2.619.625 (26.827) 235.415 177.514 (166) 2.233.689 12 PROPERTIES Effect of translation to Movement of investment properties: Fair value Change in fair presentation Fair value Investment property 2015 value currency Additions 2014 In thousands of Azerbaijani Manats 2016 2015 "Gallery Actor", Tverskaya 16, 116.640 (4.866) 45.962 - 75.544 Investment properties at fair value at 1 January 2.233.689 805.472 Moscow Additions 177.514 459.837 "St James Street" UT, London 501.986 37.196 229.425 - 235.365 Disposals (166) - "SCI 8 Palace Vendome", Paris 280.594 7.366 122.617 124 150.487 Fair value gains/(losses) (26.827) 50.380 "Kirarito Ginza" , Tokyo 680.960 1.505 219.822 459.633 - Effect of translation to presentation currency 235.415 918.000 "Pine Avenue Tower A", Seoul 653.509 9.179 300.174 80 344.076 Investment properties at fair value at 31 December 2.619.625 2.233.689 2.233.689 50.380 918.000 459.837 805.472

122 123 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Establishment of SCI 8 Place Tverskaya 16 contributed AZN Management for KRW 469,007 Milan for EUR 97 million. For this Palazzo Turati contributed AZN Vendome 5,127 thousand (2015: AZN 4,846 million (AZN 346,250 thousand). investment the Fund established 5,426 thousand (2015: nil) of rental On 19 March 2013, the Fund thousand) of rental income and During the year ended 2016, “Pine the 100% controlled Real Estate income and AZN 24,515 thousand acquired via a special purpose AZN 11,767 thousand loss (2015: Avenue Tower A” has contributed Investment Fund (REIF) that profit (2015: nil) to the net profit/ vehicle, a mixed use office, retail AZN 2,903 thousand loss) to the AZN 27,687 thousand (2015: AZN acquired the property. The Fund (loss) before tax of the Fund (Net and residential complex SCI 8 net profit/(loss) before tax of the 28,142 thousand) of rental income invested into the REIF through its profit figure includes fair value Place Vendome located on Place Fund (Net loss figure includes and AZN 41,358 thousand profit Luxembourg subsidiary - Sofaz decrease of AZN 788 thousand Vendome 8, Paris, France from fair value decrease of AZN 12,902 (2015: AZN 32,366 thousand profit) RE Europe S.A.R.L. During 2016, (2015: nil)). AXA Real Estate for EUR 135,000 thousand (2015: decrease AZN to the net profit/(loss) before thousand. SCI 8 Place Vendome is 4,866 thousand)). tax of the Fund (Net profit figure an indirect subsidiary of the Fund includes fair value increase of incorporated in France as a civil Establishment of 78 St James’s AZN 6,022 thousand (2015: AZN partnership with share capital of Street Unit Trust (the “Unit Trust”) 9,179 thousand increase)). EUR 1,000 having its registered The Unit Trust was established by office in Paris, 6 place de the Fund on 22 November 2012 Establishment of Kirarito Ginza Madeleine. SCI 8 Place Vendome under the provision of the Trust SOFAZ made an investment in is held by the Fund via two Instrument. SOFAZ Re Limited in the amount of 51,989 million JPY Luxembourg holding companies its capacity as general partner (AZN 455,736 thousand) to an (the Luxcos): SOFAZ RE Europe of the SOFAZ RE UK L.P. has a operator entity (“OE”) under a Holding S.a.r.l. - a private limited 99% holding of the Unit Trust. Tokumei Kumiai (“TK”) agreement company with a share capital of SOFAZ Re Min Limited has a 1% on 21 August 2015. This investment INVESTMENTS IN EUR 12,500 having its registered holding of the Unit Trust. SOFAZ formed 98% of the capital of office in Luxembourg which is Re Limited, SOFAZ Re UK L.P. the OE. 2% is held by the Asset JOINT VENTURES 100% held by the Fund and holds and SOFAZ RE Min Limited are Managers (“AM”), PGIM Real 13 0.1% of SCI 8 Place Vendome ultimately owned by the State Estate (Japan). SOFAZ is free and SOFAZ RE Europe S.a.r.l. - a Oil Fund of Azerbaijan. The to sell this investment(right to The table below summarises the movements in the car- private limited company with Unit Trust invests in real estate cashflows) in the OE at any a share capital of EUR 12,500 located in the United Kingdom time. The OE invested proceeds rying amount of the Fund’s investments in joint ventures. having its registered office in and owns the office complex from investors in an investment Luxembourg which is 100% held “78 St James’s Street”. The Unit property, a retail complex in by SOFAZ RE Europe Holding Trust is established, resident and Ginza, Tokyo, for 52,434 million In thousands of Azerbaijani Manats 2016 2015 S.a.r.l. and holding 99.9% of SCI 8 domiciled in Jersey, Channel JPY (AZN 459,633 thousand), Place Vendome. During 2016, SCI Islands. During 2016, the Unit including investment-related Carrying amount at 1 January 631.895 319.933 8 Place Vendome has contributed Trust has contributed AZN 20,810 acquisition costs. For detailed Additions to investments in joint venture 153.000 300.604 AZN 10,349 thousand (2015: AZN thousand (2015: AZN 15,174 information, refer to the Note 26. 6,682 thousand) of rental income thousand) of rental income and Share of after tax results of joint venture 2,694 11,358 and AZN 20,729 thousand profit AZN 39,515 thousand loss (2015: During the year ended 2016, Carrying amount at 31 December 787.589 631.895 (2015: AZN 11,116 thousand profit) AZN 50,246 thousand profit) to “Kirarito Ginza” has contributed to the net profit/(loss) before the net profit/(loss) before tax of AZN 27,430 thousand (2015: AZN tax of the Fund (Net profit figure the Fund (Net loss figure includes 6,533 thousand) of rental income includes fair value increase of fair value decrease of AZN and AZN 40,445 thousand profit On 21 June 2013, Caspian Drilling from the shareholders’ proportion additional paid-in capital of AZN 16,295 thousand (2015: AZN 57,545 thousand (2015: AZN 37,196 (2015: AZN 5,520 thousand profit) Company (90% share) and State of their respective shares. On 5 AZN 153,000 thousand in 2016 7,366 thousand increase)). thousand increase)). to the net profit/(loss) before Oil Company of Azerbaijan July 2013, State Oil Fund of the (2015: AZN 300,604 thousand) tax of the Fund (Net profit figure Republic (10% share) jointly Republic of Azerbaijan acquired directly to the entity. All strategic Acquisition of JSC Tverskaya 16 Acquisition of “Pine Avenue includes fair value increase of established “SOCAR Rig Assets” all of the shares of “SOCAR Rig financial and operating decisions On 21 December 2012, the Fund Tower A” office complex AZN 22,091 thousand (2015: AZN LLC with the share capital of AZN Assets” LLC from Caspian Drilling relating to the activity of the acquired 100% of voting shares On 31 March 2014 SOFAZ finalised 1,505 thousand increase)). 1000 (100 shares, nominal value of Company for their nominal value. acquiree require the unanimous of JSC Tverskaya 16. Its main the acquisition of prime office AZN 10 for each share). The main “SOCAR Rig Assets” LLC did not consent of both shareholding activity is management of complex, Pine Avenue Tower A in activity of the entity is financing have any operations prior to parties. The results of this joint business and retail centre called Seoul, South Korea via acquisition Establishment of Palazzo Turati the construction of a new sixth acquisition by the Fund. After venture are incorporated in these “Gallery Actor” located in the of 100% interest in Beneficiary In May 2016, SOFAZ has reached generation semi-submersible acquisition “SOCAR Rig Assets” consolidated financial statements Central Administrative District of Certificates (“BCs”) in Real an agreement to acquire Palazzo drilling rig for operations in the LLC was renamed “Azerbaijan Rigs” using the equity method of Moscow, Russia. During 2016, JSC Estate Fund from Mirae Asset Turati, an office property in Caspian Sea through funding LLC. The Fund has contributed accounting.

