PENSIONS WEBINAR THE PENSIONS SORP INVESTMENT DISCLOSURES

Transcription

1 PENSIONS PENSIONS WEBINAR THE PENSIONS SORP INVESTMENT DISCLOSURES Philip Briggs

2 Fair value hierarchy FRC published FRED 62 in March 2016 which changed FRS 102 to bring the disclosures in relation to the FVH into line with FRS 102. This amendment is effective for accounting periods commencing on or after 1 January 2017, with early application permitted. Note in accounting policies required if early adopting. PRAG Guidance was updated in May 2016.

3 Fair value hierarchy our experience of audit issues Who has been responsible for making the determination? Compliance with the PRAG/Investment Managers Association guidance. Is this an appropriate source? Consideration and approval of the disclosure. Mixed treatment of Bonds and Gilts. Treatment of Pooled Investment Vehicles generally consistent. Watch out for AVCs.

4 Fair value hierarchy our tip Don t think of as: Level 1 Easy to price Level 2 Not so easy to price Level 3 Difficult to price Think of as: Level 2 Straightforward to price Level 1 Very easy to price Level 3 Difficult to price

5 Investment risk disclosures Market Risk Credit risk Currency risk Interest rate risk Other price risk A retirement benefit plan shall disclose information that enables users of its financial statements to evaluate the nature and extent of credit risk and market risk arising from financial instruments to which the retirement benefit plan is exposed at the end of the reporting period. For each type of credit and market risk arising from financial instruments, a retirement benefit plan shall disclose: a) the exposures to risk and how they arise; b) its objectives, policies and processes for managing the risk and the methods used to measure the risk; and c) the changes in (a) or (b) from the previous period. (FRS )

6 Investment risk disclosures Credit risk Market risk Currency risk Counterparty risk The risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation. (FRS 102: Glossary) Economic exposure risk Interest rate risk Other price risk Credit risk

7 Investment risk disclosures credit risk Need to determine the counterparty. Cash. And can the counter part be credit rated? I promise to pay the bearer on demand the sum of. pounds.

8 Investment risk disclosures credit risk And if your cash is in a bank then the bank will have a credit rating the Trustees will have made a decision about credit ratings that they will accept for banks that they use wouldn t they?

9 Investment risk disclosures credit risk - equities What about Equities? Equity represent an ownership interest so there is typically no credit risk.

10 Investment risk disclosures credit risk - bonds Bonds are debt instruments. Bonds are probably the most important investment type to apply a credit risk policy so there will be quite a lot to say here. Credit risk is such a fundamental aspect of bond valuation that the trustees/investment manager will have some form of policy and understanding of bond credit ratings.

11 Investment risk disclosures credit risk - properties What about Properties? Properties represent an ownership interest and so there is no credit risk.

12 Investment risk disclosures credit risk - derivatives Derivatives are typically investments comprising contractual agreements with counterparties so there will be quite a lot to say here. Credit risk is such a fundamental aspect of derivative operations that the trustees/investment manager will have some form of policy and understanding of counterparty credit ratings and this will link with the collateral requirements.

13 Investment risk disclosures credit risk - PIVs Credit risk is dependent upon the structure of the PIV.

14 Anatomy of a CIS Investment manager Investment decisions Promoter Marketing and distribution Collective Investment Scheme Depositary Other governance oversight Administrator Registering of investors Recording transactions in units Custodian Safekeeping of investments Executing transactions

15 Anatomy of a unit-linked insurance policy Investment manager Investment decisions Marketing and distribution administration Insurance Company Custodian Safekeeping of investments Executing transactions

16 Investment risk disclosures credit risk - PIVs And why is this also important? How safe are your DC assets? A report from the Security of Assets Working Party. February 2016

17 Investment risk disclosures credit risk - PIVs In a Collective Investment Scheme you own a share of the CIS and therefore it is like an equity holding and represents an ownership interest and so there is no credit risk. Most common types of CIS are Authorised Unit Trusts and Open Ended Investment Companies (OEICs). With a unit linked insurance policy the trustees effectively have a contract of insurance with an insurance company. The insurance company will typically be credit rated but the complexities of how insurance providers structure their businesses make this quite tricky to pin down. Other most likely form of PIV are Shares in Limited Liability Partnerships (ownership interest). Other forms of PIV may exist. Common industry consensus appears to be that PIVs are unrated but it is not that simple.

