Pillar 3 Disclosures. as at 31 December 2014

Transcription

1 Pillar 3 Disclosures as at 31 December 2014

2 Contents 1. Introduction... 5 Background... 5 Overview of the regulatory framework... 5 Objective... 5 Developments since last disclosure... 6 Key Metrics Scope... 7 ( BHF KB )... 8 BHF ( BHF )... 9 Kleinwort Benson Bank Limited ( KBBL )... 9 Kleinwort Benson Channel Islands Holdings Limited and subsidiaries ( KBCIHL )... 9 Kleinwort Benson Investors Dublin Limited ( KBI )... 9 Differences in the basis of consolidation for accounting and prudential purposes... 9 Pillar 3 process and approval policy...11 Basis and frequency of disclosures...12 Future Developments...12 Location and verification Governance and Risk Management BHF Bank...13 Kleinwort Benson...19 Kleinwort Benson Wealth Management ( KBWM )...19 KBI Assessment of Group s Risk Mitigation Policies and Assumptions...29 Risk appetite...29 Risk Identification...29 Use of Credit Risk Mitigation Techniques...31 BHF Kleinwort Benson Group (Management companies)...31 BHF Bank...31 Kleinwort Benson Wealth Management ( KBWM )...32 KBI Capital resources...33 Total Available Capital

3 Indicators of global systematic importance...33 Description of Capital Instruments...33 Common Equity Tier 1 (CET 1) Capital...33 Tier 2 (T2) Capital...34 Capital Management Capital requirements...35 Internal Assessment of Capital Adequacy...35 Capital Buffers Credit risk...37 Credit Risk Exposures...37 Credit Limits for Exposures...37 BHF Kleinwort Benson Group (Management companies)...37 BHF Bank...38 Kleinwort Benson Wealth Management ( KBWM )...39 KBI...39 Netting Arrangements...39 BHF Bank...40 Kleinwort Benson Wealth Management ( KBWM )...40 Geographical Analysis of Exposures...40 Maturity Analysis of Exposures...40 Credit Risk Mitigation ( CRM )...41 Equity exposures not included in the trading book...42 BHF Bank...43 BHF KB Group (Management companies) & Kleinwort Benson Wealth Management ( KBWM )...45 Impairment of Financial Assets and Past Due Items...45 Neither past due or impaired...47 Past due but not impaired financial instruments...47 Impaired loans...47 Use of External Credit Assessment Institutions ( ECAI ) Counterparty Credit Risk...51 Settlement Risk...51 Derivatives & Financial Contracts...51 Counterparty Credit Limits...51 Wrong-Way risk...51 Counterparty Credit Risk Mitigation...52 Potential Collateral Obligations Exposure to Securitisation Positions Market Risk

4 Market Risk - BHF Bank...59 Market Risk Kleinwort Benson Wealth Management ( KBWM )...61 Market Risk Capital Requirements...61 Equity Market Risk (Trading Book)...62 Currency ( FX ) Risk...62 Currency ( FX ) Risk BHF Bank...62 Currency ( FX ) Risk KBBL, KBCIHL, KBI & BHF KB Group management companies...62 Interest Rate (Non-Trading Book)...63 Assumptions used in the calculation of the interest rate gap...64 Debt instruments (Trading Book)...64 VaR Model Based PRR...65 SVar Model Based PRR Operational Risk...67 BHF KB Group management companies...67 BHF Bank...67 Kleinwort Benson Wealth Management ( KBWM )...67 KBI...68 BHF KB Group operational risk requirements Unencumbered Assets Leverage Remuneration...73 Governance...73 Scope...73 Link between pay and performance...74 Determination of variable remuneration...74 Cap on variable remuneration...74 Deferral of variable remuneration...74 Code staff remuneration Appendix List of Acronyms...76 Terms...76 Entity names

5 1. Introduction Background BHF Kleinwort Benson Group ( BHF KB ) is regulated as an institution in the UK by the Prudential Regulation Authority ( PRA ). The PRA regulate BHF KB as a UK Consolidation Group and currently acts as the lead regulator. The Financial Conduct Authority ( FCA ) regulates the UK financial services activities of the Group via Kleinwort Benson Bank Limited ( KBBL ). All disclosures within this report have been prepared from existing internal policies and documentation reflecting BHF KB s practices as at 31st December 2014, the Group s last financial year end. Overview of the regulatory framework The PRA requires BHF KB to maintain sufficient financial resources, including own funds and liquidity resources of an amount and quality to ensure there is no significant risk that its liabilities cannot be met as they fall due. The Basel lll regulatory framework, which was implemented in Europe through the Capital Requirements Directive IV ( CRD IV ), came into effect on 1 January The requirements of CRD IV build upon the pre-existing regulations which divide the framework into three pillars that leislate how a firm should approach this responsibility: Pillar 1 sets out quantitative minimum capital requirements to mitigate a firms s credit, counterparty, market and operational risk Pillar 2 requires firms to carry out an Individual Capital Adequacy Assessment Process ( ICAAP ), a more qualitative internal review to assess its own risk profile and whether additional capital should be held against those risks not adequately covered in Pillar 1. The firm s view of the additional capital requirement is also assessed by the GFSC during its Supervisory Review and Evaluation Process ( SREP ) and is used to determine the overall capital resources required by the bank Pillar 3 rules are designed to promote market discipline by enhancing the level of disclosures made by firms to their stakeholders, allowing them to assess a firm s key risk exposures and the adequacy of the Board s risk management processes to mitigate these risks All three pillars require that a firm has in place strategies, processes and systems to identify and manage the major sources of risk relevant to the firm, given the nature and scale of its business, and to assess and maintain financial resources that it considers adequate to cover the risks to which it is or might be exposed. The Pillar 3 disclosure requirements are set out in articles 429 to 455 of the Capital Requirements Regulation ( CRR ). Objective This document comprises BHF KB s Pillar 3 disclosures on capital and risk management as at 31 December It has two principal purposes: To meet the regulatory disclosure requirements noted above To provide stakeholders with further useful information on the capital and risk profile of the Group 5

6 Developments since last disclosure BHF KB has now fully transformed itself from an industrial holding company into a focused financial services group by materially disposing of all legacy (non-financial) businesses. In addition to this, on 26 th March 2014 BHF KB acquired BHF ( BHF ), which substantially increased BHF KB s assets. During the year RHJI International SA ( RHJI ) renamed itself as BHF Kleinwort Benson SA which was part of simplifying the legal structure of The Group. This is explained on pages 2-9 of the BHF Kleinwort Benson Group Annual report The Annual Report 2014 is located on BHF Kleinwort Benson s website and can be accessed via the following link: Key Metrics The Group s performance in 2014 was in line with expectations following the acquisition of BHF and changes to BHF KB s structure. The key ratios and metrics that demonstrate The Group s capital and financial position are as follows: Table 1 Common Equity Tier 1 Capital Common Equity Tier 1 Ratio 734.8m 17.0% Tier 1 Capital Tier 1 Ratio 734.8m 17.0% Total Regulatory Capital Total Capital Ratio 888.2m 20.5% Total RWA's Total RWA Density,4333.6m 46.2% Credit Risk RWA Credit Risk RWA Density,3363.3m 50.1% Leverage Ratio (As Per CRR) 7.2% 6

7 2. Scope In line with CRR guidelines the Pillar 3 disclosures are presented at a BHF KB consolidated level. The basis of consolidation is the same as for Capital Adequacy (Own Funds) reporting to the PRA. While the BHF KB Annual Report 2014 is published in EUR, the capital adequacy reporting to the PRA is in GBP. Therefore BHF KB will publish the Pillar 3 disclosures in both GBP & EUR currencies for consistency and reconciliation purposes. CRD4 regulation states that significant subsidiaries must also report limited Pillar 3 disclosures. The main significant subsidiaries of the Group are BHF, Kleinwort Benson Channel Islands Holding Limited ( KBCIHL ) and Kleinwort Benson Bank Limited ( KBBL ). These subsidiaries also disclose their own Pillar 3 disclosures report. The diagram below shows details of The Group structure as at 31 st December 2014: Table 2 7

8 Kleinwort Benson Group Limited ( KBG ) is currently in the process of being collapsed into the parent company to create a cost-efficient single-tier holding structure. This is part of the Group s legal reorganisation strategy, which is explained on page nine of BHF KB Group s annual report For this reason, further sections below will incorporate these two holding companies into a single company where possible and refer to them as BHF KB Group (Management companies). BHF KB Group (Management companies) has disposed of its legacy portfolio relating to investments in industrial holdings, which historically would have been deducted as Qualifying Holdings. There is a small transitional amount remaining which will also be liquidated into cash once it is strategically appropriate. These items are shown at amortised cost for accounting purposes and not consolidated which is consistent to their treatment for prudential purposes. These items are risk weighted as part of Equity Credit Risk. BHF KB Group (Management companies) continues to hold small holdings ( 18m) in Financial Investments which are not significant and equity accounted, which historically would have been deducted as Material Holdings. These items are not consolidated for accounting purposes, which is consistent to how they are treated for prudential purposes. These items are risk weighted as part of Equity Credit Risk. During the year the Group acquired some new equity investments as part of the takeover of BHF. BHF holds a small number of investments, which are predominantly in Funds and they are treated in the same manner for both accounting and prudential reporting. These investments are not consolidated and risk weighted as part of The Groups credit risk calculations. This is explained further in section 7.8 of this Pillar 3 document. As at 31 st December 2014 the Group s basis for prudential consolidation is the same as the accounting consolidation for the financial statements. The entities within the business that fit one of the following descriptions have been included in the Group s prudential consolidation: 8 An institution (i.e. a bank, building society or investment firm) A financial institution An asset management company A financial holding company An ancillary services undertaking The entities considered to be financial companies and within scope of consolidation include BHF, KBBL, KBCIHL and Kleinwort Benson Investors Dublin Ltd ( KBI ). In addition investments in subsidiary undertakings or participations that are financial companies are also consolidated for both accounting and prudential purposes. The Group does not have any transitional provisions or deductions in relation to Material or Qualifying holdings. No entities have been partially consolidated and after the changes in the legal structure as explained on page 9 of the Annual Report 2014 there are no deductions in relation to Minority Interests. ( BHF KB ) The Group s ultimate parent company is a financial holding company incorporated under the laws of Belgium, having its registered office in Brussels, Belgium. BHF KB combines the two traditional brands of BHF and Kleinwort Benson to create a client-centric merchant bank with principle activities in private banking, asset management and financial markets & corporates. BHF KB provides contemporary wealth management and corporate banking in Europe for sophisticated private and corporate clients and family offices.

9 As noted above, it is assumed that KBG is part of BHF KB for the purposes of the Pillar 3 disclosures. BHF ( BHF ) BHF is the modern private bank for discerning middle-market entrepreneurs and their families. The bank has a clear strategic focus on wealth management and corporate advisory services. BHF's business activities are focused on Private Banking and Asset Management along with Financial Markets & Corporates. The close cooperation between Private Banking and a Corporate Finance unit that is clearly geared to the needs of entrepreneurs in the 'Mittelstand' segment is one of the bank's hallmarks. Headquartered in Frankfurt am Main, BHF has 12 locations in Germany and international offices in Abu Dhabi, Geneva, Luxembourg and Zurich. Kleinwort Benson Bank Limited ( KBBL ) KBBL focuses on providing private banking and wealth management services. The target clients are high net worth individuals, family offices and entrepreneurs primarily in the UK and selected international markets. KBBL offers bespoke structuring of complex wealth solutions for high net worth clients as well as in-house funds for the affluent sector whilst seeking to maintain a strong capital base and a liquid balance sheet with little reliance on wholesale funding. Kleinwort Benson Channel Islands Holdings Limited and subsidiaries ( KBCIHL ) Kleinwort Benson s offshore operations are focused on Guernsey and Jersey. Kleinwort Benson plays a pivotal role in these key financial centres and was one of the first major banks to establish itself in the Channel Islands, over 50 years ago. Jersey and Guernsey are on the G20 s White List and are classed as having substantially implemented the internationally agreed tax standard along with the UK, US, France and Germany. In addition to providing private banking services, including Fiduciary, to wealth management clients, KBCIHL delivers a business-to-business proposition to Trust Companies, assisting them in managing their clients' assets, deposits and electronic banking, custody and investment services. The Fiduciary, Fund Administration and Custodian Trustee divisions provide services to investment funds and institutional clients including the administration of Funds, Employment Benefit Trusts, Special Purpose Vehicles and the provision of Custodian Trustee services. Kleinwort Benson Investors Dublin Limited ( KBI ) KBI is an established institutional asset manager that has been managing assets for institutional investors since It currently manages specialist strategies for public and corporate pension schemes, subadvisory investors and foundations/endowments. KBI offers investment services on both a segregated and unitised basis, with the majority of its Assets under Management ( AuM ) relating to its international clients. KBI s primary goal is to enhance performance and meet clients investment expectations through specialisation and innovation. KBI focus on two key strategies: global equities and environmental equities. KBI has a global client base in Europe, North America, the UK, Ireland and Asia. Differences in the basis of consolidation for accounting and prudential purposes The Group s basis for prudential consolidation is the same as the accounting consolidation in the financial statements. In terms of presentation, some of the items are presented with different categories for accounting and prudential reporting and the table below shows how these are reallocated. 9