124 125 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

At 31 December 2016, the Fund’s interests in its joint venture and its summarised aggregate financial information, including total assets, liabilities, revenues and profit or loss, were as follows: NON-CURRENT - 15 LIABILITIES In thousands of Azerbaijani Manats 2016 2015

Name Current assets Non-current assets liabil Current ities Non-current liabilities Revenue income Other Expenses Profit/(loss) % interest held Country of incorporation Term loan (GK001 - Tokio, Japan) 472.007 - Tenancy deposits 37.776 30.934 Azerbaijan Rigs” LLC 127.414 747.708 (1) - - 4.099 (1.106) 2.993 90% Azerbaijan Other 243 1.533

Total non-current liabilities 510.026 32.467 At 31 December 2015, the Fund’s interests in its joint venture and its summarised aggregate financial information, including total assets, liabilities, revenues and Tenancy deposits comprise of property in Paris with the amount of prepayments made by tenants for AZN 1,652 thousand (2015:nil). profit or loss, were as follows: Kirarito Ginza, the investment prop- erty in Tokyo with the amount of AZN The term loan is denominated in 19,797 thousand (2015: AZN 16,164 Japanese Yen. Bank borrowings - thousand), Pine Avenue Tower A, the mature by 09 September 2024 and investment property in Seoul with bear coupon of 0.81% annually the amount of AZN 16,327 thousand (2015: nil). An investment property is (2015: AZN 14,770 thousand) and SCI pledged as collateral for the bor- 8 Place Vendome, the investment rowing. Refer to Note 12. Name Current assets Non-current assets liabil Current ities Non-current liabilities Revenue income Other Expenses Profit/(loss) % interest held Country of incorporation

“Azerbaijan Rigs” LLC 169.770 536.392 (4.052) - - 16.010 (3.391) 12.619 90% Azerbaijan

The Fund does not apply hedge accounting and has not entered into any hedging arrangements in respect of its foreign currency obligations or interest rate exposures. The carrying amounts and fair CAPITAL values of borrowings are as follows: CONTRIBUTIONS 14 Carrying amounts Fair values The movements in capital contributions to the In thousands of Azerbaijani Manats 2016 2015 2016 2015 Fund were as follows: Term loan (GK001 - Tokio, Japan) 472.007 - 472.007 - Total borrowings 472.007 - 472.007 - In thousands of Azerbaijani Manats 2016 2015

Contributions received from sales of oil and gas 8.320.046 7.369.582 Bonuses 82 2.108 The fair value of current flows discounted using a rate Pipeline transit tariffs 17.954 11.595 borrowings equals their carrying based on the borrowing rate of Acreage fees 3.266 2.220 amount, as the impact of 0.81% (2015: nil) and are within discounting is not significant. The level 2 of the fair value hierarchy. Total capital contributions 8.341.348 7.385.505 fair values are based on cash

126 127 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

NET FAIR VALUE LOSS ON FINANCIAL INTEREST INCOME AND OTHER ASSETS AT FAIR VALUE THROUGH 16 INVESTMENT INCOME 18 PROFIT OR LOSS In thousands of Azerbaijani Manats 2016 2015 Net loss on financial assets at fair value through profit

Interest income on financial assets at fair value through profit or or loss comprises: 519.939 432.953 loss Interest income on assets carried at amortized cost: In thousands of Azerbaijani Manats 2016 2015

Interest on term deposits 146.017 72.202 Unrealized gain/(loss) on change in fair value adjustment 82.537 (347.336) Income from financial assets at amortised cost 95.503 46.545 Realized (loss)/gain on trading operations (10.871) 66.729 Income from money market funds 3.309 2.884 Net gain/(loss) on financial assets at fair value 71.666 (280.607) Interest on demand deposits 85.976 104 through profit or loss Other investment income Dividend income 122.262 55.043 Income on real estate and private equity funds 32.824 -

Total interest and other investment income 1.005.830 609.731

OPERATING 19 EXPENSES Operating expenses are comprised of: FOREIGN CURRENCY In thousands of Azerbaijani Manats 2016 2015 17 TRANSLATION DIFFERENCES Asset management fee 2.464 1.357 Operating expenses of subsidiaries 30.301 17.246 Net foreign currency translation differences Wages, salaries and employee benefits 5.073 4.471 comprise of: Bank services 1.525 1.505 Depreciation and amortization 9.079 6.287 In thousands of Azerbaijani Manats 2016 2015 Short-term license fee 3.977 272 Net unrealized gain on foreign currency translation differences 5.113.878 22.505.807 Communication expenses 363 597 Net realized gain/(loss) on foreign currency translation differences 206.969 (44.928) Other operating expenses 3.468 3.398 Total net gain on foreign currency translation differences 5.320.847 22.460.879 Total operating expenses 56.250 35.133

128 129 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

tax rates for companies oper- Deferred taxes reflect the rary differences relate mostly TRANSFERS ating in the Russian Federation net tax effects of temporary to different methods of income comprised 20% for 2016 and differences between the car- and expense recognition as BY THE FUND 2015. Whereas Luxembourg rying amounts of assets and well as to recorded values of 20 and French subsidiaries are liabilities for financial reporting certain assets. subject to income tax at a rate purposes and the amounts During 2016 transfers to the State Budget, as of 33.3% (2015: 33.3%). used for tax purposes. Tempo- well as to the state institutions, state-owned entities and companies were made in accor- dance with:

• The Decree #719 of the No. 719 of the President of the • Decree #443 of the President President of the Republic of Republic of Azerbaijan dated of the Republic of Azerbaijan Azerbaijan dated 29 Decem- December 29, 2015 on “The “On Ratifying the Budget of The ber 2015 on the Approval of the Budget of the State Oil Fund State Oil Fund of the Repub- FAIR VALUE Budget of the State Oil Fund of the Republic of Azerbaijan lic of Azerbaijan for the year of the Republic of Azerbaijan for 2016”. 2015” dated 19 January 2015, OF FINANCIAL for 2016. “Program on main directions of During 2015 transfers to the management of the funds of INSTRUMENTS • Decree #852 of the President State Budget, as well as to the The State Oil Fund of the Re- 22 of the Republic of Azerbaijan state institutions, state-owned public of Azerbaijan for 2015. dated 18 March 2016 on mak- entities and companies were ing amendments to the Decree made in accordance with: Fair value measurements are analysed by level in the fair value hierarchy as follows:

