Capital Requirements Directive
Pillar 3 Disclosure
For the year ended 31 December 2009
1. Overview
1.1 Introduction
Within the UK, the Capital Requirements Directive was implemented by the Financial Services Authority (FSA) which created new rules and guidance for investment Firms.
The Capital Requirements Directive consists of three ‘Pillars’:
Pillar 1 establishes the minimum capital retention requirements that we must have to meet credit, market and operational risk exposures using standard criteria
Pillar 2 involves an assessment by us, and the FSA, of our risk exposures and the capital we should hold specific to our business, and whether there is any requirement to hold additional capital in respect of any risks not covered by Pillar 1
Pillar 3 requires us to publicly disclose our policies for managing risk and our 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.
1.2. Basis of Disclosures
Cofunds Holdings Limited (registered number 04022350) is the UK consolidation group consisting of:
- Cofunds Limited (registered number 03965289, FSA regulated number 194734), which is a wholly owned FSA regulated subsidiary of Cofunds Holdings Limited, and is a BIPRU £125k limited licence firm
- Cofunds Nominees Limited (registered number 04022340), which is a dormant company wholly owned by Cofunds Limited
- Cofunds Leasing Limited (registered number 04022744), which is a non-trading wholly owned subsidiary of Cofunds Holdings Limited.
The 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.
1.3. Scope & Application of Requirements
The disclosures made within this document are made in respect of Cofunds Holdings Limited (“Cofunds”) as the authorised and regulated FSA entity, whose primary activity is to offer business-to-business fund platform services and administration.
Cofunds act as agent in the placing of aggregated deals with fund managers, and do no not engage in any dealings as principal. Cofunds also do not offer any advice on products or investments.
This disclosure relates to, and meets with, the requirements of the regulations.
2. Cofunds Risk Management
2.1 Risk Management Objectives
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. Cofunds 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.
2.2 Cofunds Risk Management Framework
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:
- Understanding the Internal Environment
- Setting business objectives
- Risk Identification
- Risk Evaluation
- Developing Risk Response
- Assessing Control Activities
- Ensuring Information and Communication
- Ongoing Monitoring of risk
Cofunds employs this framework to assess risk from both a company wide top-down view (to assess its capacity to take risk) and business unit bottom-up view (to validate its assessment of risk).
Cofunds operates a “three lines of defence model” to assign risk management responsibilities:
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. The business lines are also responsible for complying with the Risk Management Framework including maintaining their top down and bottom up risk assessments.
2nd Line of Defence
Cofunds’ 2nd line of defence is a separate assurance function including Cofunds Limited Board, Risk and Compliance functions who undertake a set of monitoring activities on the operation of the 1st line of defence. These activities include; quarterly reviews of risk profile updates, ongoing reporting of risk profile development to the Risk committee and direct challenge of information at the Risk Committees.
These activities provide direct assurance that management activities are in accordance with Cofunds Risk Policy, and practices are aligned with the risk appetite set by the Board. Cofunds Risk Committee receives regular reports from the Risk & Compliance functions detailing the conclusions of this assurance work.
3rd Line of Defence
Cofunds’ 3rd line of defence provides independent assurance and challenge to the Cofunds Directors on all aspects of the Cofunds Risk Management and control arrangements including their design and application.
These activities are commonly reported to either the Risk Committee or the Audit committee allowing these committees to discharge specific duties stated in their Terms of Reference. For example, the Risk Committee has a specific duty to monitor the implementation and effectiveness of, and compliance with, approved risk policies and standards on risk, while the Audit Committee has a specific duty to assess the scope and effectiveness of the systems established by management to identify, assess, manage and monitor financial and non financial risks.
This model is based on the principle that, to be effective, risk management capability must be embedded in front line teams, with independent oversight and assurance.
2.3 Risk Management Methodology
To manage its risks Cofunds has implemented an enterprise-wide methodology to risk management, defined as, “a process, effected by an entity's Board of Directors, management and other personnel, applied in strategy setting and across the enterprise, designed to identify potential events that may affect the entity, and manage risks to be within its risk appetite, to provide reasonable assurance regarding the achievement of entity objectives.”.
The aim of this methodology is to identify and understand the full spectrum of risks and to take informed actions to manage or mitigate risks that exceed predicted or acceptable levels in relation to Cofunds strategic objectives. Cofunds wishes to promote a consistent risk management culture to ensure that risk is properly understood, identified, reported, and managed, which lies at the core of FSA Principles 1 (integrity), 3 (management and control) and 4 (financial prudence).
2.4 Risk Appetite
Cofunds overall 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.
The Governing Body for the risk framework within Cofunds is the Risk Committee although formal ratification and approval of high level risk appetites is performed by Cofunds Limited Board with oversight and challenge provided by the Cofunds Holdings Board “the Boards”.