10 Table 3 Consolidated Balance Sheet Financial statements versus regulatory view As at 31st December 2014 Carrying values as reported in published financial statements Reallocations between IFRS and regulatory categories Carrying values under scope of regulatory consolidation Assets m m m Cash and balances at central banks Items in the course of collection from other banks Trading portfolio assets Financial assets designated at fair value Derivative financial instruments Investments (Fair value through profit and loss) 1, ,387.1 Investments (Amortised Cost) Investments (Available for sale) 2, ,729.6 Non current assets classified as held for disposal Loans and advances to banks 1, ,105.5 Loans and advances to customers 2, ,530.9 Reverse repurchase agreements and other similar secured lending Prepayments, accrued income and other assets Investments in equity accounted investees Property, plant and equipment Goodwill and intangible assets Current tax assets Deferred tax assets Retirement benefit assets Total Assets 9, ,375.9 Liabilities Deposits from banks 1, Items in the course of collection due to other banks Customer accounts 6, ,124.6 Repurchase agreements and other similar secured borrowing Trading portfolio liabilities Financial liabilities designated at fair value Derivative financial instruments Subordinated liabilities Accruals, deferred income and other liabilities Liabilities included in disposal groups as held for sale Provisions Current tax liabilities Deferred tax liabilities Retirement benefit liabilities Total Liabilities 8, ,578.3 Equity Share capital Share premium Reserves Retained earnings Total Equity Total Equity & Liabilities 9, ,

11 The table below shows how assets and liabilities as per the financial statements are presented or disclosed for capital adequacy calculations in this Pillar 3 document. Table 4 Regulatory classifications of IFRS accounts Counterparty IFRS Classification Credit Risk Credit Risk Market Risk 3 Assets m m m Cash and balances at central banks o o Items in the course of collection from other banks o o Trading portfolio assets o o Financial assets designated at fair value o Derivative financial instruments o o Available for sale investments o o Loans and advances to banks o o Loans and advances to customers o o Reverse repurchase agreements and other similar secured lending o o Investments in equity accounted investees o o Other Assets 1 o o Liabilities Deposits from banks o o o Items in the course of collection due to other banks o o o Customer accounts o o o Repurchse agreements and other similar secured borrowing o o Trading portfolio liabilities o o Financial liabilities designated at fair value o o Derivative financial instruments o o Subordinated liabilities o o o Other Liabilities 2 o o o Other Assets consist of Prepayments, Accrued Income, Other Assets, Property Plant and Equipment, Goodwill & Intangibles, current tax assets, deferred tax assets & retirement benefit assets Other Liabilities consist of Accruals, deferred income, other liabilities, Liabilities in disposal groups as held for sale, provisions, current tax liabilities, deferred tax liabilities & retirement benefit liabilities For market risk the table above indicates specific balance sheet items that are subject to market risk fluctuations. It does not represent FX market risk which would impact the whole balance sheet. Pillar 3 process and approval policy The Pillar 3 disclosures are completed annually as part of the overall Group regulatory reporting process. Each business unit approves their components and validates the accuracy of the financial figures used in the overall consolidation. All individual business unit and consolidated disclosures are checked and validated against the relevant regulatory returns where possible to ensure the disclosures are consistent. Sections of the Pillar 3 document are checked by Finance, Risk, Treasury, Legal, Compliance and Corporate Governance representatives across each business unit. The component elements of the disclosures have been reviewed and approved by local Executive Management of each subsidiary. The consolidated Pillar 3 document is formally approved by the BHF KB Audit Committee before being published. The BHF KB Board believes these disclosures appropriately display the risk profile of The Group. 11

12 Basis and frequency of disclosures The disclosures in this document have been completed in accordance with Articles 429 to 455 of the CRR. Unless stated otherwise, all figures are as at the financial year-end, 31 st December These disclosures will be issued on an annual basis and prepared in conjunction with the Financial Statements. Future Developments The BCBS introduced a series of rules that form the basis of Basel III & CRD4 which became effective on 1 st January Although CRD4 has been reflected in these Pillar 3 disclosures, some elements are being phased in and will become effective over the course of the next few years. The impacts of the new rules are summarised below: Capital requirements and capital ratios will be gradually phased in as follows: o Minimum Common Equity Tier 1 ( CET1 ) requirement of 7% by 2019: This includes a 2.5% Capital Conservation Buffer ( CCB ) which will be phased in from 01 st January 2016 with increments 0.625% per annum. o Minimum Total Capital requirement of 10.5% by 2019 which also includes the CCB of 2.5% being phased in from 01 st January 2016 for CET1 ratio requirements. o The Bank of England also has the option to introduce a Counter-Cyclical Capital Buffer ( CCCB ) New leverage ratio of 3% will be introduced for all UK regulated banks from January 2018 subject to review in New liquidity ratios: o Intraday liquidity risk reporting will commence in 01 st July 2015 and will be required on a quarterly basis. o Additional Liquidity Monitoring Metrics (ALMM) reporting will commence 01 st July The BCBS also published revised Pillar 3 disclosure requirements in January 2015 and these are planned to take effect by year-end Location and verification The Pillar 3 disclosures for the consolidated group and its subsidiaries are located on the BHF Kleinwort Benson website and can be accessed via the following link The disclosures are not subject to external audit and do not form part of BHF Kleinwort Benson Groups financial statements. 12

13 3. Governance and Risk Management The Group is a focused financial services business with principal activities in private banking and wealth management, asset management and financial markets & corporates. These complementary businesses are offered by various businesses: Private banking and wealth management are offered by KBBL in the UK, KBCIHL in the Channel Islands and by German-based BHF; Asset management services are offered by KBI and BHF s subsidiary Frankfurt Trust; Financial markets and corporate banking services are mostly provided through BHF. Through the combined businesses, the Group faces and accepts risks in order to generate returns for its shareholders. The Group has set strategic objectives and its medium-term performance targets against following qualitative risk appetite principles: Maintenance of a strong capital position with sufficient regulatory capital surpluses which are at the high-end of European peers, set in the context of the prevailing global economic environment, market conditions, regulatory environment and reflecting the potential impact from several appropriate stress tests. Maintenance of a strong liquidity position ensuring that liabilities can be met, even under adverse business and market conditions. The Company s approach to liquidity is based on the maintenance of highly liquid low-risk treasury portfolios and stable funding with limited reliance on wholesale funding. Conduct of business in accordance with the highest ethical standards aimed at maintaining an excellent reputation with clients, employees, regulators and other stakeholders. The above qualitative principles are translated into risk appetite statements with appropriate risk tolerance levels and quantitative risk limits defined in comprehensive risk frameworks for each of the Company s businesses developed under the responsibility of their respective Board of Directors. Please refer to the BHF KB s Strategy and Business Review together with Corporate Governance sections of the BHF KB s Annual Report 2014 for further information on The Groups governance. BHF Bank BHF s risk management, measurement and control processes ensure that significant risks are identified at an early stage, fully evaluated and outlined adequately. The risk management objectives together with the strategies and processes to manage risks are demonstrated in the diagram below: 13

14 Table 5 BHF guarantees the viability and effectiveness of its risk management system through the clear, functional organisation of its risk management process. As part of this approach, the individual bodies are assigned clear tasks at strategic level: The Supervisory Board plays a supervisory role in respect of all measures related to risk mitigation and management at BHF. It approves the capital allocation proposed by the Board of Managing Directors of BHF. The Board of Managing Directors is responsible for proper organisation of the business and its continuous development. This responsibility comprises (in cooperation with the Risk Committee and the Asset-Liability Committee) the main activities of overall bank management on the basis of risk reports, overriding limit concepts and risk-bearing capacity. This includes a clear definition of the strategies, the transaction types, as well as the acceptable and unacceptable risks. The members of the Board of Managing Directors in charge of finance and credit risk management bear the responsibility for the risk management and control processes in relation to the risks entered into by BHF. The Risk Committee establishes the risk profile of BHF for the individual risk types within the framework of the strategies determined by the Board of Managing Directors, for example, by volume and structure control (achieved among other things by setting limits in the context of monitoring and limiting concentration risks), by the establishment of risk management parameters and methods and by determining measures to ensure ongoing compliance with internal and external guidelines. The Asset Liability Committee (ALCO) of BHF assumes all responsibilities that exist in relation to the liquidity management of the Bank and the Group. The ALCO ensures the liquidity position of BHF is efficiently managed, that appropriate processes and guidelines exist for monitoring and limiting risks, and that sufficient resources are available for evaluating and controlling the risks. At BHF, the Head of Corporate finance carries out the risk controlling function pursuant to MaRisk AT 4.4.1, which is responsible for the independent monitoring and communication of risks. It operates independent of the market units and reports solely to the member of the Board of Managing Directors responsible for finance. Its tasks, supported by the Risk Control department, include in particular: 14 - supporting the management in all risk-policy matters, especially in the development and implementation of the risk strategy and in the design of a system for limiting risks,

15 15 - implementing the risk inventory and creation of the overall risk profile, - supporting management in the establishment and development of risk management and control processes, - establishing and developing a system of risk indicators and an early risk detection process, - ongoing monitoring of the risk situation of the institution and the risk-bearing capacity as well as compliance with established risk limits, - preparing regular risk reports for management, - assuming responsibility for the processes involved in the immediate forwarding to the management, the responsible party and, where appropriate, the internal audit department of information that is material in terms of risk. As part of their risk control function, the Head of Corporate Finance has access to all information necessary to perform his/her duties and is involved in all important risk-policy decisions. The risk management and control processes ensure that material risks are identified at an early stage, comprehensively recorded and mapped in an appropriate manner. The risk management and control processes are adjusted promptly to take account of changing conditions. Interactions between the various types of risk are taken into account where relevant and material. Corporate Finance and Credit Risk Management submit a risk report to the Risk Committee, the Board of Managing Directors and the Risk and Audit Committee of the Supervisory Board takes place at regular intervals, but at least quarterly. This reporting also forms the basis for the presentation of risk data to the supervisory authorities and rating agencies. This comprehensive risk reporting, which includes appropriate stress tests and scenario analyses, ensures that regular monitoring of all significant risks, especially in the lending and trading business, and taking into account risk/return considerations, takes place both at the individual transaction level and at portfolio level, and that appropriate control measures can be implemented at an early stage, if necessary. The comprehensive approach to risk management at BHF also guarantees timely and recipient-based forwarding of all relevant information through appropriate measures. Defined communication channels and corresponding information events ensure there is a regular exchange of information between those involved in the various corporate divisions with respect to strategies, objectives and risks, in order to prevent an accumulation of individual risks or the combination of risks that would lead to a risk that threatens the existence of the company. Ad hoc reporting includes the immediate forwarding to the responsible party of information that is material in terms of risk (e.g. claims, relevant defects, specific suspicions of irregularities). In addition, the involvement of Group Operational Risk Control is required in the event of claims or operational risks; it informs the Board member responsible for risk controlling and the internal audit department to ensure that appropriate measures or audit procedures can be initiated at an early stage. The Management Information System (MIS) of BHF serves as the central strategic control, information and early warning system. This enables the simultaneous description of profitability, its underlying value drivers and the risks on the basis of both regulatory and economic risk measures. As part of the MIS reporting, management and other decision-makers are provided with all information relevant to controlling on a monthly basis, taking into account risk/return considerations. The control of BHF is subject to various conditions. The most important conditions are the core and total capital ratio in accordance with CRR and compliance with economic risk limits The Board of Managing Directors of BHF has a business strategy and a consistent overall risk strategy, including complementary sub-risk strategies adopted as frameworks for the BHF Group s risk policy orientation.

