Espirito Santo Investment Holdings Limited and its subsidiaries Group Pillar 3 Disclosures December 2012
1. Overview 1.1 Background With the introduction of the Capital Requirements Directive ( CRD ), also known as Basel II, on 1 January 2007, the FSA established three Pillars of capital, the purpose of which are to determine the correct level of capital and related disclosures required for regulated firms. Pillar 1 sets the minimum capital requirement as prescribed by the rules of the FSA. For Pillar 2, the Group is required to carry out an Internal Capital Adequacy Assessment Process ( ICAAP ). The purpose of the ICAAP is to assess the group s risks, how it intends to mitigate those risks and how much current and future capital is necessary having considered the relevant mitigating factors. Pillar 3 is designed to improve market discipline by requiring a firm to disclose certain details of its risks, capital and management objectives and policies. 1.2 Scope This report has been prepared for the Espirito Santo Investment Holdings Limited group because it is a UK consolidation group and also a non-eea sub-group. The group has the following entities: United Kingdom: Espirito Santo Investment Holdings Limited ( ESIHL ) Execution Holdings Limited Execution Noble Limited Noble Group Limited Noble Financial Holdings Limited Execution Noble & Company Limited Clear Capital Group Limited Execution Noble Research Limited Noble Fund Advisers Limited Isle of Man: Noble Group Holdings Limited Jersey: Noble Venture General Partner Limited United States of America: Execution Noble Holdings LLC 2
Hong Kong: Execution (Hong Kong) Limited India: Clear Info-Analytics Private Limited Noble Advisory India Limited The above companies are collectively described hereunder as the Group. The companies regulated by the Financial Services Authority ( FSA ) are: Execution Noble Limited Execution Noble Research Limited Execution Noble & Company Limited Execution (Hong Kong) Limited is regulated by the Securities and Futures Commission ( SFC ) in Hong Kong. All the above entities are fully consolidated for accounting and prudential purposes. However, there are some small differences in the treatment of certain assets and capital items for statutory accounting and capital adequacy calculations. There are no current or foreseen material restrictions or legal impediments to the movement of capital between the legal entities or repayment of liabilities among the parent and its subsidiary undertakings apart from the requirement to ensure that there is adequate capital in each of the regulated entities to meet its regulatory requirements. 1.3 Basis of Disclosures This document deals with the requirements of Pillar 3 and the information provided here is disclosed in accordance with the rules in the FSA s Prudential Sourcebook for Banks, Building Societies and Investment Firms (BIPRU) Chapter 11 Disclosure (Pillar 3). 1.4 Frequency The Group will publish the disclosures at least on an annual basis. 1.5 Media and location of publication The disclosures will be published on the Espirito Santo Investment Bank UK website: www.espiritosantoib.co.uk. 3
1.6 Verification The information contained in this document has not been audited by the Group s external auditors unless it is deemed to be equivalent to those disclosures made in terms of accounting requirements, and therefore does not constitute a part of the annual financial statements of the Group and should not be relied upon in making judgements about the Group. These disclosures explain how the Board have calculated certain capital requirements and information about risk management. 4
2. Risk management objectives and policies 2.1 Risk Management Framework The objective of creating a risk management framework is to identify measure, monitor, manage and report risk in a consistent fashion on a timely basis. To achieve this, the Group has a number of risk management processes, these being: The Board and its sub-committees The Board is made up of seven executive directors and six non-executive directors. It is supported by five sub-committees as shown in the committee structure below: Board of Directors (ESIHL) Audit and Risk Committee Executive Committee Remuneration Committee Operating Committee New Product Committee The five sub-committees collectively assist the Board in discharging its responsibilities on corporate governance. The Board and its sub-committees hold meetings as often as it is necessary for it to carry out its duties. There is a formal requirement for the Audit & Risk Committee to report annually to the Board on key risk findings during the year. Terms of Reference for Board and sub-committees The Board and its five supporting committees have approved Terms of Reference detailing the individual responsibilities they have towards risk management. 5
Non-executive directors The Group has ten non-executive directors ( NED ) including the Joint Chairmen; their role is to challenge and contribute to the development of strategy, scrutinise the performance of management in meeting objectives and strengthen the corporate governance structure of the Group. Global Risk Policy The Group has approved a Risk Appetite Statement. This statement is intended to provide an overview of the processes that are required to identify and manage risks within the Group. It is intended to assist management in discharging its risk management responsibilities. The Group has developed a comprehensive Risk Matrix for each business unit which contains all the relevant details for each identified risk including the risk definition, an explanation as to why it affects the business unit, the mitigating factors identified and the amount of capital to be held if it is identified as a significant risk. Definitive reporting lines and roles and