(i) level one are or indirectly (that is, derived a fair value measurement measurements at quoted from prices), and (iii) level uses observable inputs that prices (unadjusted) in active three measurements are require significant adjustment, markets for identical assets valuations not based on that measurement is a or liabilities, (ii) level two observable market data Level 3 measurement. The measurements are valuations (that is, unobservable significance of a valuation techniques with all material inputs). Management applies input is assessed against the INCOME inputs observable for the judgement in categorising fair value measurement in its asset or liability, either financial instruments using entirety. 21 TAXES directly (that is, as prices) the fair value hierarchy. If The Fund provides for in- and law of State Parliament As a result there are no tem- come taxes based on the regarding changes to the porary differences in respect tax accounts maintained Tax Code of Azerbaijan Re- of SOFAZ’s Azerbaijani and and prepared in accordance public dated 29 December UK operations. According with the tax regulations of 2012 starting from 1 January to double taxation treaty Russian Federation, Luxem- 2013 SOFAZ is exempted with Japan, gains from To- bourg and France. from corporate income tax. kumei Kumiai investments is All the Jersey companies are exempt from taxation in this According to the Presiden- zero corporate income tax country. tial decree №- 509-IVQD rated by virtue of being In- dated 21 December 2012, ternational Service Entities. Standard corporate income

130 131 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

The valuation technique, inputs used in the fair 158.379 396.969 396.969 238.590 405.233 Total 136.804 3.534.182 1.618.895 1.618.895 3.310.346 3.310.346 5.485.835 5.485.835 4.002.867 value measurement for level 3 measurements are as 2.233.689 3.989.388 22.084.832 22.084.832 38.823.295 38.823.295 43.209.652 follows:

Discounted cash flows method was “nominal money” used, were equal The estimated discount rate of ------used during the valuation of the to 5.30% relative to the actualiza- 2.6% derived through analysis of office and retail complex “Actor tion of the rents coming from the comparable data and adding Level 3 158.379 238.590 2.767.462 2.233.689 2.370.493 136.804 396.969 396.969 Gallery”. The significant inputs were in force lease until its expiry and risk premiums associated with the a discount rate used in a range be- equal to 5.70% per annum for the property to the yield on financial tween 12%-14% and the comparable final phase of development, con- assets. prices from less active markets. sidering also the risk connected to 31-Dec-15 the actualization of the cash flows Private equities are valued using ------St James Street real estate has generated after the in force lease discounted cash flow method or

Level 2 been valuated using income and expiry. market approach method. Dis- market approach. The discount counting cash-flow method is used rate of 1.27% and price per square Market and income approach with for revaluation, where discount rate feet GBP 1,582 (AZN 3,440) was the weight of 50% was used for is considered as a significant input used as significant inputs for val- the valuation of Pine Avenue. The for valuation.

- uation. maximum and minimum value for - - - -

405.233 both valuation was calculated. For investments in equity and Level 1 3.534.182 3.310.346 3.310.346 5.485.835 5.485.835 4.002.867 1.618.895 1.618.895 1.618.895 1.618.895 22.084.832 22.084.832 38.823.295 38.823.295 40.442.190 For the valuation of Place Vendome The significant input in the market real estate funds, increases in property, both income and market approach was the estimated unit the EBITDA multiple would each

- approach was used. 3.07% discount price per square meter in the range lead to an increase in estimated rate and EUR 2,611 per (AZN 4,868) between KRW 7,150,000 - KRW value. However, an increase in the square meter of the comparative 7,850,000 (AZN 10,496 - AZN 11,524). discount for lack of marketability

- real estates were included in cal- For the income approach, the sig- would lead to a decrease in value. 136.941 3.111.015 3.111.015 Total 344.171 344.171 393.795 737.966 7.469.002 2.619.625 2.619.625 21.691.572 21.691.572

1.968.469 culations. nificant input was the discount rate No interrelationships between 3.050.224 5.404.665 5.404.665 4.725.035 46.189.479 40.726.478 in a range between 5.2%-5.4%. unobservable inputs used in the Income method using discounted Fund’s valuation of its Level 3 cash flow projections (DCF) was The income capitalization equity investments have been used for the valuation of Palazzo approach was also used in the identified. Turati. The discounted rates at valuation of Kirarito Ginza property. ------Level 3 2.619.625 2.756.566 3.494.532 136.941 136.941 344.171 344.171 737.966 393.795 393.795

31-Dec-16 A reconciliation of movements in Level 3 of the fair A reconciliation of movements in Level 3 of the fair value hierarchy by class of instruments for the year value hierarchy by class of instruments for the year ------

- ended 31 December 2016 is as follows: ended 31 December 2015 is as follows: Level 2

Other securities at Other securities at fair value through fair value through profit or loss profit or loss In thousands of Azerbaijani Manats Corporate shares In thousands of Azerbaijani Manats Corporate shares ------3.111.015 3.111.015 Level 1 7.469.002 21.691.572 21.691.572 3.050.224 5.404.665 5.404.665 1.968.469 1.968.469 42.694.947 40.726.478 Fair value at 1 January 2016 396.969 Fair value at 1 January 2015 93.495 Gains recognised in profit or loss Gains recognised in profit or loss 65.313 34.933 for the year for the year Gains recognised in other com- Gains recognised in other com- 28.115 52.439 prehensive income prehensive income Purchases 247.569 Purchases 216.102 Fair value at 31 December 2016 737.966 Fair value at 31 December 2015 396.969 (a) Recurring fair measurements Recurring value (a) in permit or require standards accounting the that those are measurements value fair Recurring the statement of financial position at the end of eachreporting period. The level in the fairva lue hierarchy into which the recurring fair value measurements are categorised are as follows: Trading securities Trading Other financial assets at fair value through profit or loss Assets Non-financial assetsTotal recurring fair measurements value Real Estate Funds Estate Real Private Equity Funds Private Covered Bond Property and equipment, net Gold bullionsGold Money Market Money Corporate bonds Corporate Sovereign Equity securities Agency/Supranational bonds Agency/Supranational properties Investment Assets at fair value Assets Financial In thousands of Manats Azerbaijani

132 133 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS - 673 9.181 9.181 value 4.865.911 Carrying 4.866.584 FINANCIAL RISK 23 MANAGEMENT ------Management of risk is an essential portfolio of cash and cash equivalents Credit risk is managed and controlled Level 3 element of the Fund’s operations. Risks and its investments. The Fund manages through proper selection of invest- inherent to the Fund’s operations are its credit risk in accordance with the ment assets, credit quality of invest- those related to credit exposures, “Rules on Holding, Placement and Man- ment assets and setting limits on the liquidity, market and operational risks. agement of Foreign Currency Assets amount of investment per investment 31-Dec-15 A summary description of the Fund’s of The State Oil Fund of the Republic asset. 673 9.181 - 9.181 risk management policies in relation to of Azerbaijan” approved by Decree Level 2

4.865.911 those risks is discussed below. #511 of the President of the Republic The following table details the credit

4.866.584 of Azerbaijan dated 19 June 2001 as ratings of financial instruments held Credit risk. The Fund is exposed to amended by Decree #607 dated 21 by the Fund. The credit rating is credit risk which is the risk that one December 2001, Decree #202 dated issued by internationally regarded party to a financial instrument will 1 March 2005, Decree #216 dated 10 agencies Standard & Poor’s, Fitch cause a financial loss for the other par- February 2010, Decree #519 dated 27 and Moody’s. If the agencies have ------ty by failing to discharge an obligation. October 2011 (hereinafter collectively assigned different credit ratings to an Level 1 The Fund is subject to credit risk from its referred to as the “Rules”). asset, the lowest one was used.

