Sumitomo Mitsui Banking Corporation Group
PILLAR 3 RISK DISCLOSURES
As of 30th June 2010
Document disclaimer
•
The purpose of the Pillar 3 disclosures as contained within this Disclosure Document is
solely to explain the basis according to which SMBC Nikko Capital Markets Limited Group
(“CM-UK”) and its constituent entities comply with certain capital related requirements and
to provide information about the management of risks relating to those requirements.
•
This Disclosure Document does not constitute any form of financial statement on behalf of
CM-UK.
•
This Disclosure Document reflects, where appropriate, information which is contained
within the Consolidated Annual Report & Financial Statements of CM-UK.
•
The Information has been subject to internal review but has not been audited by the CMUK’s external auditors.
•
Although Pillar 3 disclosures are designed to provide transparent capital disclosure by
investment firms on a common basis, the information contained in this particular Disclosure
Document may not be directly comparable with that made available by other firms. This
may be due to a number of factors such as:
- The mix of approaches allowed under the Capital Requirements Directive (“CRD”);
- The mix of exposure types;
- The different risk appetites and profiles of firms;
- The different waivers applied for and allowed by the FSA.
•
Pillar 2 capital requirements are excluded from this Disclosure Document, but nevertheless
play a major role in determining both the total capital requirements of CM-UK and any
surplus capital available.
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AUTHORISED AND REGULATED BY THE FINANCIAL SERVICES AUTHORITY
1. Overview
The CRD, based upon the Basel 2 Accord, has established a regulatory framework across the European Union
governing the amount and nature of the capital financial institutions must maintain.
The objective of the CRD is to promote the safety and soundness of the financial system by requiring banks
and investment firms to hold a level of capital appropriate to the risks inherent in their business model. The
CRD disclosure requirements (“Pillar 3”) aim to complement the minimum capital requirements (“Pillar 1”)
and the supervisory review process (“Pillar 2”) and seek to encourage market discipline by allowing market
participants to assess information provided on the risk exposures and risk assessment processes of the firm.
SMBC Nikko Capital Markets Limited Group (“CM-UK”), previously SMBC Capital Markets Limited,
obtained the approval of the United Kingdom Financial Services Authority (“FSA”) to calculate its Pillar 1
credit and counterparty credit risk capital requirements using the Foundation Internal Ratings Based (“FIRB”)
approach to credit risk from 1st January 2008. CM-UK therefore uses internal Probability of Default (“PD”)
rates, with Loss Given Default (“LGD”) as per regulatory guidance. However, not all internal models have
yet been approved for IRB usage – approval was given for Japanese corporate names, financial institutions
and sovereign lending only. Assets rated using the non-Japanese corporate model are calculated for
regulatory capital purposes according to the standardised approach. The standardised market risk PRR
method is used to calculate market risk requirements. Operational risk requirements have been calculated
using the basic indicator approach as of 30th June 2010. This document is designed to meet the Pillar 3
obligations.
The Pillar 3 disclosures herein have been prepared in accordance with the rules of the FSA, the body charged
with implementing the CRD in the United Kingdom, as set out in the General Prudential Sourcebook
(“GENPRU”) and the Prudential Sourcebook for Banks, Building Societies and Investment Firms (“BIPRU”).
BIPRU Section 11 (Disclosure) lays out the disclosure requirements applicable to Investment Firms. The
Section 11 requirements are designed to promote market discipline by providing market participants with key
information on a firm’s risk exposures, risk management processes, and, hence, capital adequacy. Improved
public disclosures of such information lead to increased transparency and should lead directly to more
effective market discipline.
The rules of BIPRU 11 allow a firm to omit any of the required disclosures that are deemed to be immaterial
in that such an omission would not change the understanding of a reader relying on this information.
In addition a firm may omit any disclosures where it believes that the information is proprietary or
confidential. Information is deemed to be proprietary where we consider that, if shared, it would undermine
our competitive position. Information is deemed to be confidential where there are obligations binding us to
confidentiality with our counterparties and suppliers.
Unless otherwise stated all figures in this document are denominated in United States dollars.
