The European Union Capital Requirements Directive introduced standards for capital adequacy based on the assessment of risk, together with an associated supervisory framework and disclosure requirements. The Capital Requirements Directive was implemented in the UK through the creation of rules and guidance by the Financial Services Authority (“FSA”).
The Capital Requirements Directive consists of three ‘Pillars’:
Pillar 1 establishes minimum capital requirements in respect of credit, market and operational risk exposures using standard criteria.
Pillar 2 requires firms to assess the risk exposures specific to their business and to calculate the amount of capital that should be held against those exposures. This has been implemented in the UK as the Individual Capital Adequacy Assessment Process (“ICAAP”). It also establishes a supervisory process for the FSA to challenge firms’ own assessments. The amount of capital a firm is required to hold is the greater of the Pillar 1 and Pillar 2 values.
Pillar 3 requires firms to publicly disclose their policies for managing risk and their capital requirements. This is designed to promote market discipline by providing market participants with key information on a firm’s risk exposures and risk management processes.
Cofunds Holdings Limited (registered number 04022350) is the UK consolidation group consisting of:
The disclosures made within this document are made in respect of Cofunds Limited (“Cofunds” or “the Company”) as the FSA authorised and regulated entity, whose primary activity is to offer business-to-business fund platform services and administration.
Cofunds acts as agent in the placing of aggregated deals with fund managers and does not engage in any dealings as principal. Cofunds also does not offer any advice on products or investments.
This Pillar 3 disclosure is made in accordance with the FSA’s Prudential Sourcebook for Banks, Building Societies and Investment Firms (“BIPRU”).
The FSA’s rules provide that we may omit one or more of the required disclosures if we believe that the information is immaterial. Materiality is based on the criterion that the omission or misstatement could change, or influence, the assessment or decision of a user relying on that information for the purpose of making economic decisions.
In addition, we may also omit one or more of the required disclosures where we believe that the information is regarded as proprietary or confidential. Information may be deemed proprietary if sharing that information with the public would undermine our competitive position.
Proprietary information may include information on products or systems which, if shared with competitors, would render a firm’s investments therein less valuable. Information may be regarded as confidential if there are obligations to customers or other counterparty relationships binding Cofunds to confidentiality.
Where we have omitted information for either of these two reasons we have stated this, and the reasons, in the relevant section of this document.
The disclosures made in this document are subject to external verification only to the extent that they have been made in Cofunds Limited’s financial statements for the year ended 31 December 2010.
Cofunds has two mutually interdependent but complementary aims with regard to its corporate sustainability; our duty to provide a quality service whilst ensuring the fair treatment of our customers, and to provide value to our shareholders.
Risk is an inherent part of Cofunds’ business. Our objective is not to completely eliminate risk but to manage it to an acceptable level whilst balancing risk with reward. Effective risk management assists in the delivery of our strategic objectives, protecting the value of Cofunds by managing potential threats and adding value by enhancing our ability to take advantage of the available opportunities. It also aids capital planning, enabling Cofunds to retain the ability to meet its liabilities as they fall due.
A core objective of the Cofunds Risk Management Framework is the consistent identification, assessment, mitigation, monitoring and reporting of risk. This is achieved through the following component processes:
Cofunds employs this framework to manage risk from both a company wide top-down view (to assess its capacity to take risk) and from a business unit bottom-up view (to validate its assessment of risk).
Cofunds operates a “three lines of defence” model to assign risk management responsibilities. This model is based on the principle that, to be effective, risk management capability must be embedded within the business, with independent oversight and assurance.
1st Line of Defence
Cofunds’ first line of defence is its business lines that have responsibility for managing their identified risks through the implementation of a sound set of processes and controls. Responsibility for risk management resides at all levels within Cofunds’ business lines, from the Executive team to business unit team managers. All Cofunds staff members are accountable for managing risks within the business areas for which they are responsible, ensuring compliance with prescribed Company plans, policies and prevailing regulatory and legislative requirements.
The business lines are also responsible for complying with Cofunds’ Risk Management Policy and Framework, including maintaining their top-down and bottom-up risk assessments.
2nd Line of Defence
Cofunds’ 2nd line of defence consists of risk oversight by the Cofunds Limited Board (“the Board”) and the assurance provided by separate Risk and Compliance functions who undertake a set of monitoring activities on the operation of the 1st line of defence.
The Cofunds Limited Board is responsible for risk management across the Company. The Board has delegated oversight activities to an executive Risk Committee.