16 The overall risk strategy defines, amongst other things, the individual risk types classified as material and establishes the framework for dealing with these risks in the context of the risk-bearing capacity concept. Specifically, the following points are defined and substantiated: - the types of risk that are material for the Bank, - the risk-bearing capacity concept, - the transactions that can be executed, - the regulations on activities in new products or in new markets, - the procedures for risk assessment, - the risk monitoring and communication in the context of risk reporting, - the tasks of the internal audit department, - the general conditions for the outsourcing of business activities, - the requirements for organisational guidelines and for documentation and - the information on the personnel and technical resources in the BHF Group. The overall risk strategy is complemented by the individual sub-risk strategies for credit risk, market risk, liquidity risk, operational risk, investment risk, business risk and reputational risk. In its sub-risk strategy for credit risk, the Bank has laid down the conditions for entering into, monitoring, controlling and reporting with respect to this type of risk. Under this strategy, the prerequisites for the execution of credit transactions in BHF include, amongst others, the understanding of the transaction and an individual assessment of the customer s creditworthiness, including the establishment of riskappropriate conditions. The credit risk strategy also includes provisions for the identification and limitation of risk concentrations. The market risk strategy describes the fungible products and the related business objectives associated with entering into market risks. In addition, the principles of market risk management, limit setting and monitoring, including the principles of quantification of market risks, are defined. In accordance with its liquidity risk strategy BHF pursues conservative liquidity management in order to ensure that sufficient liquidity is always maintained within the BHF Group. The liquidity risk strategy describes in detail the methods used to manage and measure liquidity risk, the main committees and the contents of the regular reports. In its sub-risk strategy for operational risks, the Bank defines the principles for the management and limitation of operational risks. These include the definition of clear roles and responsibilities within the framework of risk management. One principle of the sub-risk strategy is the emphasis on maintaining the good reputation of the BHF Group in all business activities. Risk management for investment risks (-> investment risk strategy) takes place at different levels. All affiliated companies that are included in the consolidated financial statements are included in the management information system (MIS) reports in order to ensure ongoing monitoring of business developments. Moreover, the Corporate Development & Investment department regularly collects and prepares information on investments. A monthly review of the recoverability of the carrying amounts of investments is conducted on this basis. The management of business risk (-> business risk strategy) is based on a qualitative approach through regular reporting of results to the Board of Managing Directors and other stakeholders. The information on value drivers, in particular income and expense margins, in the management information system supports the identification, assessment and control of business risks. 16

17 Besides monitoring and reporting, the Bank states in its sub-risk strategy for investment risks that investments may be made for strategic reasons, for the provision of internal services or as compulsory investments. The acquisition and disposal of investments may only be made with the approval of the Board of Managing Directors. If the amount of the investment exceeds EUR 5 million, the Supervisory Board also has to approve the acquisition or disposal. The objective of BHF s Group-wide risk management and early warning system is to ensure that losses from the risks entered into at no time exceed the risk-bearing capacity in a liquidation approach. To this end, the sum of the risk capital requirements for the risk types included in the risk-bearing capacity (counterparty risk (credit risk), market risk, investment risk, operational risk and business risk) is compared with the risk capital allocated to the individual business areas and portfolios. In parallel, the risk-bearing capacity is also determined quarterly from a going-concern perspective as part of the risk reporting at the overall bank level. A traffic light system is used in both control areas, which depicts limit utilisation at an early stage. Table 6 BHF Bank Risk bearing capacity and utilisation The adequacy of the methods used to assess the risk-bearing capacity is reviewed annually by the Risk Controlling Department and the assumptions underlying them are justified in a clear manner. The risk coverage is determined on a quarterly basis on the dates of the risk report. The allocated risk capital as a percentage of the risk cover represents the potential amount of risks that can be entered into in business activities. The calculation of risk coverage is oriented toward the balance sheet and profit and loss and is based on the total IFRS equity of the BHF Group and the long-term, subordinated liabilities, taking into account various deductions that are shown in the table below. In this way, the Bank takes into account the fact that these deductible items will very likely not be available in the event of liquidation. BHF has introduced a traffic light system with defined escalation measures in order to monitor and ensure the risk-bearing capacity. One criterion within the traffic light concept considers the ratio of economic capital to the IFRS capital. At the reporting date this ratio was 75%. The risk assessment for counterparty risks and market risk is carried out on the basis of value-at-risk (VaR) concepts and stress tests. For the other types of risk included in the risk-bearing capacity concept, the risk utilisation is determined using indicator-based measurement methods. BHF uses the depiction of risk-adjusted profitability ratios in the Management Information System to ensure that the risk inherent in the business activities is taken into account in its control and monitoring processes Variance m m m Available risk capital to cover assets Free risk capital to not be quantified or allocated to risks (inc capital buffer) Risk capital available for allocation (inc capital buffer) Capital buffer Risk capital available for allocation (excl capital buffer) Risk capital utilised (Amount) Risk capital utilised (%) 83.6% 80.0% 3.6% Risk capital to cover for default risk For individual impairment For collective impairment Accruals for provisions

18 Total Private Banking Asset Management Corporates Financial Markets Internal accounts Pensions Others BHF Kleinwort Benson The Bank allocates risk capital to the individual sub-segments, portfolios and risk types and carries out its controlling using risk-adjusted profitability indicators; the objectives of this approach are to limit risks to a total amount that is consistent with the business strategy, to limit risk concentrations in a targeted way and to maintain sufficient capital even in worst-case assumptions, transparency with regard to the level of risks entered into by the individual sub-segments, the effective use of risk capital through the individual sub-segments and the linking of risk management and overall bank management. Table 7 BHF Bank Risk bearing capacity and utilisation m m m m m m m m Credit Risk Market Risk Counterparty Risk Business Risk Operational Risk Diversification and Capital deductions Risk capital available for allocation (excl capital buffer) Capital buffer 2.6 BHF Bank available risk capital Risk capital utilised (Amount) Risk capital utilised (%) 83.6% 81.8% 96.2% 89.0% 70.5% 93.4% 87.2% 0.0% Risk capital utilised (%) Previous year 80.0% 88.4% 91.4% 84.4% 67.3% 90.4% 77.0% 0.0% The risk-bearing capacity is calculated quarterly and shown in the risk reports. The responsibility for this lies with the Risk Control department of the Corporate Finance department. BHF applies risk-reducing diversification effects (resulting from the correlation between the risk types) to aggregate the individual risk contributions. The calculation of correlations is based on the Bank s internal time series and has an overall conservative orientation, as the correlations are determined based on maximum values with respect to different timeframes. The final correlation values are determined using the statistical bootstrapping method as the 95% percentile of the bootstrapping distribution. In the event limits are exceeded, the Bank has processes in place to ensure an immediate reduction of the limit utilisation. The possible measures include risk-reducing transactions, the redistribution of risk capital set aside for the specific risk type within the sub-segments or portfolios and the distribution of a capital buffer. Risk controlling is responsible for the monitoring of compliance with the limits that have been set and informs the Board of Managing Directors if the limits are exceeded. The Bank uses an emergency plan in the event of extremely unfavourable markets and heavy daily losses, which may lead to limits being exceeded due to the utilisation of market risk limits. In this context, the Bank uses an escalation process based on a traffic light concept, which should ensure an adequate response in such a scenario and guarantee that risks can be reduced within one month. This applies in particular to market risks arising from products that can be completely removed only by selling the products. No escalation was required in the reporting year. AT 4.1 item 9 MaRisk, in the version dated 14 December 2012, requires institutions to have a process of planning for future capital requirements. The planning horizon should include a reasonably long, multiyear period. According to the accompanying letter from BaFin dated 17 December 2012 on the MaRisk 18

19 amendment, both internal and regulatory capital requirements must be determined. To do so, based on its business plan BHF calculated the future development of its equity at the Group level and the regulatory capital for the period , including taking into account a stress effect to identify possible future capital requirements at an early stage and to take countermeasures. Kleinwort Benson Kleinwort Benson is the combination of KBBL, KBCIHL and KBI. KBBL and KBCIHL are the Private Banking entities of Kleinwort Benson and form Kleinwort Benson Wealth Management ( KBWM ). KBI is the Asset Management arm of Kleinwort Benson. KBBL, KBCIHL and KBI are wholly owned subsidiaries of KBG as shown in the organisational chart in table 2 of this Pillar 3 disclosure report. Kleinwort Benson Wealth Management ( KBWM ) KBWM has a vision statement to provide a compelling relationship driven proposition to clients through a focused high quality offering and state-of-the-art execution. KBWM reviews its business strategy annually and it is presented to the KBBL and KBCIHL Boards for approval. To achieve the strategy KBWM maintains a Risk Appetite and Framework ( The Risk Framework ) which is approved by the KBBL and KBCIHL Management Committee and Strategic Risk Committee before being approved by the Boards of KBBL, KBCIHL and KBCIL. The Risk Framework sets out a comprehensive framework of high level limits to control key risks facing the business but aligned to achieving the overall business strategy. KBWM has a Treasury and Financial Risks Management Policy (T&FRMP) document which is an overarching risk management framework. This document complements the Risk Framework setting out strategies, policies and how to manage the risks within the business and stay within the risk appetite. This document consists of the following key components: The Board s articulation of Kleinwort Benson Wealth Management s strategy and direction together with the associated risk appetite. This is complemented by targets and risk limits set by executive committees. Clear roles, responsibilities, reporting lines, committees and mandates exist to achieve the strategy. A comprehensive set of risk policies, processes and control procedures in place to provide bedrock for an effective control environment. Comprehensive and timely management reporting of risk exposures for decision making or mitigating potential risk on the horizon. 19

20 The following diagram illustrates how the KBWM Strategic review flows into the T&FRMP and the underlying policies and procedures. Table 8 External Factors / Clients Needs/ Core Values / Internal Objectives/ Current Risk Appetite Strategic Review Updated Risk Appetite Business Strategy Updated Risk Limits Treasury Strategy Treasury and Financial Risks Management Policy Market Risk Interest Rate Risk in Banking Book Liquidity Risk Operational Risk Credit and Counterparty Risk Policies / Procedures / Limits 20

21 The following diagram sets out the high level Board and Committee structure. It excludes details of boards for subsidiary companies wholly owned by KBBL and KBCIHL. Table 9 Kleinwort Benson Group Limited Kleinwort Benson Investors Dublin Limited BHF-BANK A.G. Kleinwort Benson Bank Limited Kleinwort Benson Channel Islands Holdings Limited Kleinwort Benson Audit Committee Kleinwort Benson Nomination and Remuneration Committee Kleinwort Benson Strategic Risk Committee Management Committee Offshore Management Committee EXCO Client Sub-Group Strategic Risk Committee The Strategic Risk Committee has responsibility for recommending The Risk Framework and overall Risk Appetite to the boards of KBWM and their subsidiaries and considers how the external environment may impact the current and future strategy of the businesses. The Committee consists of at least three members, the majority of whom are independent non-executive directors and meets at least three times per annum. Nomination and Remuneration Committee The Nomination and Remuneration Committee reviews the structure, size, function and composition of the Kleinwort Benson Boards, having regard to gender representations, and makes recommendations to the appropriate Kleinwort Benson Boards in relation to any changes deemed necessary, including the identification and nomination of candidates for the approval of the appropriate Kleinwort Benson Boards. The Nomination and Remuneration Committee agrees with the Kleinwort Benson Boards and, as appropriate, subsidiary company boards a general remuneration policy for the executive directors and officers of Kleinwort Benson and/or subsidiary company and a group policy for other members of staff, ensuring that they meet any legal and regulatory requirements. In line with local regulations and guidance, KBI also has its own Remuneration Committee. Audit Committee The Audit Committee advises the board on meeting its external financial reporting obligations and provides advice and guidance on all matters relating to internal and external audit, together with the internal control systems of KBWM. 21

22 Management Committee The Management Committee of KBWM has been given delegated authority for strategy and operational management. The Committees primary responsibilities are to: Define, recommend to the boards and promote Kleinwort Benson s strategy, business plans and annual budget Set targets and goals across the business areas; and Monitor performance against the strategic objectives and targets. Alongside the Management Committee, the Offshore Management Committee independently considers any group-wide policy, committee terms of reference or other material proposal regarding the business strategy, management, operations and performance of the non-uk businesses and considers whether or how it should be implemented having taken account of the legal and regulatory requirements relating to the business carried out by KBCIHL and its subsidiaries. The Management Committee has established the following sub-committees: Table 10 Management Committee Change Management Risk Management CEO Taskforce CEO Taskforce Change Board New Products and Instruments Committee Risk and Compliance Committee Asset and Liability Management Committee Credit Committee Project Board Project Board Cash Management Committee Reputational Risk Committee Policy Committee 22

23 The responsibilities of each of these committees are detailed in the table below: Table 11 Committee Asset and Liability Management Committee Cash Management Committee Change Board Credit Committee New Products and Instruments Committee Risk and Compliance Committee Reputational Risk Committee Policy Committee Specific Responsibilities Monitoring liquidity and capital and determining the investment policy for the treasury assets in the context of KBBL s strategy and market conditions The design of and monitoring performance against the risk framework around the product, Kleinwort Benson Cash Management Service. Monitoring progress with change projects and setting priorities. Approving counterparty limits and investment grade rated credit applications. Considering the allowable non-property collateral Reviewing existing and proposed products, services and instruments. Monitoring compliance, risk and control issues across the business and determining market risk limits. Monitoring the adequacy of the performance of outsourcers providing Credit, IT and Operational services Determines the reputational risk appetite in relation to client or business opportunities Responsible for the policy framework across the group, including the review, recommendation and, in certain circumstances, approval of policies The KBWM Boards are firmly committed to sound and prudent risk management practices, given the importance of such practices to achieving The Group s strategic objectives. In line with its ordinary activities, KBWM is exposed to a number of risks. KBWM has embedded a robust risk process into its risk management practise. The firm has a five step approach to risk management as detailed in the following diagram: 23