responsibilities The Group has a clear structure of reporting lines and each employee is aware of their role and responsibilities within the organisation. Business Continuity Plan Each office has its own Business Continuity Plan ( BCP ) which describes the logistical plan for how the organization will recover and restore partially or completely interrupted critical function(s) within a predetermined time after a disaster or extended disruption. The current BCPs in each office give clear and concise instructions during a disaster or disruption. The BCP for the UK can also be accessed by staff on the firm s intranet. Employee Policies The Group has a comprehensive list of Employee Policies which are made available to all employees. The policies detail the guidelines (such as holiday entitlement, maternity leave, etc), expectations and procedures of the business to its employees. Compliance manual The purpose of this manual is to provide guidance and set out certain principles, general practices, rules and procedures which provide the foundations for the proper conduct of business within the firm and, in some cases, reflect other 6
applicable jurisdictions legal and regulatory requirements. Each employee is given a copy of the manual during induction. Monthly consolidated management accounts Consolidated, departmental and business line management accounts are prepared each month. These are discussed at regular scheduled meetings with the departmental and business line heads on a monthly basis. The accounts incorporate variance analysis to both the previous month and to the budget. On a quarterly basis an update of the forecasts of the group is carried out. The consolidated management accounts are submitted to the Board for review and discussion. They are also used to assess the capital adequacy of each entity and of the Group and used to complete the mandatory regulatory filings. 2.2 Risk Categories The most significant risk types to which the Group is exposed are discussed below: Credit Risk Credit risk is defined as the risk of loss arising from a counterparty failing to meet its financial obligations or its failure to perform as agreed with the Group. The Group is primarily an agency broker therefore it is not exposed to credit risk in the normal course of its business. There are, however, specific activities (Market Making and Facilitation) that could expose the Group to credit risk. Such risk is measured and monitored formally against approved risk limits. Additionally, the Group only uses deposit taking institutions with at least an A credit rating for its cash deposits. Market Risk Market risk comprises of equity risk, interest rate risk, foreign currency risk and commodity risk. Interest rate risk The Group is exposed to interest rate risk in that bank balances are on a floating rate basis. The company has no borrowings at the current time. The Group does not have significant exposure to interest rate fluctuations on its balance sheet, thus this risk is accepted by the Group and is assessed annually as part of the ICAAP. 7
Foreign Currency risk Foreign currency risk is made up of transactional risk and structural foreign exchange risk on overseas subsidiary entities. The Group does not take structural hedges but any excess capital is remitted to the UK parent where possible. The Group minimizes its transactional exposure by matching foreign currency income and expenditure where possible. Equity Risk The Group is an agency broker and does not hold any trading positions. On occasion in order to facilitate a client trade, a very small position might be held overnight but is cleared the next business day. The Group also conducts market making activities which exposes the Group to equity risk as a result of holding a portfolio of stocks as Principal. As a result the Group has assessed its market risk requirement and included this within its overall capital resource requirements. Commodity risk The Group only trades in equities therefore it is not exposed to commodity risk. Liquidity Risk Liquidity Risk is defined as the risk that either the Group does not have available sufficient financial resources to enable it to meet its obligations as they fall due, or can secure such resources only at excessive cost. The Group has always aimed to maintain excess liquid resources over its cash requirements. The firm reviews its liquidity requirements and cash flows on an ongoing basis and takes the appropriate action to ensure contingency funding is in place should it be required. Cash balances are reviewed and circulated to senior management on a daily basis and daily, monthly and six-monthly cash flow forecasts are prepared and maintained. Settlement Risk Settlement Risk is defined as the risk that the entity will deliver an asset/cash to counterparty and will not receive the purchased asset/cash as expected. Agency trading is undertaken on a Delivery vs. Payment ( DVP ) basis. The Group s clearing agent is financially stable, reputable, and has a proven track record in the settlements market. 8