Non-invest- Securities 2016 AAA AA A BBB ment rating without rating Total value 12.650 472.007 484.657 Carrying 5.541.096 Cash and cash equivalents 1.970.718 962 61.746 213.176 3.764.256 207.177 6.218.035 5.520.679 20.417 Trading securities 4.784.181 7.477.835 13.944.557 9.062.951 42.982 5.413.972 40.726.478 Financial assets at amortised - - - - 5.520.679 - cost 5.520.679 ------Other financial assets at fair - - - - - 737.966 737.966 Level 3 value through profit or loss 31-Dec-16 Non-invest- Securities 2015 AAA AA A BBB ment rating without rating Total 12.650 5.541.096 Level 2 472.007 484.657 5.520.679 20.417 Cash and cash equivalents 1.162.216 26.342 170.924 623.565 1.179.987 198.372 3.361.406 Trading securities 984.462 4.605.386 15.848.730 13.352.246 29.604 4.002.867 38.823.295 Financial assets at amortised - - - 4.006.977 858.934 - cost 4.865.911 ------Other financial assets at fair Level 1 - - - - - 396.969 value through profit or loss 396.969

External managers. In accordance have at least five years of positive his- fluctuate due to changes in foreign with the “Rules”, when an external tory of management of assets, or be exchange rates. The Fund is exposed manager is engaged in manage- experienced in managing assets with to the effects of fluctuations in the ment of the Fund’s currency assets, a value not less than one billion USD. prevailing foreign currency exchange the external manager or its principal rates on its financial position and cash founder should have investment credit Currency risk. flows. ratings (not lower than Baa3 (Moody’s) Currency risk is defined as the risk that or BBB- (Standard & Poor’s, Fitch)) or the value of a financial instrument will Total AssetsTotal LIABILITIES Total b) Assets and liabilities measured not at fair but forb) value which fair is disclosed value Fair values analysed level by in the fair value hierarchy and carrying value of assets not measured at fair value are as follows: bonds Corporate Other financial assets liabilities financial Other The fair values in level 2 of fair value hierarchy were estimated using the discounted cash flowsvaluation technique. The fairvalue of floating rate instrumentsnot quoted inthat anare active market was estimated be to equal their to carrying amount. The fair value of unquoted fixed interestrate instrumentswas estimated based on estimated future cash flowsexpected to received be discounted at current interestrates for new instruments with similar credit risk andremaining maturity. Term loan payables Trade Assets Assets Financial assets at cost amortised LIABILITIES Other borrowed funds Trade receivables Trade In thousands of Manats Azerbaijani

134 135 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS 673 9.181 9.181 20.417 737.966 396.969 Total Total 4.865.911 (12.650) 6.218.035 3.361.406 5.520.679 (12.650) 53.210.925 40.726.478 53.223.575 53.223.575 47.448.254 38.823.295 47.439.073 295 - - - - 31.435 1.816 44.012 Other 65.055 65.055 Other (8.542) (8.542) 1.567.434 1.567.729 1.912.383 1.536.295 1.920.925 295 1.810.042 922 ------4.492 8.345 RUB RUB 662.255 (1.018) (1.018) 816.875 663.177 821.367 820.349 654.832 922 ------1.062 1.482 AUD AUD 299.710 299.710 369.479 369.479 367.997 298.648 ------TRY TRY 27.790 627.186 627.186 627,186 594.814 594.814 567.024 6.253 - - - - - 455 (75) (75) GBP 53.583 53.583 GBP 109.558 2.203.373 2.377.582 2.377.507 2.209.626 2.100.069 2.323.544 2.323.544 6.253 1.103 - - - EUR 158.379 EUR 18.146 243.084 243.084 1.382.417 1.245.187 (2.369) (2.369) 17.901.559 17.901.559 16.729.905 1.103 18.132.367 18.133.470 19.542.837 19.545.206 19.545.206 608 - - - - USD USD 429.827 238.590 4.865.911 3.897.627 1.200.378 5.520.679 17.475.757 17.506.461 17.506.461 608 27.354.594 27.354.594 23.780.636 23.780.028 - - - 673 ------AZN AZN 199.092 199.092 (646) (646) 198.419 207.236 207.236 206.590 Total financialTotal assets liabilities financial Total position Open financialTotal assets liabilities financial Total position Open Trading Securities Trading Other Securities at Fair Value Through Profit Lossor Other Securities at Fair Value Through Profit Lossor 2016 Cash and cash equivalents amortised at assets Financial cost Cash and cash equivalents amortised at assets Financial cost Trading Securities Trading The table below summarizes the Fund’s exposure to foreign currency currency foreign to exposure Fund’s the summarizes below table The ended December 31 2016: year the for risk rate exchange currency foreign to exposure Fund’s the summarizes below table The ended December 31 2015: year the for risk rate exchange Financial assets Financial liabilities Financial Other financial liabilities financial Other Other financial assets financial Other Other financial assets financial Other Other financial liabilities financial Other 2015 Financial assets Financial liabilities Financial

136 137 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Currency risk sensitivity. The tables currency rate against the AZN, with below indicate the currencies to all other variables held constant on

which the Fund had significant the statement of profit or loss and 20.417 737.966 Total (12.650) (12.650) 6.218.035

exposure at 31 December 2016 and other comprehensive income. The 5.520.679 53.210.925 53.210.925 53.223.575 53.223.575 2015 on its monetary assets and its effect on equity does not differ from 40.726.478 forecast cash flows. The analysis the effect on the statement of profit calculates the effect of a reason- or loss and other comprehensive ably possible movement of the income. ------1.794.559 1.794.559 1.794.559 International organizations

Impact on profit/ (loss) Impact on profit/ (loss) - - - - - for the year for the year - 2.199.876 Australia 2.199.876 2.199.876 31-Dec-16 31-Dec-15 2.199.876 and Oceania and

20.00% 5.470.919 20.00% 4.756.005 AZN/USD ------20.00% (5.470.919) 20.00% (4.756.005) - Africa

20.00% 3.908.567 20.00% 3.626.473 AZN/EUR 20.00% (3.908.567) 20.00% (3.626.473) - Asia 1.816 40.319 65.055 65.055 (8.542) 20.00% 475.501 20.00% 440.675 (8.542) 3.745.601 3.737.059 AZN/GBP 3.638.411 20.00% (475.501) 20.00% (440.675)

20.00% 125.437 20.00% 118.963 - - - AZN/TRY -

20.00% (125.437) 20.00% (118.963) 212.739 304.552 America 13.841.854 13.841.854 13.841.854 13.841.854 13.324.563

20.00% 73.896 20.00% 59.942 AZN/AUD 20.00% (73.896) 20.00% (59.942) - 368.359 18.601 (3.462) (3.462) Europe 3.983.955 19.769.069 19.769.069 24.139.984 24.139.984 20.00% 164.070 20.00% 132.451 24.136.522 AZN/RUB 20.00% (164.070) 20.00% (132.451) - - - (646) (646) 1.981,022 7.501.701 5.520.679 7.501.055 7.501.055 Azerbaijan

Commodity price risk. The Fund is affected by the vola- tility of gold prices. The following table shows the effect of price changes in gold:

31-Dec-16 31-Dec-15

AZN/XAU 20% -20% 20% -20%

Impact on profit/(loss) for the year 393.694 (393.694) 323.779 (323.779) Total financialTotal assets liabilities financial Total position Net liabilities at 31 December 2016 is set out below: out set is December 31 at 2016 liabilities Geographical concentration. Cash and cash equivalents amortised cost at assets Financial Other financial assets financial Other Financial assets Financial liabilities Financial Other financial liabilities financial Other 2016 Trading Securities Trading Other Securities at Fair Value Through Profit Lossor The geographical concentration of the Fund’s financial assets and and assets financial Fund’s the of concentration geographical The

138 139 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Interest rate sensitivity investment portfolio. Daily risk man- changed by 1%. Sensitivity analysis of At 31 December 2016 and 2015 deposits agement and monitoring is performed interest rate risk has been determined

673 and debt securities were interest-bear- within above set limits by the Risk Man- based on “reasonably possible chang- ing and, therefore, were exposed to agement Department. es in the risk variable”. The level of these 9.181 9.181 396.969 Total 4.865.911

3.361.406 the interest rate risk. Depending on the changes is determined by manage- 47.439.073 47.448.254 38.823.295 market conditions the Fund is manag- The following table presents a net ment and is contained within the risk ing this risk by gradually increasing or impact of change of the fair value of reports provided to key management decreasing the duration of assets in the securities, when market interest rate personnel. - - - - - 238.590 1.348.235 1.586.825 1.586.825 International organizations Impact on profit/(loss) before tax:

31-Dec-16 31-Dec-15 ------Interest rate Interest rate Interest rate Interest rate Australia 1.860.070 1.860.070 1.860.070

and Oceania and Assets: 1% -1% 1% -1%

Cash and cash equivalents 157 (157) 81 (81) ------6.895 6.895 6.895 Financial assets at fair value through profit or loss (360.875) 360.875 (390.559) 390.559 Africa

Net impact on profit/(loss) before tax (360.718) 360.718 (390.478) 390.478 - - - 295 295 28.762

Asia Liquidity Risk 5.291.953 5.320.715 Management’s guiding policies are to maintain conservative levels of liquidity 5.320.420 to ensure that the Fund has the ability to meet its obligations under all con- ceivable circumstances. - - - - - 155.985

America An analysis of the liquidity risk of financial position items is presented in 11.207.265 11.363.250 11.363.250 the following tables:

Up to 1 month to 3 months 1 year to Over Maturity

- 2016 1 month 3 months to 1 year 5 years 5 years undefined Total 673 8.873 8.873 158.379 Europe 2.978.239 19.108.877 22.237.295 22.246.168 Financial assets

Cash and cash equiva- 4.444.286 886.530 887.219 - - - 6.218.035 lents - - - 13 13 Trading Securities 2.538.362 3.413.128 8.676.287 20.290.320 403.716 5.404.665 40.726.478 198.420 4.865.911 5.064.331 5.064.318 Azerbaijan Other Securities at Fair Value Through Profit or - - - - - 737.966 737.966 Loss Financial assets at amor- 66.698 - 75.508 - 5.378.473 - 5.520.679 tised cost Other financial assets 20.417 - - - - - 20.417 Total financial assets 7.069.763 4.299.658 9.639.014 20.290.320 5.782.189 6.142.631 53.223.575

Financial liabilities

Other financial liabilities (12.650) - - - - - (12.650)

Total financial (12.650) - - - - - (12.650) liabilities

Total financialTotal assets liabilities financial Total position Net Liquidity gap 7.057.113 4.299.658 9.639.014 20.290.320 5.782.189 6.142.631 53.210.925 Financial assets Financial liabilities Financial 2015 The geographical concentration of the Fund’s financial assets and and assets financial Fund’s the of concentration geographical The below: out set is December 31 at 2015 liabilities policy investment with portfolios Other from reports comparing by risk risk concentrations. credit of concentrations discloses and monitors Management of the Fund approved the by President of the Azerbaijan Republic. The Fund did not have any such significant risk concentrations at 31 December 2016 and 2015. Cash and cash equivalents amortised cost at assets Financial Other financial assets financial Other Trading Securities Trading Other financial liabilities financial Other Other Securities at Fair Value Through Profit Lossor

140 141 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Operational risk. Operational risk is tory implications, or lead to financial risks. Controls should include effective the risk of loss arising from systems loss. The Fund cannot expect to segregation of duties, access, author- Up to 1 month to 3 months 1 year to 5 Over 5 Maturity failure, human error, fraud or external eliminate all operational risks, but a ization and reconciliation procedures, 2015 1 month 3 months to 1 year years years undefined Total events. When controls fail to perform, control framework and monitoring and staff education and assessment operational risks can cause damage responding to potential risks could processes, including the use of internal Financial assets to reputation, have legal or regula- be effective tools to manage the audit. Cash and cash equiva- 2.925.899 435.507 - - - - 3.361.406 lents Trading Securities 1.035.337 2.721.717 9.065.160 21.998.214 - 4.002.867 38.823.295 Other Securities at Fair Value Through Profit or - - - - 396.969 - 396.969 Loss Financial assets at amor- 73.332 - - - 4.792.579 - 4.865.911 tised cost COMMITMENTS AND Other financial assets 673 - - - - - 673 CONTINGENCIES Total financial assets 4.035.241 3.157.224 9.065.160 21.998.214 5.189.548 4.002.867 47.448.254 24 Financial liabilities Off-balance sheet transactions. Ministry of Finance and in favor, at the with the State Oil Company of the Re- On 11 August 2006 the Fund signed expense and at the risks of the Ministry public of Azerbaijan and the Fund. This Other financial liabilities (9.181) - - - - - (9.181) an Asset Management Agreement on of Finance of the Republic of Azerbaijan. legal action was brought by First Inter- “Granting free budget (balance) Funds At 31 December 2016 assets received national Merchant Bank (the “Claimant Total financial (9.181) - - - - - (9.181) to trustworthy management” with the under the above agreement were AZN Bank”) in the District Court of Rotter- liabilities Ministry of Finance of the Republic of 218,856 thousand (31 December 2015: dam (the “Court”), the Netherlands. In Liquidity gap 4.044.422 3.157.224 9.065.160 21.998.214 5.189.548 4.002.867 47.457.435 Azerbaijan. According to this agreement AZN 659,405 thousand) including ac- a verdict dated 17 February 2010 (the free budget Funds of the Ministry of crued interest. “Verdict”), the Court has rejected the Finance of the Republic of Azerbaijan claims of the Claimant Bank. After, the are to be transferred to and managed Legal proceedings. In 2004, a legal Claimant Bank has filed an appeal by the Fund within the asset manage- action totaling approximately six million against the Verdict. On 4 October 2016, Price risk. Price risk is the risk that factors affecting all securities traded ment rules set in the agreement with USD was brought against the State of the Appeal Court withheld the decision the value of a financial instrument will in the market. The Fund is exposed to the Ministry of Finance of the Republic Azerbaijan represented by the Ministry of the District Court and rejected the fluctuate as a result of changes in price risks of its products which are of Azerbaijan. The Fund manages these of Communications and High Technolo- claim of the Claimant Bank. market prices whether those changes subject to general market and specific assets free of charge, on behalf of the gies of the Republic of Azerbaijan, along are caused by factors specific to fluctuations. the individual security or its issuer or

