BANK SEPAH INTERNATIONAL plc PILLAR 3 DISCLOSURES (including Remuneration Code disclosures) As at 31 March 2017 1
Contents Page Introduction 3 Iran (Financial Sanctions) Order 2007 3 Governance 3 Capital Resources 5 Capital Requirement 6 Risk Management 7 Credit risk 7 Market risk 8 Operational risk 8 Pillar 2A risks 9 1) Credit risk 9 2) Credit concentration risk 9 3) Market risk 9 4) Interest rate risk in the banking book 9 5) Operational risk 10 6) Liquidity risk 10 Pillar 2B 10 Leverage Ratio 10 Remuneration Code 11 2
BASEL II PILLAR 3 DISCLOSURES As at 31 March 2017 Introduction: Bank Sepah International plc ( the Bank ) is a commercial bank incorporated in England in 2002 and is a wholly owned subsidiary of Bank Sepah, regulated by the Central Bank of Iran. The Bank is authorised under the terms of the Financial Services and Markets Act 2000 and regulated by the PRA and the FCA. On 17 th January 2016 the United Nations Security Council removed the sanctions introduced on 24 th March 2007 under resolution 1747. On 23 rd January 2016 the EU delisted a number of Iranian banks including the Bank and Bank Sepah under the Joint Comprehensive Plan of Action (JCPOA) between the EU and the Islamic Republic of Iran (Iran). The Managing Director s commentary in the Annual Report and Financial Statements notes that banking activities have been slow to recover and therefore the Bank has a highly liquid balance sheet. The Bank has adopted the Prudential Regulation Authority s (PRA) implementation of the EU s Capital Requirements Directive IV (CRD). The CRD framework consists of three Pillars. Pillar 1 sets out the Bank s minimum capital requirements based on the credit, market and operational risk exposure. Under Pillar 2, the Bank assesses the internal risk management process and considers whether additional capital is required to cover risks not covered in Pillar 1. Pillar 3 requires banks to disclose key elements of their risks, capital and risk management procedures. This disclosure document has been prepared by the Bank in accordance with EU legislation. Disclosures are prepared on an annual basis after the conclusion of the audit of the Annual Report and Financial Statements and published on the Bank s website, www.banksepah.co.uk. The information contained in this disclosure has been approved by the Board but is not subject to external audit. Unless otherwise stated, all figures are as at financial year end 31 March 2017 and are stated in Euros, the Bank s reporting currency. The Bank continues to monitor all risks to which it is exposed and these risks, the capital deemed required to cover them and the procedures in place to manage them are covered in the following pages. Governance The Board of Directors (the Board) currently comprises five non-executive directors of which two are independent and the Managing Director. The Independent Directors have a mixture of regulatory, financial and banking skills and experience. Board and Executive committees (see below) consist of directors and senior management with a variety of relevant skills and experience to ensure that no undue reliance is placed on any one individual. The Board meets regularly throughout the year and met eight times during the year to 31 March 2017. The Board defines the overall risk appetite, proposes and approves policies and sets authority limits. This is documented in a Risk Appetite Statement (RAS) and a Risk Framework document which is reviewed at least annually by the Board. The Board has three sub-committees each of which is chaired by a non-executive director. These are the Audit Committee, the Risk Committee and the Remuneration Committee. These committees meet in advance of regular Board meetings to review specific topics and make recommendations to the Board. 3
The Audit Committee, chaired by David Swanney, is responsible for reviewing the work of the external and internal auditors. The Risk Committee, chaired by Ian Coleman, is responsible for reviewing the Risk Register, the key regulatory documents including the ICAAP, the ILAAP and the RRP and the work of the Chief Risk Officer. The Remuneration Committee, chaired by Bob Angel, reviews the remuneration of the Managing Director, the HR framework and the appointment of senior staff. The Board delegates day-to-day management responsibilities to the Managing Director. The Managing Director chairs three management committees which have terms of reference approved by the Board. These are the Executive Management Committee, the Credit Committee, and the Asset and Liability Committee. These committees are responsible for approving procedures consistent with policies approved by the Board. Risk Management The RAS articulates the level and types of risk that the Bank is willing to accept or avoid consistent with its Regulatory Business Plan. It includes qualitative statements as well as quantitative measures covering capital, liquidity and other relevant measures as appropriate. It also addresses other risks such as IT security, reputational risk and business conduct risk. The Bank has separate Compliance and Risk functions. Compliance reports to the Board of Directors and Risk reports to the Credit Committee for credit risk and the Executive Management Committee for operational risk. Separately, specific reports are submitted to Audit and Risk Committees and the Board. The Bank adopts a "three lines of defence" operating model. Risks are owned by the responsible business line which has its own procedures, the first line of defence. These are reviewed and monitored by the control functions, Compliance and Risk; the second line. The effectiveness of the first and second lines of defence is reviewed by the independent external and internal audit function, together with the Board. This represents the third line of defence. 4