18 Investment risk disclosures credit risk - PIVs As PIVs are typically determined to be unrated then relevant credit risk information relates to the structure and regulatory environment in which the trustees are investing so we see the following: The Scheme s holdings in pooled investment vehicles are unrated. Direct credit risk arising from pooled investment vehicles is mitigated by the regulatory environments in which pooled managers operate and diversification of investments amongst a number of pooled arrangements. The Investment Sub Committee, acting on behalf of the Trustees, manages and monitors the credit risk arising from its pooled investment arrangements by considering the nature of the arrangement, the legal structure and regulatory environment. But as the structures and regulatory environments differ then better quality disclosure is provided by being more specific and providing an analysis of this.

19 Investment risk disclosures credit risk PIVs So a table works well to demonstrate this. A summary of pooled investment vehicles by type of arrangement is as follows: Unit linked insurance contracts Authorised unit trusts 5,000 5,500 Open ended investment companies Shares of limited liabilities partnerships Total 6,500 7,350

20 Investment risk disclosures credit risk PIVs But a table does not necessarily work as well to demonstrate overall credit risks. Investment grade m Noninvestment grade m 2016 Unrated m Total m Analysis of direct credit risk At 31 March 2016 Investment grade 000 Non-investment grade 000 Unrated 000 Total 000 Bonds 1,200, ,200,000 OTC Derivatives (70,000) - - (70,000) Longevity swap (50,000) - - (50,000) Cash Money market investments Other investment balances (700,000) - 2, ,000 Pooled Investment Vehicles , , , ,000 1,182,840 Direct Bonds 14, ,400 OTC derivatives (fair value) Cash 1, ,500 Repurchase agreements Unsettled trades Securities on loan 4, ,500 Property rent debtors Indirect Pooled investment vehicles ,500 8,550 20, ,138 30,693

21 Investment risk disclosures credit risk PIVs Particularly if your table looks like this: Analysis of direct credit risk 2016 Investment grade Non-investment grade Unrated Total Pooled investment vehicles ,000,000 79,000, Investment grade Non-investment grade Unrated Total Pooled investment vehicles 78,000,000 78,000,000

22 Investment risk disclosures credit risk Additional credit risk disclosures. A retirement benefit plan shall disclose by class of financial instrument: a) The amount that best represents its maximum exposure to credit risk at the end of the reporting period. This disclosure is not required for financial instruments whose carrying amount best represents the maximum exposure to credit risk. b) A description of collateral held as security and of any other credit enhancements, and the extent to which these mitigate credit risk. c) The amount by which any related credit derivatives or similar instruments mitigate that maximum exposure to credit risk. d) Information about the credit quality of financial assets that are neither past due nor impaired. When a retirement benefit plan obtains financial or non-financial assets during the period by taking possession of collateral it holds as security or calling on other credit enhancements (eg guarantees), and such assets meet the recognition criteria in other sections, a retirement benefit plan shall disclose: a) The nature and carrying amount of the assets obtained; and b) When the assets are not readily convertible into cash, its policies for disposing of such assets or for retaining them. (FRS )

23 Investment risk disclosures market risk FRS 102 defines market risk as the risk that the fair value or future cash flows of a financial instrument will fluctuate because of changes in market prices. (FRS 102: Glossary) So essentially we are considering the economic exposure risk. FRS 102 then states that Market risk comprises three types of risk: currency risk, interest rate risk and other price risk. (FRS 102: Glossary) Two primary options exist for addressing this disclosure requirement: sophisticated strategic basis of disclosure; and direct compliance basis. Unfortunately too many schemes ended up somewhere in between.

24 Investment risk disclosures market risk Example investment classifications Equities Bonds Derivatives PIVs Sophisticated strategic approach Match disclosure to the strategic investment decisions based on economic exposure consider any hedging strategies. Other price risks are more granular than those referred to in FRS 102. May also link to wider risks such as covenant, funding or longevity risks. Match disclosure to the strategic investment decisions based on economic exposure consider any hedging strategies. Other price risks are more granular than those referred to in FRS 102. May also link to wider risks such as covenant, funding or longevity risks. Match disclosure to the strategic investment decisions based on economic exposure consider any hedging strategies. Other price risks are more granular than those referred to in FRS 102. May also link to wider risks such as covenant, funding or longevity risks. Adopt a look through approach to consider the underlying exposures within the PIVS. Direct Compliance approach Overseas domiciled equities link to currency risk all equities link to Other price risks. Overseas domiciled bonds link to currency risk all bonds link to interest rate risks. The links to currency, interest rate and other risks is likely to be relatively clear based on the nature of the derivative ie forex contracts or interest rate swaps. At a high level cross reference each PIV or groups of PIVs to currency, interest rate and other risks also linking to the existence of indirect credit risk enhances the credit risk disclosures.