2. Basis and Frequency of Disclosure
These disclosures have been prepared based upon the consolidated financial position of CM-UK and the
financial position of those of its constituent companies that are regulated, United Kingdom domiciled,
investment firms as of 30th June 2010.
Future disclosures will be made annually, as of 30th June.
3. Location and Verification
This Disclosure Document has been reviewed by senior management but has not been subject to external
audit. However, where data is equivalent to that included in the Annual Report and Financial Statements,
such data has been subject to external audit during the formal review and verification process.
This report is published on the corporate website of SMBC Capital Markets Group (www.smbcnikkocm.com).
4. Corporate Structure
CM-UK consists of SMBC Nikko Capital Markets Limited (“CM-LTD”) and its wholly owned subsidiaries
SMBC Derivative Products Limited (“DP”) and SMBC Capital Markets Asia Limited (“CM-Asia”). Both
CM-LTD and DP are full scope BIPRU investment firms domiciled in the United Kingdom and regulated by
the FSA, CM-Asia is domiciled in Hong Kong.
CM-UK itself is a wholly owned subsidiary of Sumitomo Mitsui Banking Corporation (“SMBC”) of Japan.
CM-UK, together with SMBC Capital Markets Inc. (“CM-INC.”), make up the SMBC Capital Markets Group
(“CMG”), the global derivatives arm of SMBC. CMG operates a single trading book overseen by a clearly
defined global management structure supported by appropriates policies and procedures. The relationships
between the different legal entities within CMG are defined within agency and service level agreements.
CMG co-operates closely with SMBC’s international network of branches and subsidiaries.
DP is a bankruptcy remote derivatives company that has been assigned a AAA counterparty rating by Standard
& Poor’s and a Aa rating by Moody’s. DP’s conduct of business operations is defined by the document
“Operating Policies and Guidelines SMBC Derivative Products Limited” which sets the respective rating
agencies operational requirements and the calculation process used to calculate the capital required in order to
maintain the AAA / Aa credit rating. As long as DP meets rating agency capital requirements there is no
hindrance to the transfer of capital, in the form of dividend payments, to the parent CM-LTD.
CM-Asia acts as an agent for CM-UK and CM-INC. arranging transactions in Asia and Australasia. It does
not booking transactions for its own account.
The CRD framework applies to CM-LTD and DP on a solo basis and to CM-UK on a consolidated basis.
The disclosures below are presented on both a solo and a consolidated basis.
In June 2010 CM-LTD advised the Financial Services Authority (“FSA”) of its intention to enter into a
business collaboration agreement with Nikko Cordial Securities Inc., a fellow subsidiary of SMBC. The
purpose of this collaboration was to pursue securities business opportunities. As of 30th June 2010 this
collaboration arrangement was only in the planning stage.
5. Risk Management
Risk is a natural consequence of the actions undertaken in order to achieve strategic business objectives. As a
consequence of this CM-UK regards risk management as a key discipline and seeks to manage the risks arising
through an effective overall risk management framework which is overseen by the Board of Directors.
Effective risk management is the primary means through which management tries to achieve its goals of:
•
•
Optimising the return to, and protecting the interests of, stakeholders (including shareholders,
customers and staff);
Safeguarding the Group’s assets and protecting its reputation;
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•
•
Improving the Group’s operating performance; and
Fulfilling the Group’s wider strategic objectives.
CMG’s risk management department, which has responsibility for the oversight of CM-UK, comprises of two
group risk functions, Trade Analysis (market risk) and Credit; additionally there are independent control and
support functions including Legal, Compliance, Operational Risk Review and Information Security. These
support functions are themselves managed by a series of risk committees staffed by senior-management and
other relevant staff:
•
•
•
•
•
•
The Global Risk Management Committee overseeing strategies for addressing market risk, operational
risk and liquidity risk issues;
The Credit Committee overseeing credit issues and new applications in addition to outstanding credit
exposures/credit lines, expected losses and credit reserves;
The New Products Committee overseeing new products, structures or business strategies or any
significant modifications to existing products, structures or business strategies;
The Compliance Committee overseeing regulatory and compliance issues;
The Information Technology Assessment Committee overseeing potentially risky IT issues;
The Capital Management Committee overseeing capital adequacy and capital planning issues for
CMG entities subject to prudential regulation.