TRANSACTIONS 31-Dec-16 31-Dec-15 WITH RELATED PARTIES 1% decrease 1% increase 25 1% increase in in securities in securities 1% decrease in securities price price price securities price Parties are generally considered to attention is directed to the substance of the Fund, have been eliminated on be related if the parties are under of the relationship, not merely the legal consolidation and are not disclosed in Impact on profit/(loss) before tax 405.145 (405.145) 385.797 (385.797) common control, or one party has the form. Transactions with related parties this note. All government entities and ability to control the other party or can are described in Notes 7, 10, 13, 14, 15 their subsidiaries are considered to be exercise significant influence over the and 20. entities under common control with the Impact on net assets/equity 405.145 (405.145) 385.797 (385.797) other party in making financial or oper- Fund. Transactions with such entities ational decisions. In considering each Transactions between the Fund and its are disclosed below as related party possible related party relationship, subsidiaries, which are related parties transactions:

142 143 07 NOTES TO CONSOLIDATED FINANCIAL STATEMENTS

Key management personnel The senior management group consists of the Fund’s Executive Di-

sheet sheet rector and heads of administrations. The aggregate remuneration of 218.856 659.405 Off-balance transactions members of the senior management group and the number of man- agers determined on a full-time equivalent basis receiving remuner- ation within this category are: metals Precious Precious 1.618.591

1.305.590 In thousands of Azerbaijani Manats 2016 2015

Aggregate remuneration 97 106 47 Number of persons 3 3 Bank parties 207.177 198.372 accounts with related 1.773.845 3.914 9.447 6.862 5.089 79.194 37.542 parties income income Interest acquired acquired on bonds from related INTERESTS IN bonds bonds parties value of 314.720 544.214 Carrying Carrying acquired acquired 557.435 325.808 STRUCTURED from related 4.006.976 4.637.435 ENTITIES

- 26 Consolidated structured enti- on the development and manage- the company are directed by means 61.522 66.174 89.998 31.607 69.998 89.995 35.538 parties 149.998 331.776 797.427 692.849 Transfers Transfers

to related ties. SOFAZ made an investment in ment of the investment property. The of contractual arrangements. 7.615.000 8.130.000 the amount of 51,989 mln. JPY (AZN OE operates the business of the com- 455,736 thousand) to an operator pany according to the Agreement Based on the specific characteristics entity (“OE”) under a Tokumei Kumiai and the Strategic Plan. of the TK Agreement, the manage- (“TK”) agreement. This investment ment concluded that a principal/

67.318 formed 98% of the capital of the OE. TK agreement provides SOFAZ with agent relationship exists between 60.993 parties 98.905 received received 348.399

6.969.789 2% are held by PGIM Foreign Invest- limited rights with respect to the SOFAZ and the OE. According to IFRS from related 8.181.450 Contributions Contributions ment Inc. The Asset Managers of the management and development of 10, the investor should treat decision Company is PGIM Real Estate (Japan). the investment property. This makes making powers delegated to the The OE invested proceeds from the OE similar to unconsolidated agent as held by the investor/prin- investors in a retail complex in Ginza, structured entities under IFRS 12, cipal himself. The management per- Year 2015 2015 2015 2015 2015 2015 2015 2015 2015 2015 2015 2015 2015 2015 2015 2015 2016 2016 2016 2016 2016 2016 2016 2016 2016 2016 2016 2016 2016 2016 2016 2016 Tokyo, for 52,300 mln. JPY (AZN where a structured entity is an entity formed analysis based on paragraph 458,462 thousand). The building that has been designed so that vot- B60 of IFRS 10 and given the limited met the definition of an investment ing or similar rights are not dominant 2% investment by the AM, concluded property under IAS 40. factors in its management and con- that the OE is an agent of SOFAZ and - trol. Under this arrangement, voting hence, SOFAZ should consolidate the SOFAZ signed an Agreement with the rights relate to the administrative investee. OE that contains the Strategic Plan tasks only and relevant activities of Ministry Education of the of Republic Azerbaijan of Ministry Economy of the of Republic of Azerbaijan Central Bank the of Republic of Azerbaijan Star oilStar refinery complex(SOCAR) Azerbaijan (AzACG (ACG) Ltd Ltd) State OilState Company the of Republic of Azerbaijan Supply Company Gas Azerbaijan water- and melioration Azerbaijan OSC system sludge The Refugees State Committee and De Social Displaced People’ Internally Azerbaijan Bank of International The Ministry Transportation of the of Azerbaijan of Republic velopment Fund velopment Ministry Finance of the of Republic of Azerbaijan Operating Companies Operating The Budget State JSC Cenub Qaz Dehlizi (Southern Gas Corridor) Mercury Investments and Holdings Ltd.

144 145 07

FIG World Cup Final in Rhythmic Gymnastics

Federation Internationale de Gymnastique (FIG) World Cup Final in Rhythmic Gymnastics took place in Baku on July 22-24, 2016.

26 gymnasts from 17 countries of the world and 9 teams in group exercises competed for the medals in the all- around competition within the first two days of the Cup. Apparatus finals were EVENTS AFTER held on the last day of the event. THE REPORTING 27 PERIOD In accordance with the Decree of the President of the Republic of Azer- baijan on the Approval of the Budget of the State Oil Fund of the Repub- lic of Azerbaijan for 2017” dated 10 January 2017, the Fund’s budgeted contributions and distributions for the year of 2017 are estimated at AZN 8,370,590 thousand and AZN 14,483,856 thousand, respectively.

The following main types of distributions for 2017 are budgeted:

• Upper bound of transfer to the State Budget of the Republic of Azerbaijan – AZN 6,100,000 thousand;

• Financing of the measures for improvement of social conditions of refugees and internally displaced people – AZN 90,000 thousand;

• Upper bound of allocation to Central Bank of the Republic of Azerbaijan for preserving macroeconomic stability – AZN 7,500,000 thousand

• Financing “Baku-Tbilisi-Kars railway” project – AZN 165,825 thousand;

• Financing the reconstruction of the Samur-Absheron irrigation system – AZN 70,000 thousand;

• Financing the “State Program on Education of Azerbaijan youth in foreign countries during 2007-2015” – AZN 29,304 thousand;

• Financing the share of the Republic of Azerbaijan in Southern Gas Corridor projects – AZN 496,155 thousand;

• Expenses related to managing the Fund – AZN 32,572 thousand.

146 147 The opening ceremony of the Chess Olympiad SANTIAGO PRINCIPLES September 1, 2016, Baku I Avropa Oyunları

Appendix Sovereign Wealth Funds “Santiago Principles”

GENERALLY ACCEPTED PRINCIPLES AND PRACTICES SELF-ASSESSMENT APRIL, 2017

Narration of Principles / Sub-Principles Responses

A. Legal Framework, Objectives, and Coordination with Macroeconomic Policies.

GAPP 1. Principle The legal framework for the SWF should be sound Legal framework of SOFAZ is clearly defined in and support its effective operation and the the “Statute of the State Oil Fund of the Republic achievement of its stated objective(s). of Azerbaijan” (hereinafter “Statute of SOFAZ”) approved by the decree of the President of the Republic of Azerbaijan.

GAPP 1.1. Subprinciple The legal framework for the SWF should ensure legal SOFAZ is a legal entity separate from the soundness of the SWF and its transactions. 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.

GAPP 1.2. Subprinciple The key features of the SWF’s legal basis and All relevant documents related to the legal basis structure, as well as the legal relationship between and structure and the legal relationships between the SWF and other state bodies, should be publicly SOFAZ and the other government agencies are disclosed. publicly disclosed and they are available on the Fund’s website.

