Innovative  Independent  Thinking

Other Disclosures (Pillar 3)

Background

The Capital Requirements Directive (‘CRD’) and Alternative Investment Fund Management Directive (‘AIFMD’) together establish a revised regulatory capital framework across Europe governing the amount and nature of capital investment firms must maintain.

In the United Kingdom, CRD and AIFMD have been implemented by the Financial Conduct Authority (‘FCA’) in its regulations via the General Prudential Sourcebook (‘GENPRU’); the Prudential Sourcebook for Banks, Building Societies and Investment Firms (‘BIPRU’); and the Interim Prudential Sourcebook for Investment Business ("IPRU (INV)").

CRD consists of three ‘Pillars’:

  • Pillar 1 sets out the minimum capital amount that meets a firm’s credit, market and operational risk capital requirement.
  • Pillar 2 requires the firm to assess whether its capital reserves, processes, strategies and systems are adequate to meet Pillar 1 requirements and to further determine whether it should apply additional capital, processes, strategies or systems to cover any other risks it may be exposed to.
  • Pillar 3 requires disclosure of specified information about the underlying risk management controls and capital position to encourage market discipline.

AIFMD adds further capital requirements; primarily based on the Alternative Investment Fund (‘AIF’) assets the firm has under management and associated professional liability risks.

Pillar 3 Disclosure

The rules in BIPRU 11 set out the provision for Pillar 3 disclosure. This Pillar 3 disclosure document has been prepared by Absolute Return Partners LLP (‘ARP’) in accordance with the requirements of BIPRU 11 and is ratified by the Partners. Unless otherwise stated, all figures are as at the 30 April 2015 financial year-end.

Pillar 3 disclosures will be issued on an annual basis after the year end and published with the annual accounts. We are permitted to omit required disclosures if we believe that the information is immaterial; such that omission would be unlikely to change or influence the decision of a reader relying on that information for the purpose of making economic decisions about the firm.

In addition, we may omit required disclosures where we believe that the information is regarded as proprietary or confidential. In our view, proprietary information is that which, if it were shared, would undermine our competitive position. Information is considered to be confidential where there are obligations binding us to confidentiality with our customers, suppliers and counterparties.

We have made no omissions on the grounds that it is immaterial, proprietary or confidential.

Scope and application of the requirements

ARP is authorised and regulated by the FCA and as such is subject to minimum regulatory capital requirements. ARP is categorised as a, Collective Portfolio Management Investment Firm (‘CPMI’) Firm’ by the FCA for capital purposes. ARP is an investment management firm and as such has no trading book exposures.

ARP is not a member of a group and so is not required to prepare consolidated reporting for prudential purposes

Risk Management

ARP has established a risk management process in order to ensure that it has effective systems and controls in place to identify, monitor and manage risks arising in the business.

The management of the risks of the Partnership is carried out by Steven Bartel who is responsible for the oversight of the Partnership’s compliance and anti-money laundering controls and for financial controls and risk management. The Partnership’s Management Committee meets at least twice a month with all decisions being documented and all partners meet formally on an ad hoc basis.

The Management Committee receives and reviews the Partnership’s management accounts monthly. On the basis of the management accounts it is possible to monitor and project the Partnership’s capital resources.

The Partnership has a Compliance & Procedures Manual (updated in July 2015), a compliance monitoring programme and an ICAAP process that ensures it is able to manage the risks that it faces. The Partnership is supported in its compliance arrangements by a part-time compliance manager and in its accounting arrangements by an independent provider.

Given the nature and activities of the Partnership, its risk appetite is low. It does not deal in a principal capacity and therefore does not have a trading book. The key risks that it faces are as follows:

Market Risk

The main market risk of the Partnership is foreign exchange risk as a result of its management fees being calculated in a variety of currencies whilst the Partnership’s operating expenditures are mostly in sterling. This risk is monitored by the COO who actively hedges the risks the Partnership is exposed to. Net of the hedging strategy, the Partnership’s exposure to market risk is thus immaterial.

Interest Rate Risk

The Partnership is not exposed to interest rate risk as it does not rely on borrowings to meet operating expenditure and does not make loans to clients.

Credit Risk

The main credit risk of the Partnership is a defaulting debtor. As noted above, the Partnership does not extend credit to its clients. The key credit exposures that the Partnership has are management fees receivable from its clients. Cash balances are held in overnight deposit accounts and readily available.

Under Pillar 1, cash balances are risk weighted at 1.6% and management fees receivable at 8%. The partners believe that the Pillar 1 risk weight is adequate and that a Pillar 2 adjustment is not required.

Liquidity Risk

The liquidity risk that the Partnership faces is the inability to settle its liabilities as they fall due. Part of the risk management structure noted above monitors the liquidity position of the Partnership at all times. Bank reconciliations and cash flows are prepared monthly to ensure that all liabilities are understood and able to be settled as they fall due.

Cash resources of the Partnership are maintained in accounts with instant access as noted above.

Operational Risk

The Partnership is aware of the reputational damage that could result from a failure in operating procedures. The Partnership’s key policy and procedures are documented in the Compliance & Procedures Manual and monitored via the compliance monitoring programme.

Changes to procedures are communicated to partners, employees and Appointed Representatives as they occur and, if significant, all individuals will provide a written confirmation of their understanding and acknowledgement of the changes.

Partners, employees and Appointed Representatives remain aware of the policies and procedures and periodically confirm their compliance via a semi-annual compliance declaration.

Professional Liability Risk

The Partnership has a legal responsibility for risks in relation to investors, products & business practices including, but not limited to; loss of documents evidencing title of assets of the AIF; misrepresentations and misleading statements made to the AIF or its investors; acts, errors or omissions; failure by the senior management to establish, implement and maintain appropriate procedures to prevent dishonest, fraudulent or malicious acts; improper valuation of assets and calculation of unit/share prices; and risks in relation to business disruption, system failures, process management.  The Partnership is aware of, and monitors, a wide range of risks within its business operations and towards its investors.  The Partnership has in place appropriate internal operational risk policies and procedures to monitor and detect these risks.  These procedures and risks are documented, demonstrating how ARP aims to mitigate these risks.  This is reviewed annually.

The Firm holds additional own funds of £563k, equating to 0.3% of the total AIF assets under management.

Capital Resources

As the Partnership is a €125k Full Scope CPMI Firm; its capital requirements are the higher of:

  1. €125,000 + 0.02% of AIF AUM; and
  2. The sum of the market & credit risk requirements; or
  3. The fixed overheads requirement (‘FOR’) which is essentially 25% of the firm’s operating expenses less certain variable costs.

It is the Partnership’s experience that the Fixed Overhead Requirement establishes its capital requirements.

Capital Resource Requirements

The Partnership’s Pillar 1 requirement is calculated as the higher of:

  1. The Base Capital Requirement (€125k);
  2. The sum of the Credit Risk Capital Requirement and the Market Risk Capital Requirement;
  3. The Fixed Overheads Requirement (3 months’ expenditures of the Partnership).

In the opinion of the partners, the higher of these three is always likely to be the Fixed Overheads Requirement and therefore none of the Base Capital Requirement, the Credit Risk Capital Requirement or the Market Risk Capital Requirement are material to the Partnership as set out above.

Pillar 1 and Pillar 2

As at the date of this report (September 2015) the Partnership has a surplus of capital resources over its Pillar 1 capital resources requirement.

The Partnership has undertaken an Internal Capital Adequacy Assessment Process (ICAAP) to determine whether it needs any further regulatory capital due to the risks it faces as set out above.

As a result of this the Partnership has concluded that it is sufficiently capitalised to meet its requirements under Pillar 2.