Independent assurance is provided by the Audit Department of SMBC.
As a wholly owned subsidiary of SMBC, CM-UK will in general seek to ensure the alignment of its strategy
in important areas with that of SMBC in order to ensure that a cost-effective and consistent approach is
achieved across the SMBC group. CM-UK therefore follows overall SMBC group policy in assessing and
managing risks and uncertainties. However, management will at all times ensure local relevance in order to
support achievement of local objectives.
CM-UK undertakes an internal assessment of its capital needs, the Internal Capital Adequacy Assessment
Process (“ICAAP”), on an annual basis. The ICAAP considers all of the material risks faced by individual
entities and the group that are not captured by the minimum capital requirement (these are known as Pillar 2
risks). The ICAAP is subject to Board review and approval.
The most significant risk categories that CM-UK is exposed to are set out below.
Credit Risk
Credit risk is the risk that a counterparty is unable to honour its obligations to CM-UK as and when they fall
due. Adverse changes in the credit quality of individual counterparties or a general deterioration in economic
conditions could affect the recoverability and value of CM-UK’s assets. CM-UK management recognises
that total credit risk, the aggregation of credit, counterparty and concentration risk (GENPRU 2.1.51(i) – (iii)),
and in particular concentrations of counterparty credit risk, constitute the greatest risk faced by the Group.
The CMG Risk Management Department employs a broad array of control and monitoring tools including:
•
•
•
•
•
•
maximum potential exposure (by simulation) credit limits for each counterparty;
periodic analysis based on grade;
continuous communication with SMBC’s credit departments;
stress testing;
measurement and monitoring of settlement risk;
analysis of rapidly emerging trends in credit quality using the KMV system.
CM-UK has adopted the Foundation Internal Ratings Based (“FIRB”) approach for calculating Pillar 1 capital
requirements for credit and counterparty risk except for exposures to non-Japanese corporate customers where
4
the standardised approach is used.
Central to the credit assessment is the internal credit grading system. CMG uses SMBC’s grading models for
all counterparties and outsources credit applications to the relevant credit departments of SMBC for approval,
consequently CM-UK operates wholly within the overall credit governance structure of SMBC. All major
developments associated with the IRB approach, including developments with relation to internal rating
systems design and implementation, are subject to the approval of senior management, up to and including the
board of the parent bank. CM-UK has established an arrangement with the wider SMBC Group whereby
CM-UK’s Capital Management Committee, consisting of board members and relevant risk management,
accounting and compliance staff drawn from across CMG, can share regular reports on internal ratings model
developments.
CM-UK has three major ways of addressing credit risk: fundamental credit analysis and control by the
relevant credit departments of SMBC; a credit reserve based upon market fair value; and active involvement
of management, through the front office, in pursuing credit mitigation in the day to day business over and
above the credit requirements of the institution and fostering a culture of pricing to reflect all risks. A more
detailed discussion of credit risk mitigation is set out in section 8.
Market Risk
Market risk is the risk of an adverse change in the value of CM-UK’s assets and liabilities arising from
movements in market rates, including interest rates, equity prices, commodity prices and currencies.
CM-UK fully hedges the market risk of all its customer transactions through matching trades with either its
associated company, CM-INC. or a market counterparty. As a result the derivatives portfolio is left with
minimal market risk. Market risk does arise on the securities portfolio, where the charge is calculated in
accordance with the interest rate PRR rules, and on any balance sheet foreign exchange exposures arising,
where the charge is calculated in accordance with the foreign currency PRR rules.
CM-UK has no position limits for commodity, equity, interest rate or currency derivatives.
Liquidity Risk
Liquidity risk is the risk that CM-UK is unable to meet its financial obligations as they fall due.