24 Table 12 Risk Identification Risk Monitoring Risk Culture Risk Assurance Risk Reporting Risk Management Risk Identification This is the identification of all risks which could have a material impact on the operation of the business and/or the achievement of the business s strategy and objectives. KBWM control functions undertake assessments in specialist areas, incorporating external drivers, e.g. new legislation, to assist in risk identification. The internal audit, external audit, compliance and risk monitoring processes, the business change process and the due diligence process also highlight new risks. Regular internal business meetings also assist in risk identification, and new risks may be identified through analysis of root causes of other (related) risks. Risk identification includes risks that are both internal and which are caused by factors external to the firm. Risk Assessment The objective of risk assessment is to develop an understanding of each risk, including cause, potential likelihood of occurrence and the impact on the business. The firm uses an impact v likelihood matrix to quantify and prioritise the risk on the basis of financial, operational, reputational, and other loss categories. Risk Management The risk management or risk mitigation process requires Kleinwort Benson to identify a range of options around managing individual risks. Once agreed, this is then followed by mitigation planning and implementation. 24

25 Overall risk management strategy options include, but are not limited to: Table 13 Risk Management Strategy Options Mitigation Sharing Avoidance Transfer Acceptance Implementation of new or revised policies and processes to ensure the risk is mitigated to an appropriate level. Risk is reduced or spread across the organisation or external parties sharing risk, through such sources as subcontracting, outsourcing or entering into partnerships or joint ventures By performing or not performing an action which prevents an initial risk materialising Can be achieved through external assurance (ie insurance) or parental guarantees, use of credit derivatives, selling positions or portfolios and use of collateral In some cases the firm recognises that the risk exists and accepts it to accomplish business objectives. In some cases the firm recognises that the risk exists and accepts it to accomplish business objectives. Risk reporting and Management Information KBWM identifies and captures a wide range of information concerning events and activities, both internal and external, that is relevant to achieving the strategic business aims of KBWM. Providing the appropriate level of information to the relevant business and function heads, at the right time enables KBWM to be better informed of the risks faced, as well as providing effective monitoring of the key risks within KBWM. Information is gathered centrally through a variety of business as usual mechanisms including, as new risks on risk registers, as incidents occur, through local self-assessments, internal audit, external audit, postincident assessments and general risk reviews. 25

26 The following table provides an overview of the key management information provided to the Boards and various committees which enable KBWM to manage it s financial and risk exposures and mitigate or take correcting actions for potential risks that may be on the horizon. Table 14 KBBL & KBCIHL Boards Minimum three meetings per annum Strategic Risk Committee Minimum three meetings per annum Asset & Liabilitee Committee Monthly Meetings Risk and Compliance Committee Minimum nine meetings per annum Credit Committee Quarterly meetings Financial update Chief Risk Officer s report Treasury portfolio status and market conditions Compliance breaches Credit approvals Strategic update Market conditions and trends report Balance sheets Regulatory findings / interactions Loan book and analysis Capital status Liquidity report Margins Complaints Client Watch List Liquidity status Lending report Capital position Major risk events Provisions and losses against loans Risk Appetite (annually or on change) Risk Appetite (annually or on change) Liquidity position Key risks per business area Regulatory issues (where necessary) Exceptions to Risk Appetite Exceptions to Risk Appetite Counterparty exposure Major initiatives Audit findings (where necessary) Strategic Risk Committee report Market Risks exposure Key risk indicators for top enterprise risks (quarterly) Audit Committee report Compliance Assurance status and progress against findings Nomination and Remuneration Committee report Internal Audit status and progress against findings TCF/Conduct risk metrics/report KBI The governance structure within KBI provides a clear overview of the basic principles of KBI s risk governance, the roles and responsibilities of each of the KBI Board and the various KBI Board subcommittees, e.g. the Executive Committee and KBID Audit Committee and its decision making policies. From a solvency risk perspective KBI s capital is managed within this governance framework taking into account the relevant regulatory requirements with which the KBI Board and subsidiary boards must comply. There are regular checks and reviews of its adequacy to mitigate against such risk. 26

27 The chart below gives an overview of the KBI governance structure including sub-committees: Table 15 KBI Board of Directors Audit Committee Remuneration Committee Executive Committee Pricing Committee Risk Committee IT Steering Committee Business Continuity Management Committee The KBI Board The KBI Board has adopted Principles of Corporate Governance, which provide an effective corporate governance framework for KBI. The KBI Board meets at least on a quarterly basis and more frequently if required. It is responsible for: Setting the strategic goals of the company and for the overall oversight and supervision of the affairs of the company; Defining and documenting the risk strategy and the capital planning of the company; Supporting the internal development of risk awareness within the organisation; Delegating and overseeing the implementation of the ICAAP to the Executive Committee; Approving the risk and capital policies as set out by the Executive Committee; Delegating and overseeing the risk management function; and Approving on a regular basis the risk and capital management processes of the company through regular reporting by the Executive Committee. The KBI Board maintains the following committees to assist in discharging its oversight responsibilities: Remuneration Committee Audit Committee Executive Committee Remuneration Committee The Remuneration Committee advises and supports the Board in developing and managing a coherent, fair and responsible remuneration policy aligned to the business strategy and the interests of relevant stakeholders, and will oversee its implementation in a manner that does not encourage excessive risktaking. 27

28 Audit Committee The Audit Committee assists the Board of Directors and does this by supervising on behalf of the Board, the integrity, efficiency and effectiveness of risk management and the internal control measures in place, paying special attention to correct financial reporting. The Audit Committee also oversees the company s processes to secure compliance with laws and regulations. Executive Committee The Executive Committee implements the strategies, policies and decisions of the Board and manages the company and its subsidiaries from a day-to-day perspective. It is responsible for managing the business and affairs of the company and for the leadership and operational management of the company. The Executive Committee maintains the following sub-committees to assist it in discharging its oversight responsibilities: Risk Committee IT Steering Committee Pricing Committee Business Continuity Management Committee 28

29 4. Assessment of Group s Risk Mitigation Policies and Assumptions Risk appetite The Group and its subsidiaries have a comprehensive and conservative medium-term plan which sets out a three year strategy to manage the business in the face of the changing economic environment. BHF KB sets its qualitative risk appetite principles that are then translated into a risk appetite statement for each of the business units as explained in section three of this Pillar 3 document. BHF has clearly defined its risk appetite as part if its business and risk strategy. The framework for this appetite is set by BHF s low-risk business model as such. The outcome of this process is as follows: With respect to pillar 1 requests, BHF s significantly high tier 1 and total capital ratios underline its degree of risk-awareness. With respect to ICAAP (pillar 2), the risk appetite is given by a set of buffers (i. e. only a part of the adjusted own funds is allocated as risk capital) and consistent risk limits. KBWM adopts a Risk Appetite and Framework ( The Risk Framework ) which is explained in section three of this Pillar 3 document that is approved by the Boards. This is a comprehensive document which outlines the nature and quantum of risk KBWM is prepared to tolerate in the process of achieving its strategic and operational objectives whilst remaining within relevant and regulatory constraints. KBI defines its Risk Appetite as the process to quantify as fully as possible the amount of risk the company is willing to bear in order to achieve its strategic, profitability and growth objectives while remaining within the bounds of regulatory constraints. To define this, KBI has a Risk Appetite Frontier which sets the tolerance range of acceptable versus unacceptable risks. Risk Identification BHF KB is a focused financial services business and through its combined businesses faces and accepts risks in order to generate returns. The main risks that The Group face is outlined in the principle risks and uncertainty section (pages 31 35) of BHF KB s Annual Report The risks which impact The Group by business unit are shown in the table below: 29

30 Table 16 Key Risks Counterparty and Credit Risk Description Credit risk is defined as the risk of loss due to a debtor's nonpayment of a loan or other line of credit (in terms of either the principal amount or interest or both). Counterparty credit risk is where the business can suffer significant loss of assets placed with a counterparty or the non completion of a trade, both arising from the failure of a counterparty BHF KB Group (Mgt Co's) BHF BANK KBWM KBI Market Risk Operational Risk The risk that the value of an investment will increase or decrease due to movement in market factors The risk to the business from inadequate or failed internal processes, people and systems or from external events. This will include IT systems risk (risk to the business from poor/inadequate/overly complex IT systems or failure of IT systems) Liquidity Risk Concentration Risk The risk of not being able to meet liabilities as they fall due. The ability of the firm to transact in the market may fall away if there is a liquidity crisis. The risk that arises when lending toward a single borrower or a group of connected counterparties is large enough to impact the group in the event of the failure of the borrower or counterparties. Business / Strategy Risk Residual Risk Securitisation Risk The risk of failure to achieve the business objective of increasing revenues/fees and deposits for the business and lack of responsiveness to new challenge. This may arise when the firms Credit Risk Mitigation techniques are not effective in reducing the risk The risk that assets which are owned by The Group which have been securitised by a pool of other assets are impacted by any adverse changes in this pool Interest Rate Risk in the Banking Book Risk of Excessive Leverage The risk of mismatches in the asset and liabilities for fixed and floating interest rates. The risk that the firms has taken on too much leverage Pension deficit risk arises as a result of changes in life expectancy Pension and other parameters for pension and dependants benefits as well Obligation Risk as invalidity benefits in so far as they are covered by The Group Subsidiary / Group Risk Regulation, Financial Crime Risk & Reputational Risk Insurance Risk Group Risk is the risk that the financial position of the company may be adversely affected by its relationships (financial or nonfinancial) with other entities in the same group or by risks which may affect the financial position of the whole group. The risk to the business arising from breaching rules or regulations or losses due to internal/external fraud The risk associated with insurance policies taken out or and contracts undertaken/written and the potential obligations against them 30

31 The table above demonstrates that BHF KB Group management companies incur most of its risk from its main subsidiaries which are BHF Bank, KBWM & KBI. Each of these business units have their own risk governance, appetite and frameworks as explained in these Pillar 3 disclosures. Liquidity risk, though very important for BHF, cannot be covered by risk capital, but has to be limited by a target survival period. BHF considers any impacts of liquidity within its stress testing. Reputational risk is also an important risk for BHF but more of an indirect risk, mostly covered by the other risk types mentioned above. The remainder of this risk leads to a deduction from the risk capital which is available for allocation to different business areas. The process through which KBWM indentifies its top risks is explained in section three and table 12 of these Pillar 3 disclosures. KBI operates a Risk Appetite Frontier in which a Risk Register is maintained to identify the risks that the business faces. By its nature, this is an ongoing process that involves all units and it is updated on a continuous basis. It covers risks across all business processes from execution risk, including fraud and front running, to client take-on risks, including investing mandates fully and in line with client restrictions and objectives. Use of Credit Risk Mitigation Techniques The Group adopts a range of measures to reduce inherent risk in its credit risk including a thorough analysis and assessment of each counterparty with reference to the ability to service and repay the requested facility or debt. In almost all customer lending cases, risk is further mitigated by the taking of collateral to cover the funds advanced. BHF Kleinwort Benson Group (Management companies) BHF KB Group management companies are subject to Credit Risk predominantly on its investments. The value of these items is 30.2m as at 31 st December 2014 and most of this is prudently risk weighted at 250%. There is also some cash which is held for day-to-day operational purposes and this is held with highly rated counterparties. BHF KB Group Management companies do not have any formal credit risk mitigation in place. BHF Bank BHF takes into account the credit risk mitigation in KSA guarantees, financial securities and real estate collateral. The bulk of the guarantees used for credit risk mitigation are made for the state export credit insurance. The guarantor here is primarily the Federal Republic of Germany. Through the collection of guarantees in the context of investments without funding, usually by financial institutions, counterparty risks are hedged. Before a guarantee is accepted, the creditworthiness of the guarantor is assessed according to the credit analysis of a borrower. Guarantees are taken into account in consideration of maturity, currency and credit rating (external). The calculation of risk-weighted exposure amount of guarantees is carried out in accordance with Article 235 of the CRR depending on the risk weight (credit) to the guarantor and the borrower. Here, the same rating rules apply as for all other borrowers. Currency and maturity mismatches between demand and guarantee are also accounted for by reductions where necessary. The recognition of financial collateral (cash deposits at BHF and securities) is based on the comprehensive method in accordance with Article 223 of the CRR. 31