Within the market making activity there are certain settlement risks which are taken into account for the purposes of ensuring the adequacy of the capital resources of the Group. Operational Risk Operational risk is defined by the FSA using the Basel definition as the risk of loss, resulting from inadequate or failed internal processes, people and systems, or from external events. The components of operational risk have been defined as: Process risk The risk of direct or indirect loss resulting from inadequate or failed internal business processes. People/key person risk The risk of direct or indirect loss resulting from the deliberate or intentional actions of employees and/or management of the company. Systems/infrastructure risk The risk of direct or indirect loss resulting from inadequate or failed system infrastructure of the organisation including all network, hardware, software, communications and their interfaces. External risk The risk of direct or indirect loss resulting from events outside of the Group s direct or indirect control or from events that impact on an external relationship. Group risk/conflicts of interest The risk of loss due to conflicts of interests between stakeholders. Also the risk of direct or indirect loss resulting from the relationship which exists between the Group and its majority shareholder, BESI. Legal/regulatory risk The risk of loss due to non-compliance with laws, rules, regulations, agreements, prescribed practices or ethical standards. Trade processing risk The risk of loss from errors in trade processing. 9
Strategic risk The risk of loss arising from changes in the business environment and from adverse business decisions (for example, failure of new business), improper implementation of decisions (that is, risk of failing to manage new business) or lack of responsiveness to changes in the business environment. Reputation risk Current or prospective risk to earnings and capital arising from adverse perception of the image of the entity on the part of customers, counterparties, shareholders, investors and regulators. From the risks above, the Group considers people risk as its only significant operational risk. 3. Capital 3.1 Capital Resources The Group has the following capital resources at 30 June 2012: 000 Tier 1 Capital Total tier 1 capital before deductions 61,629 Deductions: intangible assets and investment in own shares (30,193) Total tier 1 capital/total capital after deductions 31,436 The Group does not have any tier 2 and 3 capital resources. 3.2 Capital Planning Monthly consolidated and entity-level management accounts are prepared and reviewed in detail by the Group management (ExCo) and subsequently discussed at the Board meetings quarterly. The Group s financial resources compared to its minimum capital requirements are also discussed at these meetings. Annual budgets for each entity are prepared and approved by the Group Board and these are tracked against the actual performances with significant deviations investigated. 10
Results from the extensive stress testing on plausible events performed as part of the ICAAP concluded that the Group had sufficient capital to meet its regulatory resource requirements and also to support its current and foreseeable activities. As discussed above, there are no restrictions on management in regards to the transfer of capital in or out of businesses and in the jurisdictions that the Group operates in, apart from the need to hold the minimum regulatory capital in each regulated entity. 4. Regulatory Capital Requirements This chapter describes the regulatory capital requirements of the Group. This is based on the Pillar 1 requirements of CRD. The regulatory capital requirements for the consolidated group as at 30 June 2012 are as follows: 000 Credit risk capital requirement 2,314 Market risk capital requirement 688 Counterparty risk capital requirement 28 Operational risk capital requirement 6,796 Total capital requirements 9,826 4.1 Credit risk The Group applies the risk weights under the standardised approach to credit risk to calculate its risk weighted exposure amounts for each of its exposures. 4.2 Market risk As discussed above the majority of the Group s operations are as an agency broker thus trading positions are not usually held in the normal course of business. Thus, the Group s market risk capital requirement is usually only foreign exchange risk. 4.3 Counterparty risk The Group applies the risk weights as defined in the FSA handbook BIPRU 13 to calculate its risk weighted exposure amounts for counterparty risk exposures. 4.4 Operational risk The Group has adopted the Basic Indicator Approach to calculating the operational risk capital requirement as stipulated in the FSA handbook under BIPRU 6.3. 11
5. Remuneration Disclosure at 31 December 2012 5.1 Decision making process ESIHL has established a Remuneration Committee which operates within formal Terms of Reference under delegated authority from the Board of Directors of ESIHL. The Remuneration Committee has oversight of the implementation of the Remuneration Policy set by the Board. The Remuneration Committee s role includes an assessment of whether remuneration decisions have adequately taken into account the implication for risk and risk management of the firm, the longer-term interests of shareholder, investors and other stakeholders, and the management of any conflicts of interest. The members of the Remuneration Committee are Keith Jones, Brian Henderson and Francisco Cary. All are non-executive directors. The Chairman of the Remuneration Committee is Keith Jones, who is an independent non-executive director. The Remuneration Committee s work is not currently supported by any retained external consultant, but the Committee keeps this under review as the Remuneration Policy develops. 5.2 Link between pay and performance Remuneration is made up of fixed and variable pay. Variable remuneration is determined based on profitability of the overall business and the relevant business area, as well as individual performance. Individual performance targets include financial and non-financial metrics, which are measured through the annual employee appraisal process. 12
5.3 Quantitative Remuneration Disclosure December 2012 Department Remuneration Percentage % Equities No of Staff In Category Fixed 2,568,355 58.82 20 Variable 1,797,931 41.18 Aggregate 4,366,286 Advisory Fixed 1,015,000 64.24 6 Variable 565,000 35.76 Aggregate 1,580,000 Senior Management Fixed 1,550,000 81.60 11 Variable 349,500 18.40 Aggregate 1,899,500 Aggregate All 7,845,786 37 13