The activities of the Risk and Compliance functions include reviews of risk profile updates, ongoing reporting of risk profile development to the Risk Committee, direct challenge of information at the Risk Committee and other relevant operational committees and monitoring of risk exposures and control performance in key risk areas.
These activities provide direct assurance that management activities are in accordance with Cofunds’ Risk Management Policy and Framework and are aligned with the risk appetite set by the Board. Cofunds’ Risk Committee receives regular reports from the Risk and Compliance functions detailing the conclusions of this assurance work.
3rd Line of Defence
Cofunds’ 3rd line of defence, consisting of an independent Internal Audit function and non-executive Audit Committee, provides independent assurance and challenge to the Cofunds Directors on all aspects of Cofunds’ risk management and control arrangements, including their design and application.
The activities of the Internal Audit function are reported to either the Risk Committee or the Audit Committee, allowing these committees to discharge their risk management oversight duties.
To manage its risks Cofunds has implemented an enterprise-wide methodology to risk management. The aim of this methodology is to identify and understand the full spectrum of risk exposures facing the organisation and to take informed actions to manage or mitigate risks that exceed predicted or acceptable levels in relation to Cofunds’ strategic objectives.
Cofunds promotes a consistent risk management culture to ensure that risk is properly understood, identified, reported, and managed. This lies at the core of FSA Principles 1 (integrity), 2 (skill, care and diligence), 3 (management and control) and 4 (financial prudence).
Cofunds’ approach to risk management supports the belief that risk taking is an essential part of doing business and therefore does not need to be, and cannot always be eliminated. Risk must be fully understood and adequately measured to ensure that the risk exposure is appropriate for the returns anticipated, and is consistent with Cofunds’ long term goals and obligations to its stakeholders. The objective is to safeguard the assets both of Cofunds and its clients whilst allowing sufficient operating freedom to secure a satisfactory return.
Cofunds’ risk appetite defines the boundaries of activity that the Board intends for the Company and forms the basis against which the business and financial decisions are taken and risks are monitored and reported to management, the Risk and Audit Committees and the Board.
The Cofunds Limited Board is responsible for setting Cofunds’ risk appetite and has defined a series of risk appetite statements covering the various risk types to which the Company is exposed. These statements set out the nature and scale of the risks acceptable to Cofunds in achieving its business objectives. Risk appetite statements are reviewed annually by the Risk Committee and the Board to ensure they remain appropriate to Cofunds’ risk profile and strategic objectives.
Cofunds recognises that it is exposed to a wide range of risks and to ensure that employees and stakeholders can demonstrate a consistent view of what the key risks are and how their management is aligned to the strategic objectives a common risk language is used. Central to this language is our categorisation of risk.
Risk categories relevant to this disclosure are detailed below:
Operational Risk
The risk of loss resulting from inadequate or failed internal processes, people or systems or from external events. Cofunds’ definition of operational risk includes risks arising from outsourced operations, project/change risk, and strategic and business risks. Cofunds is exposed to numerous types of operational risk which are further categorised to facilitate meaningful assessment and reporting in accordance with our Risk Management Framework processes.
Controls and risk mitigation strategies, including the use of insurance where appropriate, are put in place to address operational risk exposures in line with Cofunds’ agreed risk appetites.
Group Risk
The risks associated with the impact of events arising from other parts of the firm’s group. Cofunds is subject to risks arising from its shareholder structure and relationships.
Credit Risk
The risk of loss caused by the failure of a counterparty to perform its contractual obligations. Cofunds is exposed to credit risk relating to default by its retail and institutional clients, product providers (fund managers) and banks holding either corporate or client money assets.
In respect of client default Cofunds may sell the assets on which settlement is awaited. Cofunds is therefore only exposed to market movements over the period taken to liquidate holdings. Cofunds actively monitors its credit risks, considering the effects of potential contagion where relevant, and employs appropriate aggregation and diversification techniques to manage exposure.
Market Risk
The risk of loss arising from fluctuations in the value of, or income from, assets or in interest or exchange rates. Cofunds acts as agent in the placing of aggregated deals with fund managers. It does not deal or hold positions as principal.
Cofunds may be subject to the impact of market movements during the period while it unwinds positions where it has erroneously failed to place a trade in a timely manner or places a trade in the wrong fund. In addition, where a client fails to settle a trade Cofunds is entitled to sell the assets on which settlement is awaited and is therefore subject to market exposure until it liquidates the holding. Such exposures are managed via Cofunds’ credit risk management arrangements.