32 For the volatility adjustments to securities collateral, BHF uses regulatory prescribed haircuts. For currency and maturity mismatches between security and demand additional discounts will be considered. The Bank also has credit risk associated with domestically established and situated residential and commercial properties where there is a charge against these properties. The valuation of the property is carried out by an independent credit approval process by certified real estate appraisers under the mortgage lending value regulation. The equity value is reviewed annually as part of the loan application. BHF regularly checks the concentration risk for pledged securities collateral and guarantees and publishes the results in the risk report. The concentration is determined and monitored as the total of pledged securities per issuer or the concentration by guarantor. Kleinwort Benson Wealth Management ( KBWM ) KBWM receives collateral from customers against lending to reduce the risk in the event that the client is unable to service or repay the debt. The types of collateral which KBWM accept as security include: Cash Deposits; Portfolios of Stocks and Shares; Charges over UK & Channel Island Residential Property; Charges over UK Commercial Property; Guarantees; Mortgages / Assignments of Life Insurance Investment Bonds Property backed transactions are usually subject to a professional and independent appraisal to determine valuation and suitability as lending collateral. Residential property values are reviewed according to published Land Registry indexation figures on a regular basis and, where deemed appropriate, by formal re-valuation. In respect of commercial premises it is KBWM s practice to revalue properties held as collateral on a regular basis, at the Credit Committee s discretion. All other forms of security which are subject to fluctuation in value are re-assessed with a suitable frequency ranging from daily to monthly (as a minimum). Standard facility and security documents used have been prepared by external lawyers and are subject to periodic review to ensure that they remain robust and enforceable. Non-standard loans are subject to bespoke and independently commissioned documentation on a case by case basis. KBWM also takes accepts collateral as part of reverse repo transactions with certain banking counterparties. This is further explained in section seven of this Pillar 3 document. KBI KBI is not involved in any customer lending and therefore the Credit Risk that KBI is subject to is predominantly the cash which it holds on it balance sheet. This is relatively small in the context of the wider Group with balances of 20.6m as at 31 st December KBI mitigates its risk by holding a proportion of this cash within The Group by placing these as short term deposits with KBWM. The remainder of the cash in line with the Risk Framework is kept short term and with the approved external counterparties. KBI has been disaggregated from changes to revised Risk Framework (and we have recently requested revised counterparty limits in June 2015). It should be checked whether the reference to Risk Framework is still appropriate or was still appropriate at end

33 5. Capital resources Total Available Capital As at 31 st December 2014, The Group complied with all of the externally applicable capital requirements. Details of the components of regulatory capital as at 31 st December 2014 are summarised in the table below: Table 17 Own Funds As at 31st December 2014 m Capital instruments and the related share premium accounts Retained earnings 36.8 Accumulated other comprehensive income (and other reserves) (7.2) Common Equity Tier 1 (CET 1) capital before regulatory adjustments (As per Financial Statements) Regulatory adjustments and deductions Additional Value Adjustments (Prudential filters) (4.4) Goodwill and intangible assets (net of related tax liability) (50.9) Deferred tax assets that rely on future profitability not including temporary differences (net of related tax liability) (2.2) Defined-benefit pension fund assets (net of related tax liability) (5.3) Total Regulatory Adjustments (62.8) Fully Loaded Common Equity Tier Additional Tier 1 (AT1) Capital 0.0 Fully Loaded Tier 1 Capital Tier 2 (T2) Capital Qualyfying T2 own funds instruments (including minority interests) issued by subsidiaries and held by third parties Fully Loaded Total Regulatory Capital The disclosure above has been prepared based on the format set out in Annex IV of EU Commission implementing regulation EU 1423/2013. The Group does not have any transitional provisions and therefore the figures are on a fully loaded basis. Indicators of global systematic importance The Financial Stability Board produces a list of Global Systemically Important Financial Institutions ( G- SIFI ) on an annual basis. These institutions are identified as representing a high risk to the global economy due to their size. G-SIFI banks will be required to hold additional capital buffers and be subject to additional disclosures. BHF KB has not been identified as G-SIFI as at 31 st December Description of Capital Instruments Common Equity Tier 1 (CET 1) Capital The CET1 Capital is made up of fully paid up share capital, share premium accounts, retained earnings and other small reserves (predominantly revaluation reserve). 33

34 Tier 2 (T2) Capital The T2 Capital as at 31 st December 2014 is made up of subordinated notes issued by BHF as follows: Table 18 Tier 2 (T2) Capital Instruments As at 31st December 2014 Nominal Regulatory Value IFRS Value Value Dated subordinated liabilities Maturity Date m m m 4.460% Fixed Rate Subordinated Notes 05/01/ % Fixed Rate Subordinated Notes 05/01/ % Fixed Rate Subordinated Notes 05/01/ % Fixed Rate Subordinated Notes 05/01/ % Fixed Rate Subordinated Notes 05/01/ % Fixed Rate Subordinated Notes 05/01/ % Fixed Rate Subordinated Notes 05/01/ % Fixed Rate Subordinated Notes 05/01/ % Fixed Rate Subordinated Notes 23/12/ % Fixed Rate Subordinated Notes 23/12/ % Fixed Rate Subordinated Notes 23/12/ % Fixed Rate Subordinated Notes 23/12/ % Fixed Rate Subordinated Notes 24/01/ % Fixed Rate Subordinated Notes 24/01/ % Fixed Rate Subordinated Notes 24/01/ % Fixed Rate Subordinated Notes 24/01/ % Fixed Rate Subordinated Notes 24/01/ % Fixed Rate Subordinated Notes 24/01/ % Fixed Rate Subordinated Notes 24/01/ % Fixed Rate Subordinated Notes 24/01/ % Fixed Rate Subordinated Notes 24/01/ % Fixed Rate Subordinated Notes 24/01/ % Fixed Rate Subordinated Notes 30/01/ % Fixed Rate Subordinated Notes 30/01/ % Fixed Rate Subordinated Notes 24/01/ % Fixed Rate Subordinated Notes 24/01/ % Fixed Rate Subordinated Notes 24/01/ % Fixed Rate Subordinated Notes 24/01/ Total Dated Subordinated Liabilities (Tier (T2) Capital) Capital Management The Group s approach to capital management takes into account the regulatory, economic and commercial environment it operates in. This involves regular monitoring of capital adequacy against business plans and forecasts. The Group maintains a strong capital base to support the development of its businesses and to ensure it meets the regulatory requirements at all times. 34

35 6. Capital requirements An assessment of The Group s capital adequacy is undertaken by the Board to ensure that the Group has adequate and robust management strategies for dealing with the risks its businesses are exposed to. This assessment is captured in The Group s ICAAP and monitored as part of the monthly/daily capital risk reporting processes. It is the Group s policy to ensure that it and its entities have sufficient capital to meet their regulatory requirements for all identified risks. Internal Assessment of Capital Adequacy The Group assesses the adequacy of its capital through its Internal Capital Adequacy Assessment Process ( ICAAP ). Under the ICAAP, the Group considers whether the amount of capital held is sufficient to meet its requirements. Pillar 1 rules define a quantitative capital amount based on the specific positions at reporting date. However, the Group in assessing the adequacy of available capital also undertakes a risk analysis to consider whether there are any other risks that can best be mitigated by holding additional capital. This includes risks that are either not considered under Pillar 1 or are risks that are considered under Pillar 1 but where the generic Pillar 1 framework does not capture the risks adequately for the Group s specific business model and portfolio. This additional capital is considered under Pillar 2A. In addition, the Group undertakes stress testing to identify whether additional capital should be held to help ensure that the firm can continue to maintain an adequate level of capital under a number of specific stress scenarios. The output from this analysis is the capital that should be held over and above the Pillar 1 and Pillar 2A requirement and is referred to as Pillar 2B. The Pillar 2A and Pillar 2B calculations are reviewed by the PRA and set as part of the firms Individual Capital Guidance ( ICG ). The PRA will set this requirement following their assessment of the Group s own calculations, controls, governance, risk management & risk mitigating processes. Once the guidance has been set the Group will monitor its capital adequacy against this guidance as part of its risk and control framework. Capital Buffers By 2019, BHF KB has to achieve a CET1 ratio regulatory requirement of 7% plus a Pillar 2A add-on of 3.5%. The 7% is made up of a CRR minimum CET1 ratio of 4.5% plus CCB of 2.5%, which will be phased in from 1 st January As at 31 st December 2014 the Group had a CET1 ratio requirement of 4.5% that will increase by 0.625% per annum from 2016 through to In addition to this, from 2015 The Group will need to meet its Pillar 2A add-on with 56% of CET1 capital. Based on the current PRA guidelines the Group s capital buffers are projected to be as follows: Table 19 Capital Buffers A B C = A + B D E = C/D Capital Total CET1 Ratio Total Capital % requirement Reporting Period Minimum CET1 Ratio Conservation Buffer (CCB) requirement excl Pillar 2A Requirement Ratio to be met with CET1 capital From 1st January % 0.000% 4.500% 8.000% % From 1st January % 0.000% 4.500% 8.000% % From 1st January % 0.625% 5.125% 8.625% % From 1st January % 1.250% 5.750% 9.250% % From 1st January % 1.875% 6.375% 9.875% % From 1st January % 2.500% 7.000% % % 35

36 The Bank of England may require UK Banks to also hold Counter-Cyclical Capital Buffers ( CCCB ) and/or Sectoral Capital Requirements ( SCR ). In addition to this CRD4 could require firms to hold a Systemic Risk Buffer ( SRB ), however, BHF KB is not required to hold any of these buffers as at 31 st December The table below details the Group s capital requirements and adequacy as at 31 st December 2014: Table 20 Capital Adequacy Capital As at 31st December 2014 resources m Common Equity Tier 1 (CET 1) Regulatory adjustments and deductions (62.8) Fully Loaded CET 1 & Tier 1 Capital Qualifying Tier 2 own funds instruments Fully Loaded Total Regulatory Capital Capital RWA Required Credit & Counterparty Credit Risk - Standardised Approach (SA) m m Central governments or central banks Regional governments or local authorities Public sector entities Multilateral Development Banks International Organisations Institutions Corporates 1, Retail Secured by mortgages on immovable property Exposures in default Items associated with particular high risk Covered bonds Claims on institutions and corporates with a short-term credit assessment Collective investments undertakings (CIU) Equity Other items Securitisation positions SA Total Credit & Counterparty Credit Risk 3, Settlement / Delivery Risk Total Settlement / Delivery Risk Market Risk - Standardised Approach (SA) Traded debt instruments PRR Foreign Exchange PRR Market Risk - Internal Models (IM) VaR model based PRR SVaR model based PRR Total Market Risk Credit Valuation Adjustment (CVA) Standardised method Total CVA Risk Operational Risk Basic Indicator Approach (BIA) Total Operational Risk Total Capital Requirements 4, CET1 Capital Ratio 17.0% Surplus of CET1 capital T1 Capital Ratio 17.0% Surplus of T1 capital Total Capital Ratio 20.5% Surplus of T1 capital

37 7. Credit risk Credit Risk Exposures Credit risk is defined as the risk of loss due to a debtor's non-payment of a loan or other line of credit (either the principal or interest or both). In the Group, credit risk predominantly arises within the banking entities of BHF Bank, KBCIHL and KBBL as a result of direct lending to customers and the investment of customer deposits into third party institutional assets. There is also a minimal degree of settlement risk. The Group follows the standardised approach in the calculation of Pillar 1 credit risk requirements as set out in Articles 111 to 141 of the CRR. This involves classification of exposures into defined categories and applying standardised risk weightings. The table below shows the Risk Weighted Assets ( RWA ) by exposure class for each business unit. Table 21 Credit & Counterparty Credit Risk Analysis Risk Weighted Assets by Business unit As at 31st December 2014 BHF Bank Benson*1 co's) Group Credit & Counterparty Credit Risk - Standardised Approach (SA) m m m m Central governments or central banks Regional governments or local authorities Public sector entities Multilateral Development Banks International Organisations Institutions Corporates 1, ,887.1 Retail Secured by mortgages on immovable property Exposures in default Items associated with particular high risk Covered bonds Claims on institutions and corporates with a short-term credit asse Collective investments undertakings (CIU) Equity Other items Securitisation positions SA Total Credit & Counterparty Credit Risk 2, ,363.3 *1 Kleinwort Benson refers to the combination of KBBL, KBCIHL and KBI Kleinwort BHF KB Group (Mgt BHF Kleinwort Benson Credit Limits for Exposures The Banking entities within The Group assign credit limits against counterparties to ensure that exposures do not exceed the Risk Appetite and stay within regulatory guidelines for both the entity itself and the wider Group. These limits are monitored carefully and a variety of methods are used to agree credit limits for counterparties. BHF Kleinwort Benson Group (Management companies) The largest credit limits at a Group level are set against banking counterparties and sovereigns. Each business in the Group sets its own limits against these counterparties and where these are common counterparties across the Group a limit is set at Group level to ensure that the combined exposure to connected clients/counterparties do not exceed regulatory limits. 37