Capital Resources The Bank s regulatory capital resources as at 31 March 2017 amounted to 168,068,000, comprised as follows: 31 03 2017 '000s Share Capital 160,000,000 Ordinary shares of 1 each 160,000 Retained Earnings 8,585 Total Common Equity Tier 1 Capital (CET1) 168,585 Less Deferred Tax Asset (517) Total Capital Resource 168,068 Share Capital The Bank s authorised share capital at 31 March 2017 5,000,000 ordinary shares of 1 each 200,000,000 ordinary shares of $1 each 200,000,000 ordinary shares of 1 each Of which 160,000,000 is issued and fully paid. Retained Earnings: These comprise audited retained earnings as at 31 March 2017. 5
Capital Requirement The Bank s total capital requirement as at 31 March 2017 under Pillars 1 and 2 amounted to 32,254k and was comprised as follows: PILLAR 1 2017 '000s Credit risk 12,065 Market risk 526 Operational risk 411 Total PILLAR 1 capital 13,002 PILLAR 2 Credit concentration --Single Counterparty risk 6,032 Credit concentration Country risk 754 Credit concentration Sector risk 3,016 Market risk 120 Interest rate risk in the banking book 3,800 Operational risk 4,000 Liquidity risk 1,500 Total PILLAR 2 capital 19,222 Total PILLAR 1 and PILLAR 2 Capital Requirement 32,224 Total Capital Resource 168,068 Capital Cover over Pillar 1 and Pillar 2 522% An explanation of each of the risks identified above and the calculation of the appropriate capital requirement figure follows. 6
Risk Management The principal risks facing the Bank are credit risk market risk (including foreign exchange risk) operational risk (including conduct risk) These risks are documented below: Credit Risk Credit risk is the risk that counterparties will be unable to meet their obligations to the Bank which may result in financial loss. The risk profile of the asset portfolio is managed through the Credit Committee which meets formally on a monthly basis and on other occasions as required. The Risk function also prepares for Credit Committee an annual review prior to the year end of all assets with particular regard to any loans where it is considered that the expected recoverable amount is less than the carrying value. Recommendations for any bad debt provisioning are hence made to the Audit Committee who in turn make recommendations to the Board. A final decision is taken by the Board in the light of discussions with the external auditors. As at 31 March 2017 loans to the value of 4,650k were considered impaired against which impairment provisions of 981k were made as follows 000 s Total Exposure Unimpaired Exposure Impaired exposure Impairment Provisions Net Carrying Value Loans and advances to customers 7,427 2,777 4,650 981 6,447 Total Exposures 7,427 2,777 4,650 981 6,447 The Bank calculates its Pillar 1 credit risk capital requirement by applying the rules in respect of the Standardised Approach to credit risk. Credit risk weighted exposures as at 31 March 2017 are summarized below 000 s Net Carrying Value Risk Weight under Basel II 8% of Risk Weighted Assets Cash and placements and loans to banks 353,386 129,729 10,378 Loans and advances to customers 6,447 9,660 773 Property, plant and equipment 3,682 3,682 295 Other Assets 756 238 19 Commitments 10,000 7,500 600 Total Exposures 374,271 150,809 12,065 As at 31 March 2017 there was one committed facility represented as an off-balance sheet exposure. Under Pillar I the capital required to support the weighted exposures as at 31 March 2017 therefore amounted to 12,065k. 7
Market risk Market risk for the Bank arises from the change in value expressed in the reporting currency of assets and liabilities other than the reporting currency due to the effect of exchange rate movements. Gains and losses are recognised immediately in the Profit and Loss account. The foreign exchange position risk requirement in Pillar 1 is calculated in accordance with the PRA s Foreign Currency Position Risk Requirement as follows: calculating the net open position in each currency converting each such net position into base currency equivalent at spot rates of exchange calculating the total of all net short positions multiplying the total of all net short positions by 8% The net open currency positions of the Bank at 31 March 2017 were as follows 000 s GBP CHF JPY USD Other Total Assets 312,965 40,526 4-10,785 559 364,839 Liabilities 319,144 40,708 35 178 4,763 11 364,839 Net Currency position (6,179) (182) (31) (178) 6,022 548 - The total net short currency positions expressed in 000 s as at 31 March amounted to 6,570k. The Bank s Pillar 1 foreign exchange minimum capital risk requirement as at 31 March 2017 is thereby calculated as 526k, being 6,570k x 8%. Operational risk Operational risk is the risk of loss to the Bank resulting from inadequate or failed processes, people and systems, or from external events other than credit, market and liquidity risk. The definition includes legal risks but does not include reputational or strategic risks. In common with other financial institutions, these risks include (but are not limited to) fraud, human error, IT failure, data theft and damage. To mitigate against these risks, the Bank has processes, procedures and controls in place together with a Business Continuity plan. Data backups are taken daily and stored off-site. The recovery plan is tested on an annual basis. The Bank has adopted the Basic Indicator Approach to calculate its operational risk capital. Under this approach, the Operational Risk Capital is determined by calculating the Bank s three year average net interest income and net non-interest income and applying 15% thereto, as in the following table. 000 s 2015 2016 2017 Net interest income 2,443 2,608 3,131 Commissions received 2 3 1 Foreign exchange gains 66 280 (308) Total 2,511 2,891 2,824 Average for the 3 years 2,742 15% of the average over 3 years 411k The Bank s Pillar I operational risk capital requirement has therefore been calculated as 411k. 8