For further information: http://www.oilfund.az/en/content/25

149 SANTIAGO PRINCIPLES

GAPP 2. Principle GAPP 4. Principle The policy purpose of the SWF should be clearly SOFAZ was established for the purpose of There should be clear and publicly disclosed policies, SOFAZ’s Funding and Withdrawal rules are clearly defined and publicly disclosed. accumulation and management of the revenues rules, procedures, or arrangements in relation to the defined by the “Statute of SOFAZ” and “Rules generated from implementation of oil and gas SWF’s general approach to funding, withdrawal, and on the preparation and execution of the annual agreements. spending operations. program of revenues and expenditures (budget) of the State Oil Fund of the Republic of Azerbaijan” SOFAZ’s primary objectives are to help maintain GAPP 4.1. Subprinciple macroeconomic stability in the country (neutralize The source of SWF funding should be publicly (hereinafter “Rules on the budget of SOFAZ”) which negative impact of the currency inflows) and disclosed. are publicly disclosed on the Fund’s website. to generate wealth for present and future generations. GAPP 4.2. Subprinciple For further information: The general approach to withdrawals from the SWF http://www.oilfund.az/en/content/25/154 Above discussed purpose of establishment, as well and spending on behalf of the government should be http://www.oilfund.az/en/content/25/156 as the primary objectives are publicly disclosed on the Funds website. publicly disclosed. http://www.oilfund.az/uploads/budget%20system-1_eng.pdf

For further information: http://www.oilfund.az/en/content/25/9 http://www.oilfund.az/en/content/3

GAPP 5. Principle The relevant statistical data pertaining to the SOFAZ submits monthly statistical reports to SWF should be reported on a timely basis to the the President and Ministry of Finance, as well owner, or as otherwise required, for inclusion where as quarterly and yearly reports to the State GAPP 3. Principle appropriate in macroeconomic data sets. Statistical Committee. SOFAZ also reports on its Where the SWF’s activities have significant direct According to its bylaws, SOFAZ is not permitted revenues and expenditures to the Parliamentary domestic macroeconomic implications, those to invest domestically. Expenditures of SOFAZ Chamber of Accounts and on other relevant constitute part of the consolidated state budget activities should be closely coordinated with the information to the Ministry of Taxes, State Social approved by the Parliament. According to Budget domestic fiscal and monetary authorities, so as to Protection Fund and other relevant government System Law the consolidated state budget is ensure consistency with the overall macroeconomic being prepared in close consultation with all agencies. Additionally, SOFAZ regularly provides policies. relevant government entities (Ministry of Finance, the relevant information on its activities to the Ministry of Economy, etc.) and involvement of World Bank and International Monetary Fund. SOFAZ. All the relevant statistical data pertaining to the For further information: fund, is publicly disclosed on the Fund’s website http://www.oilfund.az/en/content/25/154 (audited annual reports, quarterly statements, http://www.oilfund.az/en/content/25/156 etc.). http://www.oilfund.az/uploads/budget%20system-1_eng.pdf

For further information: 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

150 151 SANTIAGO PRINCIPLES

B. Institutional Framework and Governance Structure

GAPP 6. Principle GAPP 9. Principle The governance framework for the SWF should be SOFAZ has a three-tier governance structure, The operational management of the SWF should “Statute of SOFAZ”, “Rules on management of sound and establish a clear and effective division with the President of the country being a supreme implement the SWF’s strategies in an independent foreign currency assets of the State Oil Fund of the of roles and responsibilities in order to facilitate governing and reporting authority for the Fund. manner and in accordance with clearly defined Republic of Azerbaijan” (hereinafter “Investment accountability and operational independence in the responsibilities. guidelines”) and “Rules on the budget of SOFAZ” management of the SWF to pursue its objectives. SOFAZ’s activities are overseen by a Supervisory clearly define the role and responsibilities of the Board which is headed by the Prime Minister Executive Director. and consists of the Vice-Speaker of Parliament, Minister of Finance, Minister of Economy, Governor In accordance with these role and responsibilities of the Central Bank and the Economic Advisor to Executive Director has independence in the President. operational management.

The operational management of SOFAZ is vested For further information: in the Executive Director. The relevant duties and http://www.oilfund.az/en/content/25/154 responsibilities of the President of the country, http://www.oilfund.az/pub/tiny_upload/Inv_guide.pdf Supervisory Board and Executive Director are http://www.oilfund.az/en/content/25/156 clearly defined in the “Statute of SOFAZ”.

For further information: GAPP 10. Principle http://www.oilfund.az/en/content/25/154 The accountability framework for the SWF’s Accountability framework of SOFAZ is clearly operations should be clearly defined in the relevant defined in the “Statute of SOFAZ”, “Investment legislation, charter, other constitutive documents, or guidelines”, “Rules on the budget of SOFAZ” and management agreement. Budget System Law all of which are available on GAPP 7. Principle the Fund’s website. Fund produces and publicly The owner should set the objectives of the SWF, The objectives of SOFAZ are clearly defined in discloses audited annual reports and quarterly appoint the members of its governing body(ies) in “Statute of SOFAZ” approved by the President of reports. Information about Fund’s activities is also accordance with clearly defined procedures, and the Republic of Azerbaijan. disseminated through regular press conferences exercise oversight over the SWF’s operations. and published on the Fund’s website. Please see also the response on GAPP 5 and 6. See also response on GAPP 5. For further information: http://www.oilfund.az/en/content/25/154 For further information: http://www.oilfund.az/en/content/25/154 http://www.oilfund.az/pub/tiny_upload/Inv_guide.pdf GAPP 8. Principle http://www.oilfund.az/en/content/25/156 The governing body(ies) should act in the best The Supervisory Board of the Fund, which is http://www.oilfund.az/uploads/budget%20system-1_eng.pdf interests of the SWF, and have a clear mandate and headed by the Prime Minister and consists of the adequate authority and competency to carry out its Minister of Finance, Governor of the Central Bank, functions. Minister of Economy, Vice-Speaker of Parliament and the Economic Advisor to the President, have 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.

For further information: http://www.oilfund.az/en/content/25/154

152 153 SANTIAGO PRINCIPLES

GAPP 11. Principle GAPP 13. Principle An annual report and accompanying financial Since the start of its operations, SOFAZ has Professional and ethical standards should be clearly Professional and ethical standards are clearly statements on the SWF’s operations and prepared annual reports and accompanying defined and made known to the members of the defined in the “Investment Guidelines”. performance should be prepared in a timely fashion financial statements. SWF’s governing body, management and staff. and in accordance with recognized international Management and staff of the Fund have to or national accounting standards in a consistent All financial statements are prepared in comply with ethical norms and rules of the manner. accordance with International Financial Reporting International Financial Markets Association Standards (“IFRS”). (ACI, Paris) and “Rules of Ethical Conduct for the Employees of SOFAZ”. All annual reports and accompanying financial statements are published on the Fund’s website. For further information: http://www.oilfund.az/pub/tiny_upload/Inv_guide.pdf For further information: http://www.oilfund.az/en_US/about_found/etik-davranis- http://www.oilfund.az/en/content/25/154 qaydalari.asp http://www.oilfund.az/en/account