25 Investment risk disclosures market risk But remember the requirement is that: A retirement benefit plan shall disclose information that enables users of its financial statements to evaluate the nature and extent of credit risk and market risk arising from financial instruments to which the retirement benefit plan is exposed at the end of the reporting period. (FRS ) This means some form of quantification. Two primary options exist for addressing this disclosure requirement: the vague % exposure basis; and direct amount basis.

26 Market risk disclosures examples Investment risk disclosures market risk examples. (ii) Currency risk The Trust is subject to currency risk because some of the Trust s investments are held in overseas markets via pooled investment vehicles. The Trustee limits overseas currency exposure through a currency hedging policy. The Trust s total net unhedged exposure by major currency at the year end was as follows: Currency Euro 8,000 3,000 Japanese Yen 17,000 2,200 US Dollar 135, ,000 (iii) Currency risk The scheme is subject to currency risk because some of the Scheme s investments are held in overseas markets, either as segregated investments or via pooled investment vehicles. The Trustees have set a benchmark limit to overseas currency exposure of 15% of the total portfolio value which is achieved through a currency hedging policy. This was the net currency exposure at the year-end.

27 Investment risk disclosures market risk Example Market risk disclosures typical PIV approach. The following table summarises the extent to which the various classes of investments are affected by financial risks: Pooled investment vehicles Credit Risk Market risk Direct Indirect Currency Interest rate Other price UK Equity Y N N N Y 4,700,000 5,000,000 - Overseas Equity Y Y Y N Y 4,800,000 5,100,000 - UK Corporate Bonds Y Y Y Y N 6,000,000 6,000,000 - UK Index-Linked Gilts Y Y N Y Y 3,000,000 3,000,000 - Diversified Growth Y Y Y Y Y 2,000,000 1,500,000 Total Investments 20,500,000 20,600,000

28 Investment risk disclosures qualitative Market Risk Credit risk Currency risk Interest rate risk Other price risk A retirement benefit plan shall disclose information that enables users of its financial statements to evaluate the nature and extent of credit risk and market risk arising from financial instruments to which the retirement benefit plan is exposed at the end of the reporting period. For each type of credit and market risk arising from financial instruments, a retirement benefit plan shall disclose: a) The exposures to risk and how they arise; b) Its objectives, policies and processes for managing the risk and the methods used to measure the risk; and c) The changes in (a) or (b) from the previous period. (FRS )

29 Investment risk disclosures quantitative Market Risk Credit risk Currency risk Interest rate risk Other price risk A retirement benefit plan shall disclose information that enables users of its financial statements to evaluate the nature and extent of credit risk and market risk arising from financial instruments to which the retirement benefit plan is exposed at the end of the reporting period. For each type of credit and market risk arising from financial instruments, a retirement benefit plan shall disclose: a) The exposures to risk and how they arise; b) Its objectives, policies and processes for managing the risk and the methods used to measure the risk; and c) The changes in (a) or (b) from the previous period. (FRS )

30 Investment risk disclosures don t forget in year 2 Market Risk Credit risk Currency risk Interest rate risk Other price risk A retirement benefit plan shall disclose information that enables users of its financial statements to evaluate the nature and extent of credit risk and market risk arising from financial instruments to which the retirement benefit plan is exposed at the end of the reporting period. For each type of credit and market risk arising from financial instruments, a retirement benefit plan shall disclose: a) The exposures to risk and how they arise; b) Its objectives, policies and processes for managing the risk and the methods used to measure the risk; and c) The changes in (a) or (b) from the previous period. (FRS )

31 Investment risk disclosures final points Fully insured arrangements require particular consideration. More sophisticated financial instruments require deeper consideration ie Repos, special purpose vehicles. For DC investments the sophisticated strategic approach is unlikely to be appropriate. Annuity policies are financial instruments and form part of the investment strategy. AVCs need to be considered. Much time and costs have been wasted approaching these disclosures from strategic investment principles rather than compliant financial reporting principles. As experience grows and practice develops we hope clients will be challenged to improve.

32 QUESTIONS AND ANSWERS?

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