Pillar 2A Risks 1) Credit Risk As part of its Pillar 2 capital assessment requirement the Bank has considered the need for an additional allocation of capital for unexpected credit losses above the amount calculated as part of the Pillar 1 capital requirement. The Bank does not consider that a credit counterparty risk capital add-on is required as the Bank is not significantly exposed to asset classes likely to be underestimated under Pillar 1 as the business of the bank is focused on trade finance. 2) Credit Concentration Risk Credit concentration risk is the risk of losses arising as a result of concentrations of exposures due to imperfect diversification. This imperfect diversification can arise from: the small size of a portfolio a large number of exposures to specific obligors (single name concentration) imperfect diversification with respect to economic sectors or geographical regions. The Bank recognises that it is exposed to a variety of credit concentration risks as set out in its Risk Appetite Statement. As specified by the PRA, The Bank calculates a Pillar 2 allocation using the Herfindahl-Hirschman Index (HHI) for each of the concentrations listed and then uses the PRA mapping models to arrive at a Pillar 2 add on. This process is detailed in the The PRA s methodologies for setting Pillar 2 capital (October 2017). The HHI is a commonly accepted measure of market concentration, calculated by squaring the market share of each firm competing in the market and then summing the resulting numbers. It takes into account the relative size distribution of the firms in a market. The HHI increases both as the number of firms in the market decreases and as the disparity in size between those firms increases. Risk Capital Add on % Pillar 2 A Charge 000 s Single Counterparty 4.00 6,032 Country 0.50 754 Sector 2.00 3,016 Total Pillar 2 Credit Concentration 9,802 3) Market Risk The Bank has set a maximum limit of 5,000k in FX aggregate net open positions at close of business each day across all currencies under normal trading conditions. The Bank considers that it would be appropriate to allocate an additional Pillar 2 amount to cover the possibility of losses from a more significant exchange rate movement than anticipated in the Pillar 1 calculations. Given recent events and intraday movements in currency rates, The Bank considers that a 30% movement represents a severe but plausible scenario and has therefore allocated 120k Pillar 2 capital against this scenario. The Bank has not allocated capital against market risks other than FX as it is does not maintain any trading positions. 4) Interest Rate Risk in the Banking Book With regard to Interest Rate risk the Bank seeks to match fund interest bearing assets and liabilities wherever practicable. Within this general policy the following parameters have been set:- maximum unhedged mismatch limit EUR1m. The Bank will not hold fixed rate bonds with a residual maturity of greater than 10 years. 9
The Bank considers a 200 basis point shock to be an appropriate scenario to allocate Pillar 2A capital against interest rate risk in the banking book and accordingly has allocated the sum of 3,800k against this eventuality. This is calculated on a 2% increase in negative interest rates on the Bank s liquid Euro assets of 190m as at 31 March 2017. 5) Operational Risk Despite the controls in place and the intention of the Bank to take a cautious approach whilst it reintroduces itself to the market, there exists the possibility of operational losses. Given the historical data together with the control enhancements implemented, the Bank considers that Pillar 2 add on of 4,000k is appropriate to cover operational risk. 6) Liquidity Risk A capital add-on of 1,500k has been allocated to liquidity risk to cover potential losses arising from the disposal of marketable assets and increased funding costs that might be incurred in the time of a liquidity stress. Pillar 2B In addition to Pillar 1 and Pillar 2 capital, the Bank holds Pillar 2B. This has been set by the PRA (the PRA Buffer) and comprises a percentage of Risk Weighted Assets in excess of their Individual Capital Guidance. It is intended to ensure that the Bank is able to withstand severe but plausible stress scenario without breaching the overall financial adequacy rule, in line with CRD IV rules. The PRA requires that by 1 January 2019 100% of the PRA buffer is met with 100% of CET capital. Leverage Ratio CRD IV requires firms to disclose a non-risk based leverage ratio in addition to the calculation of risk based capital requirements. The ratio is intended to limit the accumulation of excessive leverage in the banking sector which was widely considered to be a root cause of the 2007/2008 Global Financial Crisis. The leverage ratio is calculated by dividing the Bank s CET 1 capital by the total of on and off-balance sheet exposures (subject to the application of appropriate credit conversion factors). The leverage ratio has been set as a minimum of 3% by the Basel Committee and was subject to an observation period by the European Banking Committee until 1 January 2017. The ratio will be finalised as a binding requirement for implementation on 1 January 2018. Total CET 1 Capital (a) 168,585 Total balance sheet assets 364,271 Off-balance sheet assets (credit conversion factors applied) 5,000 Total assets and contingents (b) 369,271 Leverage ratio (a) / (b) 45.7% 10