38 BHF Bank Lending business, which is an integral part of BHF s product range, inevitably involves credit risks. The Board of Managing Directors determines the credit risk strategy and thus sets out the central framework for the assumption of credit risks and lending business in BHF. By defining appropriate credit policy targets, the credit risk strategy sets the parameters for the operations of the individual divisions as well as for the central credit risk management and finance units as regards managing credit risks at client level and throughout the entire bank. The credit portfolio strategy additionally restricts default risks at client, country, sector and portfolio level. In every area of credit business, lending and pricing takes due account of the risk and return, i.e. the individual creditworthiness of the client (rating), the collateral and the transaction structure, the overall business relationship with the respective client and risk concentrations, if applicable. Transactions or business relationships that could damage BHF s reputation are strictly avoided. BHF will only grant loans on the basis of standardised written loan applications and within the framework of risk-based decision-making authorities delegated by the Board of Managing Directors. Credit decisions are taken jointly by the front office and credit risk management areas. If a credit decision is taken by a committee, credit risk management will always have the right to put in a final veto. The strategic management of credit risk is performed at Group level by the risk committee. In line with The Group s business strategy and the credit risk strategy stipulated by the Board of Managing Directors, this committee determines the credit policy targets. The main tasks of this committee include managing the volume and structure of lending business as well as monitoring and limiting concentration risks. Credit risk management is responsible for measuring and managing credit risks. Its tasks include, in particular, the monitoring of credit risk exposures and commitments, credit - worthiness analyses, creditrating decisions and the approval of loans within the framework of credit-granting authorities. The credit risk management department furthermore defines limits, draws up diversification strategies, further develops the collateral standards and policies and is responsible for decision-making regarding lending policy. It also monitors compliance with the regulatory requirements relating to lending business. On an organizational level, a clear separation was made between the front office, and the back office, which includes the credit risk managers and analysts in the central credit risk management unit. This separation is adhered to throughout the bank, including the Board of Managing Directors. Credit is granted and collateral monitored in accordance with the credit risk strategy, the credit policy guidelines determined therein and further credit guidelines. The delegation of lending authority is based, in particular, on the experience of the credit risk manager involved, the client segment, the rating, the amount and the term of the loan as well as the type of transaction. The responsibility for making provisions for risk lies with a provisions committee comprising staff from credit risk management and finance. BHF uses separate internal rating procedures for loans and advances granted to banks, corporate and private clients. Each rating model includes quantitative and qualitative elements as well as assessments as regards the borrower s future development. Specific industry risks and external ratings are also taken into account, as are current market indicators. The model parameters are calibrated using internal historical default data as well as external information. The security provided is assessed by the collateral department taking account of the recovery rates estimated by experts. In operational terms, credit risk management is carried out on the basis of country, borrower, product and, if required, term-related risk limits, as well as daily limit and position monitoring. As part of the credit portfolio management, target-oriented strategies, measures and transactions are used to optimize the risk/return profile of the credit portfolio and increase returns as well as limit migration and concentration risks. An early-warning system has been installed to recognize the initial signs of a 38

39 critical situation arising among corporate clients and to identify potential migration risks. Furthermore, monitoring concentration limits serves to limit and reduce concentration risks in lending business. Concentrations are assessed at counterparty, country, sub-portfolio and sector level. Adherence to internal limits and the large exposures limit is monitored intraday by a bank-wide monitoring system with almost real-time processing of all the major credit relationships. Kleinwort Benson Wealth Management ( KBWM ) KBWM s maximum exposure limits to governments, multilateral development banks and institutions are stipulated in the KBWM Risk Appetite and Framework. This Framework describes and quantifies the appetite with limits set for credit exposure, country and concentration risk. Country risk exposure is limited to institutions domiciled principally in Western European democracies, USA, Canada, Australia, New Zealand, Japan, and Hong Kong. (With specific additional countries that are outside of the Risk Framework being individually approved by the Strategic Risk Committee). The Group adopts a conservative approach to credit risk and will generally only undertake government, multinational development bank or institutional exposures with a minimum Issuer Rating of Moody s A3 (or equivalent) as dictated in the Risk Appetite. The only exception to this are the Added Yield Portfolio, where the minimum Issuer Rating is Moody s B3, and also any high yield, illiquid investments which may not be rated (and which each require approval from both the Strategic Risk Committee and the relevant Boards). Positions not in full conformance with the Risk Framework are required to be approved by the Credit Committee on an exceptional basis and are subject to Board ratification. The counterparties used by KBWM for the booking of foreign exchange and interest rate swaps are subject to approval in accordance with the Risk Framework. KBWM offers a range of private banking services to its clients that include mortgages, terms loans and revolving credit lines all of which result in credit risk exposures. KBWM has adopted a Collateral Cover Quality Matrix (CCQM) framework which assigns an internal rating and risk weighting to loans based on the quality of the collateral provided. This acts as an internal grading system with the lowest risk loans classified as Class A and the highest risk unsecured loans being classified as Class C1c. The CCQM framework plays a part in agreeing an overall limit for a customer and assists in analysing and monitoring their credit risk. KBI KBI sets out its credit limits as part of its Risk Appetite Frontier in which acceptable tolerance of risk is defined. KBI does not have significant exposure to credit risk as its receivables are mainly short-term trading items. Most of KBI s credit risk arises when placing its cash reserves and deposits with external counterparties. KBI sets a low acceptable limit of risk tolerance at 2% of debtors on its receivables and a maximum deposit with external counterparties of 4m ( 3m). Netting Arrangements Counterparty credit risk can be further mitigated by holding netting arrangements so that receivables can be offset against payables. These arrangements are predominantly against banking counterparties which the Group have similar counteracting contracts to be able to net. 39

40 BHF Bank To reduce the counterparty risk in the context of commercial transactions netting agreements are used in BHF on derivatives and repurchase agreements. Standard framework agreements are used. The conclusion of new contracts for the BHF is carried out by the legal department. The legal enforceability of netting agreement in the different jurisdictions will be reviewed on the regular collection of legal opinions As part of the collateralization of the derivatives business exclusively cash collateral and securities are currently being taken in. Netting agreements on money receivables are not used in BHF. Kleinwort Benson Wealth Management ( KBWM ) KBWM has Global Master Repurchase Agreements (GMRA) in place with counterparties which allow the netting of collateral on reverse repo exposures. This is all off balance sheet exposure netting. KBWM does not have any on balance sheet netting arrangements or any other legally enforceable on/off- balance sheet netting arrangements that would enable any credit mitigation. Geographical Analysis of Exposures The following table provides a geographic analysis of the Group s Gross Exposures (before credit risk mitigation and provisioning) by regulatory asset class as at 31 st December 2014: Table 22 Credit & Counterparty Credit Risk Analysis Gross Exposure (Before Provisions and CRM) by Geographical location of the counterparty As at 31st December 2014 United Kingdom Germany Europe *1 North America Channel Islands *2 Rest of the World Credit & Counterparty Credit Risk - Standardised Approach (SA) m m m m m m m Central governments or central banks Regional governments or local authorities 0.0 1, ,170.2 Public sector entities Multilateral Development Banks International Organisations Institutions ,249.3 Corporates , , ,360.2 Retail Secured by mortgages on immovable property Exposures in default Items associated with particular high risk Covered bonds Claims on institutions and corporates with a short-term credit assessment Collective investments undertakings (CIU) Equity Other items Securitisation positions SA Total Credit & Counterparty Credit Risk 1, , , , ,881.1 *1 EEA Countries *2 The UK Crown Dependencies Total Maturity Analysis of Exposures The table below provides a residual maturity breakdown of the Group s Gross Exposures (before credit risk mitigation and provisioning) by regulatory asset class as at 31 st December 2014: 40

41 Table 23 Credit & Counterparty Credit Risk Analysis Gross Exposure (Before Provisions and CRM) by residual maturity As at 31st December 2014 Credit Risk Mitigation ( CRM ) The tables below shows the collateral used for CRM by The Group as of 31 st December 2014: Table 24 Credit & Counterparty Credit Risk Analysis Pre & post CRM and yearly averages As at 31st December 2014 Less than 3 Months Over 3 months less than 1 year Over 1 year Over 3 years less than 3 less than 5 years years Over 5 years On Demand Total Credit & Counterparty Credit Risk - Standardised Approach (SA) m m m m m m m Central governments or central banks Regional governments or local authorities ,170.2 Public sector entities Multilateral Development Banks International Organisations Institutions ,249.3 Corporates 1, ,360.2 Retail Secured by mortgages on immovable property Exposures in default Items associated with particular high risk Covered bonds Claims on institutions and corporates with a short-term credit assessment Collective investments undertakings (CIU) Equity Other items Securitisation positions SA Total Credit & Counterparty Credit Risk 1, , , , , , ,881.1 Gross Exposure Pre- Net Exposure Post- CRM & Provisions CRM & Provisions RWA Capital Requirements Year end 2014 Av'ge Year end 2014 Av'ge Year end 2014 Av'ge Year end 2014 Av'ge Credit & Counterparty Credit Risk - Standardised Approach (SA) m m m m m m m m Central governments or central banks , Regional governments or local authorities 1, , , , Public sector entities Multilateral Development Banks International Organisations Institutions 2, , , , Corporates 4, , , , , , Retail Secured by mortgages on immovable property Exposures in default Items associated with particular high risk Covered bonds Claims on institutions and corporates with a short-term credit assessment Collective investments undertakings (CIU) Equity Other items Securitisation positions SA Total Credit & Counterparty Credit Risk 10, , , , , ,

42 Table 25 Credit & Counterparty Credit Risk Analysis Credit Risk Mitigation As at 31st December 2014 Equity exposures not included in the trading book Cash collateral (Funded) Other eligible collateral security (Unfunded) Inbound guarantees (Unfunded) Total Credit Risk Mitigation (CRM) m m m m Central governments or central banks Regional governments or local authorities Public sector entities Multilateral Development Banks International Organisations Institutions Corporates (733.7) (178.7) Retail Secured by mortgages on immovable property Exposures in default (34.9) (34.9) Items associated with particular high risk Covered bonds Claims on institutions and corporates with a shortterm credit assessment Collective investments undertakings (CIU) Equity Other items Securitisation positions SA Total (0.0) The Group has a number of non-trading equity exposures which are held for various investment purposes. Some of these are where the Group has participated in an Alternative Investment Fund ( AIF ), Collective Investment Undertaking ( CIU ) or entered into a small investment of a listed company for operational purposes. These equity positions are categorised as credit risk for capital requirements calculations. The table below shows the entities in which these investments are held across the Group and the capital requirements for them: 42

43 43 Table 26 Gross Exposure (Before Provisions and CRM) to Equities not included in the trading book As at 31st December 2014 BHF Bank Shareholder risk in the case of equity investments is described as equity risk. This risk defines the risk of loss arising from the equity provided. It has been defined as a significant risk for the bank. BHF s equity investments portfolio mainly comprises strategic holdings used for implementing the business model and for providing internal services. The following table shows the carrying value of BHF s equity instruments reported in the balance sheet as at 31 st December 2014 and their fair value pursuant to IFRS for the investment groups depending on the objectives being pursued and the strategy: Table 27 Gross Exposure pre-crm & Provisions Managing and monitoring risks At BHF, the ongoing monitoring and steering of the equity investments portfolio is performed in the corporate development & investments department and the finance and credit risk management divisions. All these units cooperate closely, exchange information and reconcile results on an ongoing basis. As a rule, every equity investment is allocated to either Private Banking & Asset Management or to Financial Markets & Corporates, which are then in charge of the equity investment allocated to them. As part of the mandate management performed by the corporate development & investments department, the business activities of the affiliated companies and equity investments are monitored continuously. As a rule, members of BHF s Board of Managing Directors will also be members of these companies supervisory boards. The economic performance of the affiliated companies included in BHF s consolidated financial statements is monitored by the finance department on a monthly basis as part of the bank-wide Management Information System (MIS), using the value drivers specific to the respective business. This RWA Capital Requirements Investment m m m BHF Bank KBBL BHF KB Group (Management companies) Total Credit Risk for Equities BHF Bank Gross Exposure (Before Provisions and CRM) to Equities not included in the trading book As at 31st December 2014 Carrying values as reported in published financial statements Fair Value Investment m m Funds Other strategic holdings Other investments Total Credit Risk for Equities

44 task also comprises the comparison of budget/actual figures as well as the analysis and evaluation of key performance trends. These companies are included in the bank s planning process. Annual financial statements and key performance figures are processed for the most important companies which support BHF s business model. Risks are assessed in the corporate development & investments department in close liaison with the finance department. The assessment is based on a categorisation of the equity investments by risk class in combination with their reported financial statement values and/or book values. The categorisation is made in particular on the basis of the business objective and the business activities of the company in question. The risk capital for equity risk is calculated by multiplying the risk class (expert estimate) by the exposure. If less than 50 % of the company s capital is held, the exposure corresponds to the equity investment s book value plus any potential obligation to provide additional capital. If more than 50 % of the respective company s capital is held, the exposure corresponds to the total assets less the debt capital provided by BHF. The risks arising from indirect equity investments are covered via the shareholder risk from direct equity investments. The most important equity investments are reviewed on a look-through basis and the equity risk is based on their own equity investments. The degree of risk arising from equity investments is limited at divisional and Group level and is monitored on a monthly basis. The risk committee and the Board of Managing Directors are informed about the equity investments and changes in the equity investments portfolio at least on a quarterly basis. Valuation in accordance with the Commercial Code The investments in the banking book of BHF comprise exclusively unlisted equity instruments that are included in the IFRS consolidated financial statements as available for sale instruments (AFS). Investments in the AFS portfolio are measured at fair value if one has been determined. Investments whose fair value cannot be reliably measured are accounted for at cost. Regulatory evaluation The following comments refer exclusively to investments that are not consolidated but are recognised as risk-weighted assets. Under the CRSA approach these investments are generally reported in the asset class "equity investments" and in special cases in the new asset class "positions associated with particularly high risks". Income from investment instruments In the reporting year 3 companies were sold or wound up. This resulted in income of 17.5m ( 13.6m). Revaluation gains of 1.1m ( 0.9m) are included in the investments held in accordance with IFRS. 44

