PILLAR 3 RISK DISCLOSURE
1. Introduction
The European Capital Requirements Directive (“CRD”) introduced capital adequacy standards and an associated supervisory framework in the EU based on the Basel II rules. It affects banks, building societies as well as certain investment firms. The Directive was introduced into the UK by the Financial Services Authority (“FSA”). The new framework consisted of three ‘pillars’.
Pillar 1
• The minimum capital required by a firm to meet credit, market and operational risk.
Pillar 2
• A regular assessment of a firm’s regulatory capital, through a process known as the Internal Capital Adequacy Assessment Process (“ICAAP”), which determines whether the amount of internal capital is sufficient to cover all the risks to which the firm is exposed or whether additional capital needs to be held against the risks not covered in Pillar 1.
Pillar 3
• This introduces public disclosure of qualitative and quantitative information and is aimed to encourage market discipline by providing market participants access to key information on a firm’s capital, risk exposures and risk management processes.
The rules in BIPRU 11 set out the Pillar 3 requirements. This document is designed to meet the Pillar 3 requirements. The rules permit Polygon Investment Partners LLP (the “LLP”) to omit any information that is considered immaterial, such that its omission would be unlikely to change or influence the decision of those relying on that information. In addition, the LLP may omit required disclosures which it regards as propriety or confidential. Propriety information is that which may undermine the LLP’s competitive position if it is shared. Information is considered to be confidential where there are obligations binding the LLP to confidentiality with its customers, suppliers and counterparties.
No omissions have been made on the grounds that it is immaterial, propriety or confidential.
2. Scope and application
The LLP is authorized and regulated by the FSA and as such is subject to minimum capital requirements, based on its categorization as a €50K limited licence firm.
The LLP serves as the investment manager to two funds.
The LLP does not form part of a consolidation group for prudential purposes.
3. Risk Management and the Risk Management Process
The LLP is governed by an Executive Committee (the “Executive Committee”). The Risk Committee and Business Management Committee report to the Executive Committee and with their input the Executive Committee determines the business strategy and risk appetite for the LLP. The Executive Committee includes the LLP’s Chief Executive Officer (the “LLP CEO”) and Chief Investment Officer.
For various reasons, the Executive Committee considers that from a regulatory capital perspective, the LLP is a relatively low risk organization. For example the LLP does not directly take custody of any investor assets.
Due to the small size of the LLP and its relatively low risk profile, the Executive Committee considers that the LLP does not warrant the need for a separate risk management function within the LLP. Risk management is undertaken by the Risk Committee with the assistance of the LLP CEO together with support from internal compliance, legal and operations teams. In addition, the LLP retains external professional services firms for expert advice and consultation, as and where considered appropriate.
The Executive Committee of the LLP, through formal and informal meetings, are actively involved in determining the LLP’s business strategy and implementing process to mitigate risks. The LLP’s risk profile is assessed, as part of the ICAAP process, at least annually and more frequently as and when the need arises, upon the discretion of the Executive Committee.
The Executive Committee also determines how the risks the LLP faces may be mitigated and assesses the arrangements to manage those risks on an ongoing basis. The Executive Committee meets both formally and informally to discuss current projections for profitability, cash flow, regulatory capital management, business planning and risk management. The Executive Committee manages the LLP’s business and identifies risks through a framework of policy and procedures taking account of relevant laws, standards, principles and rules (including FSA principles and rules) with the aim of operating a defined and transparent risk management framework. These policies and procedures are updated as required.
The Executive Committee has identified that credit, business and operational, and market risks are the main areas of risk to which the LLP is exposed. The Executive Committee formally review the risks, controls and other risk mitigation arrangements and assesses their effectiveness. Where the Executive Committee identifies material risks, it considers the financial impact of these risks as part of the LLP’s business planning and capital management and concludes whether the amount of regulatory capital is adequate.
4. Credit Risk
Client Concentration
The LLP has two clients - the Funds- with which it has very close linkages. For example, two of the members of the LLP are representatives of the Funds. This results in a high client concentration risk. The LLP is financially dependent upon the Funds. Their continued support is enshrined in their management agreements.
5. Business and Operational Risk
Operational risk is defined by the FSA as the risk of loss resulting from inadequate or failed internal processes, people and systems or from external events, including legal risk. The Management Committee has identified relevant risks and related mitigation and controls as part of its ICAAP review.
The LLP has policies and procedures and ongoing operational and related compliance monitoring to help identify weaknesses and potential control failures which are required to be reported promptly when observed to the Executive Committee.
6. Market Risk
The Executive Committee believes that the LLP’s market risks, which include the potential effects of a long term downturn in financial markets and foreign currency exchange risk, would not have a direct material effect on the LLP due to its funding relationship with the Funds.
7. Regulatory Capital
The LLP’s capital position as at the year ended 30 November 2009 was as follows:
| Capital Item |
$’000 |
| Tier 1 Capital |
8,437 |
| Total Tier 2 and Tier 3 Capital |
- |
| Deductions |
- |
| Total Available Capital after Deductions |
8,437 |
The LLP is a relatively small firm with a simple operational infrastructure. The LLP’s market risk is mainly limited to foreign exchange risk on its foreign currency cash balances. In addition, the LLP is subject to credit risk on management and performance fees receivable from the Fund. The LLP follows the standardized approach to market risk and the simplified standard approach to credit risk. The LLP is subject to the Fixed Overhead Requirement and is not required to calculate operational risk capital.
The LLP is an FSA €50K limited licence firm and as such its minimum capital requirement is the greater of:
• The base capital requirement of €50,000;
• The sum of its market and credit risk requirements; and
• The 13 Week Fixed Overhead Requirement (“FOR”).
The Executive Committee considers that the available capital at 30 November 2009 more than adequately exceeds the minimum capital requirement of the FOR.