Remuneration Code REMUNERATION POLICY Overall responsibility for Bank Sepah International plc ( the Bank ) remuneration strategy lies with the Board. The governance of remuneration arrangements is delegated by the Board to the Remuneration Committee. The Remuneration Committee is responsible for the implementation of the Remuneration Policy Governance of all matters related to remuneration within the Bank. The Remuneration Committee is chaired by a Non-Executive Director, and comprises of two Independent Non-Executive Directors, the Bank s Managing Director and the HR Manager who is Secretary of the Committee. The Remuneration Committee has defined the Bank as a Proportionality Level Three firm under the PRA Remuneration Supervisory Statement SS2/17 and has adopted a proportionate approach to our remuneration policy. The Remuneration Committee has reviewed the Bank s remuneration policy to ensure compliance with the regulatory requirements set out in the FCA Handbook. The Bank remunerates all staff, independently of the level of seniority, through a combination of fixed and variable remuneration. The variable component, if any, is allocated to each individual and is discretionary and will depend on factors, which include individual performance, and the financial performance of the Bank. Remuneration is determined annually. The Remuneration Committee decides each year if the profit made by the Bank is sufficient to provide variable remuneration rewards to all participating staff. If the profit is sufficient, a bonus pool amount will be allocated which will be awarded to the participating staff. Any awards made under the scheme qualify as variable remuneration as defined in the Code. The Remuneration Policy is integrated into the Bank s business and risk management framework and it is aligned with the Bank s objectives. Significant developments that may require change to the Remuneration Policy are discussed with the Executive Management Committee and any proposed changes are submitted to the Remuneration Committee for its review and approval. Remuneration offered and paid by the Bank consists of the following elements: Fixed Remuneration The fixed remuneration makes up the largest part of staff remuneration. The level applied to each position reflects the responsibility which it carries and the related skills required. No staff, including Executive Directors, are paid over 500,000. Performance related bonus (Variable Remuneration) The Bank pays a small part of employees remuneration by way of performance and profit related variable remuneration. However, the award of any such variable remuneration is entirely at the discretion of the Remuneration Committee. The level of performance of the annual profits of the Bank is determined by the Board, following the recommendations of the Managing Director and Chief Financial Officer. The variable remuneration does not include deferred payments therefore no deferred payments were considered in respect of the variable remuneration during the financial year 2016-2017. The Bank applies the Remuneration Code guidance that states that no individual staff member should have more than 33% of their total salary as variable remuneration or earn more than 500k per annum in variable remuneration. 11
Aggregate Quantitative Remuneration Disclosure financial year ended 31 March 2017 As at 31 March 2017 the number of employees totalled 30, with 25 being eligible for variable remuneration awards in respect of their services during 2016-2017 (Non-Executive Directors are not eligible for variable remuneration). 11 of the 25 staff who are eligible for variable remuneration are classified as Code Staff. Business Areas Total Employees Fixed Variable Banking Operations & Support 17 771,000 58,500 Finance, Risk & Compliance 7 442,000 18,000 Directors 6* 365,000 0 TOTAL 30 1,578,000 76,500 Employee type Total Employees Fixed Variable Material Risk Takers (MRTs) ** 11 725,000 28,000 Non material risk takers 19 853,000 48,500 TOTAL 30 1,578,000 76,500 A breakdown of MRT s by business area is not possible due to the small numbers involved as this would reveal individual confidential remuneration levels. Due to the nature, scale and low level of complexity of the Bank risks currently involved in the Business, the Remuneration Committee does not consider it necessary to have any deferred remuneration arrangements (such as shares or share linked instruments) for MRT staff which may require the Bank to adopt malus and clawback arrangements. * Of the 6 Directors, 4 are remunerated. The remaining 2 Directors are based overseas ** A material risk taker is an employee of a CRR firm whose professional activities have a material impact on the firm s risk profile, including any employee who is deemed to have a material impact on the firm s risk profile in accordance with criteria set out in articles 3 to 5 of the Material Risk Takers Regulation. 12