45 BHF KB Group (Management companies) & Kleinwort Benson Wealth Management ( KBWM ) Strategic objectives The BHF KB Group management (Previously RHJ International SA) historically held a portfolio of investments which are now regarded as legacy holdings. These were acquired prior to the Groups strategic change in 2010 to transform itself into a focused financial services group. Since 2010 the BHF KB Group management companies have divested most of its legacy industrial holdings and acquired financial services companies including Kleinwort Benson & BHF-BANK, which are wholly-owned and fully consolidated as well as certain non-controlling investments in financial services companies. Accounting techniques and valuations used The only remaining non-controlling investment in financial services is a 27.8% holding in Quirin Bank which is valued at 17.9m ( 13.9m) as at 31 st December This investment is equity accounted while all the other investments are shown at fair value through profit and loss. The table below shows the carrying and fair value of BHF KB Group (Management companies) & KBBL s equity investments as at 31 st December 2014: Table 28 BHF Kleinwort Benson Group (Management Companies & KBBL) Gross Exposure (Before Provisions and CRM) to Equities not included in the trading book As at 31st December 2014 Carrying values as reported in published financial statements Fair Value Investment m m Funds Other strategic holdings Other investments Total Credit Risk for Equities Impairment of Financial Assets and Past Due Items The Group is subject to credit risk impairments and loans becoming past due. A loan is considered past due where contractual interest or principle payments which are due are not received on their contractual dates. If a loan is more than 90 days in arrears then an assessment of default would need to be considered as part of CRR Article 178. The Group considers evidence of impairment for financial assets measured at amortised cost (loans and receivables and held to maturity investment securities) at both a specific asset and collective level. All individually significant assets are assessed for specific impairment. Those found not to be specifically impaired are then collectively assessed for any impairment that has been incurred but not yet identified. Assets that are not individually significant are collectively assessed for impairment by grouping together assets with similar risk characteristics. In assessing collective impairment, The Group uses historical trends of the probability of default, the timing of recoveries and the amount of loss incurred, adjusted for management s judgement as to whether current economic and credit conditions are such that the actual losses are likely to be greater or less than suggested by historical trends. 45

46 An impairment loss in respect of a financial asset measured at amortised cost is calculated as the difference between its carrying amount and the present value of the estimated future cash flows at the asset s original effective interest rate. Losses are recognised in profit or loss and reflected in an allowance account against loans and receivables or held to maturity investment securities. Interest on the impaired asset continues to be recognised. When an event occurring after the impairment was recognised causes the amount of impairment loss to decrease, the decrease in impairment loss is reversed through profit or loss. The table below shows The Group s Credit Risk assets and how impairments are applied to get to a net exposure: Table 29 Credit & Counterparty Credit Risk Analysis Gross and Net Exposures - Application of Credit Risk Mitigation & Impairments As at 31st December 2014 Gross Exposure Individual Impairment Collective Impairment Credit Risk Mitigation Credit Substitution Off Balance Sheet Conversion Factor Exposure after Impairment and CRM m m m m m m m Central governments or central banks (55.3) 1,307.0 Regional governments or local authorities 1, ,170.2 Public sector entities (22.4) Multilateral Development Banks (12.1) International Organisations Institutions 2, (290.4) (67.4) 2,051.8 Corporates 4, (554.9) (733.7) (1,039.6) 2,032.0 Retail (39.0) 0.0 (4.1) 73.7 Secured by mortgages on immovable property (0.0) Exposures in default 73.0 (20.7) 0.0 (0.0) (34.9) (0.8) 16.5 Items associated with particular high risk Covered bonds Claims on institutions and corporates with a short-term credit assessment (21.1) 22.7 Collective investments undertakings (CIU) Equity Other items Securitisation positions SA Totals 10,881.1 (20.7) 0.0 (884.4) (0.0) (1,222.9) 8,

47 The table below shoes The Group s past due and impairments split by exposure category: Table 30 Credit & Counterparty Credit Risk Analysis Gross Exposure (Before Provisions and CRM) to customers and banks - Past due and impairments As at 31st December 2014 Impaired loans Neither past due or Past due but impaired not impaired Individual Collective Total Loans Credit & Counterparty Credit Risk - Standardised Approach (SA) m m m m m Central governments or central banks Regional governments or local authorities 1, ,170.2 Public sector entities Multilateral Development Banks International Organisations Institutions 2, ,249.3 Corporates 4, ,360.2 Retail Secured by mortgages on immovable property Exposures in default Items associated with particular high risk Covered bonds Claims on institutions and corporates with a short-term credit assessment Collective investments undertakings (CIU) Equity Other items Securitisation positions SA Totals 10, ,881.1 Neither past due or impaired These are instruments where contractual interest or principal payments are within agreed terms. Past due but not impaired financial instruments These are instruments where contractual interest or principal payments are past due but the Group believes that specific impairment is not appropriate on the basis of the level of security/capital available and/or the stage of collection of amounts owed to The Group. Impaired loans These are instruments for which the Group determines that it is probable that it will be unable to collect all principal and interest due according to the contractual terms of the financial instrument agreement(s). The Group recognises a provision against these amounts which represents its best estimate of amounts that may not be recovered. 47

48 The table below shoes the Group s past due and impaired assets by geographical location: Table 31 Credit & Counterparty Credit Risk Analysis Gross Exposure (Before Provisions and CRM) to customers and banks - Arrears by geographical location As at 31st December 2014 United Kingdom Germany Europe *1 North America Channel Islands *2 Rest of the World m m m m m m m Neither past due or impaired loans 1, , , , ,808.2 Past due but not impaired loans Individually impaired loans Collectively impaired loans Total Credit & Counterparty Credit Risk 1, , , , ,881.1 *1 EEA Countries *2 The UK Crown Dependencies Total The table below shows show s the movement of the impairments during Table 32 Credit & Counterparty Credit Risk Analysis Credit risk - Movements for impairments and provisions against loans losses As at 31st December 2014 Collective / Specific General Total m m m As at 31st December 2013 (1.0) 0.0 (1.0) Acquisitions*1 (21.5) (14.1) (35.6) Charges against profits (0.1) 0.0 (0.1) Recoveries Amounts written off (3.3) (2.1) (5.5) Other small movements As at 31st December 2014 (20.8) (15.2) (36.0) *1 During the year the group acquired BHF Bank and these balances were taken on as part of this acquisition 48

49 The following table analyses impairments against investments in subsidiaries as of 31 st December Table 33 Credit & Counterparty Credit Risk Analysis Impairments and movement of Equity Investments As at 31st December 2014 Use of External Credit Assessment Institutions ( ECAI ) The Group uses nominated ECAI s as part of the standardised approach for credit risk to determine risk weightings applied to rated counterparties. The Group currently uses Moody s, Standard & Poor s & Fitch rating agencies to determine the external rating of specific counterparties. The Group previously used only Moody s as a nominated ECAI but have now adopted these agencies as part of the acquisition of BHF Bank. In addition to the above, BHF uses credit assessments of Export Credit Agency "AGA Länderklassifizierung" within the meaning of Article 137 CRR predominantly for its securitisation position. The Group uses ECAI risk assessments as part of the determination of risk weightings for the following asset classes: Central governments or central banks Regional governments or local authorities Public sector entities Multinational development banks International organisations Institutions Claims on institutions and corporates with a short-term credit assessment Corporates Covered bonds Specific Collective / General m m m Equity investments as at 31st December Acquisitions *1 Charges against profits (2.9) 0.0 (2.9) Disposals (18.8) 0.0 (18.8) Amounts written off Exchange rate movements Other small movements (1.6) 0.0 (1.6) Equity investments as at 31st December *1 During the year the group acquired BHF Bank and these positions were taken on as part of this The table below shows the external ratings of the nominated ECAI s which The Group uses and their association with CRR Part Three, Title II, Chapter 2 and how this is then used for risk weighting of relevant exposure classes. Total 49

50 Table 34 Credit & Counterparty Risk Table Credit Step The Group uses various system tools to upload Issue and Issuer ratings to the specific counterparties and assets on the balance sheet. The Group would apply the Issuer rating for exposures which are not debt securities and issue ratings for exposures which are. The Group would use the most prudent rating available to ensure that the highest risk weighting possible is assigned to an exposure in the event that 2 or more ECAI credit assessments are available for the same exposure. The Group follows the rules set out in Articles 138 to 141 to map ECAI credit assessments to exposures. The table below shows The Group s Gross Exposures (Before credit risk mitigation and provisioning) as at 31 st December 2014 and where ECAI credit assessments have been used for risk weighting purposes: 50 Table 35 Corporates Institutions (Including Banks) Central governments Standard & Poor's Fitch Rated Unrated Unrated > 3 Mths < 3 Mths or central banks Public sector entities Moody's 1 Aaa AAA AAA 20% 100% 20% 20% 20% 0% 20% 1 Aa1 AA+ AA+ 20% 100% 20% 20% 20% 0% 20% 1 Aa2 AA AA 20% 100% 20% 20% 20% 0% 20% 1 Aa3 AA- AA- 20% 100% 20% 20% 20% 0% 20% 2 A1 A+ A+ 50% 100% 50% 50% 20% 20% 50% 2 A2 A A 50% 100% 50% 50% 20% 20% 50% 2 A3 A- A- 50% 100% 50% 50% 20% 20% 50% 3 Baa1 BBB+ BBB+ 100% 100% 100% 50% 20% 50% 100% 3 Baa2 BBB BBB 100% 100% 100% 50% 20% 50% 100% 3 Baa3 BBB- BBB- 100% 100% 100% 50% 20% 50% 100% 4 Ba1 BB+ BB+ 100% 100% 100% 100% 50% 100% 100% 4 Ba2 BB BB 100% 100% 100% 100% 50% 100% 100% 4 Ba3 BB- BB- 100% 100% 100% 100% 50% 100% 100% 5 B1 B+ B+ 150% 100% 100% 100% 50% 100% 100% 5 B2 B B 150% 100% 100% 100% 50% 100% 100% 5 B3 B- B- 150% 100% 100% 100% 50% 100% 100% 6 Caa1 CCC+ CCC 150% 100% 150% 150% 150% 150% 150% 6 Caa2 CCC CCC 150% 100% 150% 150% 150% 150% 150% 6 Caa3 CCC- CCC 150% 100% 150% 150% 150% 150% 150% Credit & Counterparty Credit Risk Analysis Gross Exposure (Before Provisions and CRM) by credit exposure class As at 31st December 2014 Exposure where ECAI ratings have been applied Credit Quality Credit Quality Credit Quality Credit Quality Step 1 Step 2 Step 3 Step 4 Step 5 Step 6 Applied Provisions) (CRM) Provisons n Factor after CRM Credit & Counterparty Credit Risk - Standardised Approach (SA) m m m m m m m m m m m m Central governments or central banks (55.3) 1,307.0 Regional governments or local authorities , , ,170.2 Public sector entities (22.4) Multilateral Development Banks (12.1) International Organisations Institutions ,249.3 (130.1) 0.0 (67.4) 2,051.8 Corporates , ,360.2 (1,288.6) 0.0 (1,039.6) 2,032.0 Retail (39.0) 0.0 (4.1) 73.7 Secured by mortgages on immovable property (0.0) Exposures in default (34.9) (20.7) (0.8) 16.5 Items associated with particular high risk Covered bonds Claims on institutions and corporates with a short-term credit assessment (21.1) 22.7 Collective investments undertakings (CIU) Equity Other items Securitisation positions SA Total Credit & Counterparty Credit Risk 2, , ,881.1 (884.4) (20.7) (1,222.9) 8,753.1 Credit Quality Credit Regulatory Quality Std'ised Treatment Total (Pre CRM Credit Risk & Mitigation Off Balance Sheet Conversio Net Exposure