GAPP 14. Principle GAPP 12. Principle Dealing with third parties for the purpose of the Fund’s activities related to third parties are The SWF’s operations and financial statements Since the start of its operations SOFAZ has been SWF’s operational management should be based based on economic and financial grounds. Fund’s should be audited annually in accordance with audited by reputable international audit firms. In on economic and financial grounds, and follow clear “Investment Guidelines” and “Investment Policy” recognized international or national auditing line with the Public Procurement Law, the Fund rules and procedures. regulate SOFAZ’s dealing with third parties. standards in a consistent manner. conducts open market tender processes to select its auditor. Price Waterhouse Coopers has been All aspects of dealing with external managers appointed to audit SOFAZ financial statements for are clearly defined in relevant documentation years 2016-2018. about Fund’s activity. Appointment of external managers is carried out in compliance with the All annual reports and accompanying financial current legislation of Azerbaijan Republic on statements are available on the Fund’s website. “State Procurement”. External managers are selected on the basis of the criteria, such as credit SOFAZ also has Internal Audit department that rating of manager, assets under management, prepares periodic internal audit reports. experience in the asset management industry, proposed rate of return and risk, proposed For further information: fees schedule etc. Compliance of the external http://www.oilfund.az/en/content/25/154 managers’ investments to their mandate is http://tender.gov.az/new/docs/tlotroa.doc monitored daily. Performance of external managers’ portfolios is monitored monthly.

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

154 155 SANTIAGO PRINCIPLES

C. Investment and Risk Management Framework

GAPP 15. Principle GAPP 18. Principle SWF operations and activities in host countries Fund conducts its operations and activities in The SWF’s investment policy should be clear and “Investment Guidelines” and “Investment should be conducted in compliance with all host countries in compliance with all applicable consistent with its defined objectives, risk tolerance, Policy” set up SOFAZ’s asset management applicable regulatory and disclosure requirements of regulatory and disclosure requirements of those and investment strategy, as set by the owner or framework and ensure the transparency in the countries in which they operate. host countries. the governing body(ies), and be based on sound its investment decisions. Among the others, portfolio management principles. they define strategic asset allocation, currency composition, benchmarks, risk limits, minimum requirements for the Fund’s external GAPP 18.1. Subprinciple managers and limitations on the investment The investment policy should guide the SWF’s directions, as well as the credit quality limits GAPP 16. Principle financial risk exposures and the possible use of for Fund’s counterparties (custodian banks, The governance framework and objectives, as well Fund’s governance framework, objectives and its leverage. correspondent banks, etc.). as the manner in which the SWF’s management is operational independence are clearly defined in operationally independent from the owner, should be the relevant legislation. Derivatives (i.e. swaps, forwards, futures, etc.) publicly disclosed. GAPP 18.2. Subprinciple may only be used for hedging or optimizing the For further information: The investment policy should address the extent to currency composition and asset allocation of http://www.oilfund.az/en/content/25/154 which internal and/or external investment managers the Investment Portfolio. are used, the range of their activities and authority, and the process by which they are selected and their For policies and procedures related to the performance monitored. Fund’s external managers please see our response on GAPP 14. GAPP 18.3. Subprinciple A description of the investment policy of the SWF Fund’s “Investment guidelines” and “Investment GAPP 17. Principle should be publicly disclosed. Policy” are available on its website. Relevant financial information regarding the SWF Audited financial statements are published in should be publicly disclosed to demonstrate Fund’s annual report, which is publicly available. For further information: its economic and financial orientation, so as to Quarterly reports and all other relevant financial http://www.oilfund.az/pub/tiny_upload/Inv_guide.pdf contribute to stability in international financial information about the Fund’s activities are http://www.oilfund.az/uploads/Inv_policy1.pdf markets and enhance trust in recipient countries. published on the Fund’s website. Disclosed financial information includes AUM, asset allocation, benchmark, annual rates of return, etc.

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

156 157 SANTIAGO PRINCIPLES

GAPP 19. Principle GAPP 22. Principle The SWF’s investment decisions should aim to According to its “Investment Policy”, Fund’s The SWF should have a framework that identifies, Identification, assessment and management of maximize risk-adjusted financial returns in a manner investment decisions should aim at maximizing assesses and manages the risks of its operations. the risks of the Fund’s operations play crucial role consistent with its investment policy, and based on the risk adjusted returns. Fund’s all investment in the Fund’s overall management framework. economic and financial grounds. decisions are made purely on an economic and SOFAZ’s risk management system is supported financial basis according to the sound asset GAPP 22.1. Subprinciple with appropriate legal framework (“Investment management principles. The risk management framework should include Guidelines”, “Investment Policy”, etc), a specialized GAPP 19.1. Subprinciple reliable information and timely reporting systems, risk unit (Risk Management Department), internal If investment decisions are subject to other than See also response on GAPP 18. which should enable the adequate monitoring and and external audit functions and tools like economic and financial considerations, these should management of relevant risks within acceptable RiskManager 4 by RiskMetrics and proprietary be clearly set out in the investment policy and be For further information: parameters and levels, control and incentive models. publicly disclosed. http://www.oilfund.az/uploads/Inv_policy1.pdf mechanisms, codes of conduct, business continuity planning, and an independent audit function. “Investment Guidelines” and “Investment Policy” set the main principles of risk management GAPP 19.2. Subprinciple framework and clearly define limits on major The management of an SWF’s assets should be GAPP 22.2. Subprinciple factors for market, credit, concentration and consistent with what is generally accepted as sound The general approach to the SWF’s risk management liquidity risks. Certain pre-trade limits are set asset management principles. framework should be publicly disclosed. 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 GAPP 20. Principle and monitoring of the market risk is performed on The SWF should not seek or take advantage of According to its bylaws, SOFAZ is not permitted a regular basis through: interest rate sensitivity privileged information or inappropriate influence by to invest domestically. In line with the “Investment analysis (key rate durations, PV01, etc.), risk the broader government in competing with private guidelines”, SOFAZ makes investment decisions concentration analysis (duration by groups, VaR by entities. independently of the government. Institutional groups, marginal VaR, etc.), tail events (conditional and legal framework of SOFAZ has been designed VaR, stress tests) and scenario analyses. in a way that the Fund cannot seek or take advantage of any privileged information. Operational risk is managed in accordance with Fund’s Operational Manual and business For further information: continuity planning. http://www.oilfund.az/pub/tiny_upload/Inv_guide.pdf http://www.oilfund.az/en/content/25/154 For further information: http://www.oilfund.az/pub/tiny_upload/Inv_guide.pdf http://www.oilfund.az/uploads/Inv_policy1.pdf

GAPP 21. Principle SWF’s view shareholder ownership rights as a SOFAZ started to invest in equities in 2012 and has fundamental element of their equity investments’ chosen not to exercise its ownership rights at this value. If an SWF chooses to exercise its ownership stage. 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.

158 159 GAPP 23. Principle The assets and investment performance (absolute Comprehensive reports on assets of SOFAZ and relative to benchmarks, if any) of the SWF should (including information on breakdown of investment be measured and reported to the owner according portfolio by foreign currencies, asset class, credit to clearly defined principles or standards. 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.

For further information: http://www.oilfund.az/en/account

GAPP 24. Principle A process of regular review of the implementation of This report was first published on SOFAZ’s official the GAPP should be engaged in by or on behalf of website in April, 2011 and it is reviewed on an the SWF. annual basis.

160