The Boards of Cofunds empowers the business to be entrepreneurial and to actively take on risk; however, risk must be fully understood and adequately measured to ensure that the risk exposure is appropriate for the returns anticipated, and is consistent with the 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.
The ‘Risk Appetite’ of Cofunds defines the level and nature of risks to which senior management considers it is acceptable to expose the firm. It therefore defines the boundaries of activity that the board intends for the firm. It is an essential component of Cofunds approach to risk management.
The Risk Committee sets and approves on an annual basis, risk appetite statements for all areas of actual or potential significant risk to the business. Adherence to these risk appetites is monitored on a regular basis as outlined in Cofunds risk policy and is part of the overarching risk management framework operating within Cofunds.
2.5 Categorisation of Risk
Cofunds recognises that it is exposed to a wide range of risk 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 the categorisation of risk.
Risk categories relevant to this disclosure are detailed below:
Operational Risk
Operational risk relates to inadequacies or failures in Cofunds processes, people or systems, or as a result of external events. As described earlier, a robust risk management framework is applied to identify and assure the acceptability of our risk exposures. Cofunds is exposed to significant operational risks.
Business Risk
The key risk in this area is business failure as a result of poor reputation, mistrust of the financial services industry, a global reduction in fund values due to a significant general market downturn or competition, and poor contingency management arrangements. Risk exposures are managed in accordance with our risk appetite using the risk management framework described earlier. Conservative assumptions are used within our business planning and stress testing is performed to ensure that in the event of a severe downturn, there would be sufficient capital to enable Cofunds to meet its capital requirements.
Credit Risk
Cofunds principle gross credit risks relate to non timely settlement in respect of income due from Fund Managers and default by our customers or institutional clients (nominee-to-nominee trading). Fund Managers pay fees monthly, and there are robust financial systems and controls in place to manage late payment or default.
In respect of customer default, liquidity would only be impacted on a short term basis. As Cofunds holds assets on which settlement is awaited, if this settlement fails to materialise, Cofunds can liquidate the positions and is, therefore, only exposed to market movements. Such exposures are not material, and are included within the operating costs as reduction of the revenue figure.
Our risk assessment and monitoring of counterparty risk exposures includes Fund Managers and banks used in respect of both customer funds (Client Money Account) and corporate funds.
As events during 2008 demonstrate, counterparty financial stability can deteriorate quite rapidly. Cofunds employ appropriately prudent mitigating activities to avoid any undue exposure to counterparty risk crystallisation.
We consider the effects of potential contagion and identify probable transmission mechanisms and touch points, whilst employing appropriate aggregation and diversification techniques to minimise counterparty risk exposure.
Liquidity Risk
Risk of losing earnings and capital due to an inability to meet obligations in a timely manner when they become due. Associated with the increased exposure to counterparty risk, Cofunds also has a liquidity risk exposure.
Reputational Risk
Risk of damage to the Cofunds reputation that could lead to negative publicity, costly litigation, a decline in the customer base or the exit of key employees and therefore, directly or indirectly, to a loss of revenue. Cofunds is exposed to reputational risks as reputation is essential to its success as a financial institution.
However no separate risks are detailed within this framework for reputational risks as Cofunds considers that reputational damage occurs due to the crystallisation of other types of risks, mainly Operational.
Market Risk
Cofunds acts as agent in the placing of aggregated deals with Fund Managers, and does not engage in any dealings as principal. Therefore, Cofunds do not take any positions. An immaterial market risk does exist during the time Cofunds unwinds positions where Cofunds fails to place a trade in a timely manner, or places a trade in the wrong fund. This risk is relatively small because where a customer or institutional client fails to settle a trade, title to the underlying investments rests with Cofunds. Such exposures are not material, and are included within the operating costs included within the CRR (Pillar 1).
Concentration Risk
Cofunds does have concentration of client exposures 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.
Insurance Risk
Cofunds has insurance cover with a highly rated and financially stable underwriter. The significant risks arising relate to excesses on insurance policies. These are currently not deemed material.
Interest Rate Risk
Cofunds has minimal debt and therefore movements in interest rates have limited impact. At current rates the risk of further falls in interest receivable are limited and an increase in rates would generate additional income.
Pension Obligation Risk
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.
3. Capital Resources and Requirements
The Pillar 1 capital requirement is defined as the higher of the sum of the following:
- Base Capital Requirement (€125,000)
- Fixed Operating Requirement (FOR)
- Market & Credit Risk
The Cofunds Pillar 1 requirement was £9.58m as at 31st December 2009.
Pillar 2: The Cofunds Internal Capital Adequacy Assessment Process (ICAAP) looks at the key risks faced by the business. The directors of the business feel that a more appropriate capital requirement when consideration of stress events and various scenarios are taken into account is a capital requirement of £15.5m.
Cofunds therefore is assessed as a pillar 2 company for capital purposes.
The available capital as at 31st December 2009 is £25.2m.
Surplus: Cofunds has a surplus of £9.7m (£25.2m – £15.5m)