The variable rate of interest (base plus 3%) on the debt is significantly below the floor rate (7%), so movements in interest rate should have no impact.
Liquidity Risk
The risk that the firm, although solvent, either does not have sufficient available resources to enable it to meet its obligations as they fall due, or can secure them only at excessive cost. Cofunds is exposed to liquidity risk in respect of payment obligations to its clients and product providers and the settlement timing of corresponding cash inflows and outflows.
Reputational Risk
The risk of direct or indirect loss arising from damage to the Company’s reputation. Cofunds considers that reputational risks exist as the potential outcome of risks occurring within other risk categories (such as operational or liquidity risks) and do not exist in isolation. The identification and mitigation of reputational risks is therefore managed through Cofunds’ Risk Management Framework processes for managing those other risk types.
Concentration Risk
The risk that exposure to sectoral, geographic, liability and asset concentrations increase a firm’s exposure to credit risk. Cofunds does have concentrations of exposures to fund managers or institutional clients which could give rise to a level of potential credit risk. However, all material counterparties are comprised exclusively of financial institutions and, as such, are authorised and regulated by the FSA.
Securitisation Risk
Cofunds does not engage in securitising any of its own assets or investing in securitised assets.
Pension Obligation Risk
The risk of losses arising from contractual or other liabilities to or with respect to a pension scheme. Cofunds has no obligation to subscribe any sums to staff pension plans in excess of the agreed monthly contribution based on a percentage of salary. All pension schemes operated by Cofunds are defined contribution schemes.
The Terms of Reference for the Remuneration Committee (“the Committee”) are agreed by the Board of Cofunds Holdings Limited and set, amongst other things, the structure of the Committee, its’ responsibilities and the detailed risk assessments to be conducted by the Committee on Cofunds’ remuneration arrangements.
The Committee is comprised of four non-executive directors, one of whom is appointed Committee Chairman, and appointments are for a three year term.
The Committee sets and agrees the Remuneration Policy of the Company and aims to ensure that Cofunds can recruit, motivate and retain talented and suitably experienced staff. In so doing the Committee ensures that:
The Committee did not employ the services of any external consultant during 2010, save for the recommendation of KPMG Corporate Finance who were specifically authorised by the Board for the purposes of determining the annual evaluation of the Long Term Incentive Plan.
The payment of an annual bonus is entirely discretionary and is based on the achievement of personal and corporate objectives.
The Company operates a performance management process which assesses:
Overall individual performance is rated and has a direct impact on variable pay.
Funding of the overall bonus pool is based on the profits of the Company and both the methodology and the overall pool funding are agreed on an annual basis by the Committee. Bonus funding is based on profit with the Committee agreeing an annual profit target at which bonus would be paid at the “on-target level”. Over achievement of the profit target leads to an increase in the bonus pool on a non-linear basis, that is for every 5% increase in the bonus pool, profits must increase by a greater proportion. Where performance is below target, the bonus pool decreases until such time as bonuses become payable on an exceptional basis only, to the very highest performers and entirely at the discretion of the Committee.
In assessing the funding, if any, for the bonus pool the Committee will consider both the short and long term financial position of the Company and will ensure that the results of the latest ICAAP, together with other appropriate risk assessments, have been considered before reaching a decision.
The Pillar 1 capital requirement is defined as the higher of the following:
Cofunds’ Pillar 1 requirement as at 31 December 2010, based on the Fixed Overhead Requirement, was £11.4m.
Cofunds’ Pillar 2 capital requirement is calculated by the Company in accordance with its ICAAP. This includes an assessment of the adequacy of capital resources to support current and future activities and to cover the key risks faced by the business, including relevant stress scenarios. The ICAAP is reviewed and approved at least annually by the Cofunds Limited Board.
Based on its ICAAP assessment, the directors of the business consider that an appropriate level of capital to support current and future business requirements, when consideration of stress events and various key risk scenarios are taken into account, is £19.5m.
Cofunds therefore is assessed as a Pillar 2 company for capital requirement purposes.
Cofunds therefore had a capital surplus, as at 31 December 2010, of £25.9m (£45.4m – £19.5m).
Subsequent to 31 December 2010 the Company has given notice on the £6m subordinated loan which therefore no longer qualifies as Tier 3 capital. Capital resources and the capital surplus reduce by £6m.
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Cofunds Limited is authorised and regulated by the Financial Services Authority FSA Registration No 194734.
* Calls may be recorded for training and quality purposes.