51 8. Counterparty Credit Risk Counterparty credit risk is the risk of financial loss if a customer or counterparty fails to meet a payment obligation under a contract. The Group incurs counterparty credit risk within its banking entities where derivative contracts are taken out with other counterparties for the purpose of hedging or trading. The Group monitors its counterparty credit risk exposures against limits that have been set which is covered in section 7.2 of this Pillar 3 disclosure. Settlement Risk Settlement Risk is defined as the risk that a settlement in a transfer system does not take place as expected. Generally, this happens because one party defaults on its clearing obligations to one or more counterparties. This could be caused by an operational issue, a shortage of stock, liquidity issues or insolvency. The Group continues to take a prudent approach to the calculation and assignment of settlement risk. Trading for underlying clients is performed on an agency basis and, given the nature of the client base, is generally with stock or cash already held in custody. Further to the formal assessments provided for each approved counterparty broker, additional monitoring and control is performed for the assessment and assignment of settlement risk. Settlement Risk within The Group is principally in relation to Treasury activities. Derivatives & Financial Contracts Counterparty risk arises when the bank enters into an off-balance sheet Over-the-Counter ( OTC ) derivative contracts with another counterparty that matures in a future period. There is a risk that the counterparty may not be able to honour this contract. The Group uses approved market counterparties for transacting foreign exchange and interest rate swaps in order to manage risk in treasury book positions. These transactions, including associated client initiated deals, gives rise to a counterparty risk and creates an exposure to the bank. In the event that a counterparty does not honour a contract, The Group may suffer a loss and incur a cost to replace this contract with another counterparty. These exposures give rise to a Pillar 1 capital charge. The Group adopts the Mark-to-Market Method to calculate its counterparty credit risk in accordance with CRR Article 274. Counterparty Credit Limits The Group may suffer losses if a counterparty does not honour a contract therefore all counterparties are given limits to control the level of exposure The Group has against them. Counterparty limits in relation to Derivatives and Financial Contracts are set as part of an overall limit for a counterparty which covers all exposures including credit risk. This is covered in Section 7.2 of this Pillar 3 document. Wrong-Way risk Wrong-way risk is defined as the risk that occurs when an exposure to one counterparty is closely correlated with the credit quality of another counterparty. This risk could happen if The Group took out a credit derivative with a counterparty to hedge an exposure and also has a different exposure with the same counterparty which the credit derivative was taken out with. 51

52 The Group does not have any credit derivative transactions and closely monitors all its counterparties which it engages with to ensure that risks such as this are minimised where possible. The Board do not consider this as a material risk due to the nature of the business and transactions which BHF KB engages in. Counterparty Credit Risk Mitigation The Group secures collateral and applies netting against counterparty credit risk on derivative contracts. This is explained in more detail in section 4.3 & 7.2 of this Pillar 3 document. The Group does not have any credit derivative hedges/transactions or contracts where exposures with protection are linked to them. The table below shows The Groups exposure to counterparty credit risk as at 31 st December 2014 showing any netting, credit risk mitigation and net exposure. This is in accordance with Part three, Title II, and Chapter 6 of the CRR: Table 36 Counterparty Credit Risk by financial contract and reporting approach As at 31st December 2014 Gross Gross Positive Potential Nominal Fair Value Future Value of of Credit Contracts Contracts Exposure Netting Benefits Net Current Credit Exposure Collateral Held Provisions Net Exposure Mark to Market method m m m m m m m m Financial Contract Type Interest Rate Contracts 15, (528.1) (101.8) Foreign Currency Contracts 2, (1.0) Equities Contracts 1, (51.8) Precious Metals & Commodities Contracts (0.8) Securities Financing Transactions Credit Derivatives Any other contracts Total Mark to Market Method 19, (528.1) (155.4) Potential Future Credit Exposure Gross Positive Fair Value of Contracts Potential Future Credit Exposure Netting Benefits Net Current Credit Exposure Collateral Held Provisions EAD post- CRM Internal Method m m m m m m m m Financial Contract Type Interest Rate Contracts Foreign Currency Contracts Equities Contracts Precious Metals & Commodities Contracts Securities Financing Transactions Credit Derivatives Any other contracts Total Internal Method The exposures above are incorporated into the overall credit risk tables shown in Section 7 of this Pillar 3 document. These exposures will be included within the institutions exposure class. The Group s financial contracts are with well rated counterparties and are usually short term in nature. Most of the contracts are Interest Rate Swaps which are used for hedging the interest rate risk in the banking book. The large size in the nominal values of the contracts when compared to the exposure value is partly due to the fact these swaps are offsetting each other and partly due to the counterparties attracting low credit conversion factors, resulting in negligible Pillar 1 capital requirements. The net exposure to counterparty credit risk represents 2% of The Groups overall credit risk requirement. 52

53 Potential Collateral Obligations BHF has a long term credit rating of BBB- awarded by Fitch and is the only entity within The Group which carries an ECAI rating. BHF has a limited number of financial contracts with counterparties which stipulate that in the event that this rating was to be downgraded that there will be an increased collateral requirement. This is the case together with 4 guarantees that have been given in the context of revolving credit facilities. The amount of potential obligation can only be estimated, since the contractual agreements do not clearly differentiate between actual additional collateral obligations and a simple necessity of acceptance in case of a rating downgrade. Together with OTC derivatives, there are no further obligations agreed upon. 53

54 9. Exposure to Securitisation Positions Securitisation is the process of pooling various types of contractual debt such as mortgages, credit card loans or other assets which generate receivables and selling their related cash flows to a third party investor as a securitised position. In connection with securitisations, an institution may act as an originator, sponsor or investor as defined by the regulations. For regulatory purposes there are thus different consequences and treatments depending on the role of the institution. The only entity within The Group which holds such a position is BHF. BHF is currently active in the market solely as an investor. In the role of investor, it buys securitised assets from other financial institutions. All receivables acquired in this context are due from domestic companies. A credit insurance policy is taken out for the securitisation position which can be counted as a risk-mitigating guarantee for each receivable. When new securitisation positions are acquired, specific internal requirements must be observed in order to meet the special requirements for securitisation positions with respect to due diligence and the deductible in accordance with Articles 405 and 406 of the CRR. The internal processes to monitor the risk profile of securitisation positions is based both on the provisions of the CRR and the principles of MaRisk. Both before investing in a securitisation and with existing positions, it is ensured that all material relevant data and documents are collected, analysed and evaluated continuously and promptly. In general, the competent market area is responsible for obtaining the required data. As a CRSA institution, BHF determines the capital requirements for securitisation positions in accordance with the CRR s rules for CRSA securitisation positions. As no external rating exists for the existing securitisation position, the Bank uses the look-through approach in accordance with Article 253 of the CRR. The risk weighting of the securitisation position is determined by the average risk weighting of the securitised receivables. The Bank s securitisation transaction is maintained in the banking book and The Group does not have any trading book positions. No impairments were necessary in The table below shows the approaches to calculating RWA for The Group on securitisation positions: Table 37 Securitisations by approach As at 31st December 2014 Non-Trading Book Exposure Capital value RWAs Requirement m m m Approach Standardised Ratings based Internal Ratings Based (IRB) Supervisory method Totals The table below shows the securitisations in the year including any gains or losses and whether these were Traditional or Synthetic: 54

55 Table 38 Securitisation during the year As at 31st December 2014 Non-Trading Book Movement in the year As at 31st December 2013 Traditional Synthetic Total Movement Gains / Losses on sale As at 31st December 2014 m m m m m m Originator Mortgages Loans to Corporates or SMEs Consumer loans Trade receivables Securitisations / Re-securitisations Other assets Totals The only securitisation The Group has been taken up in the year was in BHF Bank which was not part of the Group in The table below shows the securitisation positions during the year where the Group acted as Investor, Originator or Sponsor: Table 39 Securitisation during the year As at 31st December 2014 Non-Trading Book Movement in the year As at 31st Gains / As at 31st December As Total Losses on December 2013 originator As sponsor As investor Movement sale 2014 m m m m m m m Originator Mortgages Loans to Corporates or SMEs Consumer loans Trade receivables Securitisations / Re-securitisations Other assets Totals

56 There were no assets awaiting securitisation as at 31 st December 2014: Table 40 Assets awaiting securitisation As at 31st December 2014 Non-Trading Trading Book Book m m Originator Mortgages Loans to Corporates or SMEs Consumer loans Trade receivables Securitisations / Re-securitisations Other assets Total IRB The table below demonstrates that no securitisation positions were past due or impaired as at 31 st December 2014: Table 41 Securitisation amounts and impairments As at 31st December 2014 Non-Trading Book Total Non- Trading of which Impairments Traditional Synthetic Book past due Recognised m m m m m Originator Mortgages Loans to Corporates or SMEs Consumer loans Trade receivables Securitisations / Re-securitisations Other assets Totals

57 The table below shows balance of securitisation positions as at 31 st December 2014 by Originator, Sponsor and Investor: Table 42 Securitisation exposure value by exposure class As at 31st December 2014 Non-Trading Book Total Non- As Trading originator As sponsor As investor Book m m m m Originator Mortgages Loans to Corporates or SMEs Consumer loans Trade receivables Securitisations / Re-securitisations Other assets Totals The only securitisation position that the Group had as at 31 st December 2014 was not deducted from capital resources nor was it risk weighted at 1,250% as seen below: Table 43 Securitisation exposure by risk weighting As at 31st December 2014 Non-Trading Book Exposure Value Capital Requirement As originator As sponsor As investor Total Non- Trading Book As originator As sponsor As investor Total Trading Book m m m m m m m m Originator Less than or equal to 10% > 10% <= 20% > 20% <= 50% > 50% <= 100% > 100% <= 650% > 650% <= 1250% Deduction from capital Total IRB

58 The table below shows the Geographical split of securitisation positions as at 31 st December 2014: Table 44 Securitisation exposure value by geography As at 31st December 2014 Non-Trading Book United North Channel Rest of the Total Trading Kingdom Germany Europe America Islands World Book m m m m m m m Originator Mortgages Loans to Corporates or SMEs Consumer loans Trade receivables Securitisations / Re-securitisations Other assets Totals

59 10. Market Risk Market risk is defined as the risk that the value of a financial asset or liability will increase or decrease due to changes in market factors. The most significant proportion of market risk within The Group is within BHF Bank, KBCIHL & KBBL. KBI and the BHF KB Group management companies do not hold any market risk positions apart from FX risk which arises as part of the balance sheet composition which is very small. The standard market risk factors which The Group is exposed to are as follows: Table 45 Market Risk - Main risks Risk Type Equity risk Interest rate risk Currency risk Commodity risk Description The risk that stock prices will change The risk that interest rates will change The risk that foreign exchange rates will change The risk that commodity (i.e grains, metals, etc) will change These market risk factors contribute in fluctuations of the market value in The Groups assets, liabilities and currency positions which can result in a loss. Most of The Groups assets and liabilities are predominantly interest bearing and therefore The Group is also exposed to interest rate fluctuations which can result in a loss to the firm. Each entity within The Group manages their market risk as part of their individual risk framework. Market Risk - BHF Bank BHF uses an Internal Market Risk Model for risk management as well as for quantification of own funds requirements according to article 366 of the CRR. The process for measurement and supervision of market risk is identical for all the portfolios in the trading and banking book. This leads to maximum transparency from the single portfolio level up to BHF Bank as a whole. The internal risk management is based on a Value-at-Risk (VaR) approach with a confidence level of 99% and a holding period of 1 day for the trading book with the exception of some strategic positions which are held for up to 1 month. VaR calculations are based on volatilities that are updated daily and calculated from the time series stored in BHF s in-house market database. The VaR number for the linear part of general market risk is given by a variance-covariance-model and for the non-linear part (e.g. out of options) by Monte Carlo simulations. In addition to this, a stressed VaR (SVaR) calculation is also required. The final own funds requirement using the internal VaR approach is then defined by the sum of the own funds requirements of both Standard-VaR and Stressed-VaR according to article 364 of the CRR. Daily stress scenarios are a vital supplement of VaR calculations. The scenarios are not only composed of shifts of the basic risk-factors (e.g fx-rates, stock prices, interest rate curves and credit spreads) but also of the implied volatility, and are always performed in the way of a full valuation of each single position. The results for the scenarios are limited by the allocation of capital; the usage of limits is monitored daily. The design of these scenarios is subject to at least an annual review. In addition to these standard scenarios, BHF performs stress tests that use data from different historical financial crises (e.g. euro-crisis, subprimecrisis 2007/2008, 1987 crash etc) as well as portfolio-specific stress tests. These non-standard stress tests are done on a monthly basis. 59

60 In order to validate the quality of the risk model, VaR values are compared to the real revaluation results (back-testing). Article 366 of the CRR stipulates that back-testing on hypothetical changes in the portfolio's value is based on a comparison between the portfolio's end-of-day value and, assuming unchanged positions, its value at the end of the subsequent day. Back-testing on actual changes in the portfolio's value is based on a comparison between the portfolio's end-of-day value and its actual value at the end of the subsequent day excluding fees, commissions, and net interest income. The back-testing results (i.e. the comparison of VaR-overshootings to the statistically expected number of overshootings), is used to validate the risk model internally and externally. The table below shows the supervisory back-testing history over 2014 as required by CRR Article 366: Table 46 The table below shows the high, low, mean and end-of-period calculation for the period ending 31 st December 2014: Table 47 Market Risk - VaR & SVaR Back-Testing As at 31st December 2014 BHF has neither a model for incremental default & migration risk nor for the specific risk of the correlation trading portfolio. The scope of permissions given to BHF to use an Internal Market Risk Model covers all of the following market risk components: general risk of equity instruments; specific risk of equity instruments; general risk of debt instruments; high low mean end-ofperiod m m m m VaR SVaR model based PRR