As CM-UK’s derivative trading portfolios consist of fully hedged intermediation trades it has minimal funding
risk, and it effectively eliminates currency risk, however imbalances do arise between collateralised and
uncollateralised counterparties. Collateral agreements are increasingly a requirement in the interbank market
whereas most customers would neither wish nor be able to manage transactions entered into under such
conditions. Such imbalances can result in swings in net collateral and therefore the funding position under
volatile market conditions. Potential imbalances in collateral are only an issue for CM-LTD as DP is
prevented by its operating policies and guidelines from collateralising exposures.
As at 30th June 2010 CM-LTD had pledged collateral of $1.3 billion however it was in receipt of collateral of
$1.5 billion. This colateral excess was the result of management identifying its most material, uncollateralised exposures and purchasing a collateralised guarantee, from its parent, to cover potential material
deficiencies.
Other funding requirements are minimal. CM-INC. acts as treasurer for all CMG entities and has access to
both committed and uncommitted facilities, provided by SMBC, and to SMBC guaranteed programmes for
both U.S. and Euro commercial paper. Medium and longer term funds can be raised through SMBC’s multiissuer medium term note programme and through loans from Japanese Life Assurance Companies (“Seiho
loans”) arranged by SMBC.
5
Operational Risk
Operational risk is the risk of losses being incurred as a result of inadequate or failed internal processes,
people or systems, or from external events. CMG manages operational risk through a variety of techniques
most importantly the monitoring of key risk indicators, particularly the requirement that any adjustments with
an impact greater than +/- $10,000 must be formally reported and explained to management.
CMG has adopted a risk and control self-assessment methodology whereby it identifies the operational risks
arising within each business area, identifies the controls in place to mitigate these risks and evaluates the
effectiveness of these controls. This assessment is undertaken quarterly.
Due to the relative simplicity of its mono-line business model CM-UK calculates Pillar 1 operational risk
capital using the Basic Indicator Approach.
Residual risk
Residual risk is the risk that losses may arise from the partial performance or failure of credit risk mitigation
techniques (see 8 below) for reasons that are unconnected with their intrinsic value. Residual risk can arise
from, for example, ineffective documentation, a delay in payment or the inability to realise payment from a
guarantor in a timely manner.
CM-UK has undertaken a risk self-assessment process and has determined that its credit risk mitigation
process using treasury bills and cash collateral is robust. All credit support agreements are documented under
International Swaps and Derivatives Association (“ISDA”) master agreements or a broadly equivalent legal
framework. Acceptable collateral is restricted to cash or government securities (to which an appropriate
haircut is applied). CM-UK further mitigates residual risk by close monitoring of all collateral agreements
and the submission of daily settlement failure reports, which cover collateral, to management. The vast
majority of credit support agreements are with highly rated financial institutions so this risk is deemed to be
minimal.
Reputational risk
Reputational risk is the risk arising from a deteriorating perception of CM-UK’s standing in the eyes of,
particularly, the wholesale markets. Management has considered how this might arise and, consequently
requires that due consideration is given to any potential legal and reputational issues arising in credit
applications, or in the decision as to whether a credit application is required. Deals with any potential legal or
reputational issues, whilst not unknown, are a small percentage of activity so each is brought to the attention
of management regardless of credit impact.
Data quality risk
CMG undertakes a quarterly self-assessment of any data processing errors. Key risk indicators show that the
impact of such errors has been immaterial.
CM-UK recognises that it is insufficient to simply understand and quantify the above risks as they currently
exist and that it must also understand the risks that might arise in times of economic stress. In order to meet
this requirement CM-UK regularly undertakes a number of stress tests that model the impact of movements in
factors such as interest rates, foreign exchange, credit spreads and equity index levels on the portfolio. CMUK also runs stress tests and reverse stress tests specifically for capital planning purposes that seek to capture
specific vulnerabilities.
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6. Capital Resources
Table 1 provides a summary of the relevant capital ratios as at 30th June 2010:
Table 1
Tier 1 (after deducting material holdings):
Total Capital:
CM-UK
41%
68%
CM-LTD
22%
53%
DP
145%
146%
Ratios are calculated by taking the relevant capital resources as a percentage of risk weighted assets. Total
risk weighted assets as at 30th June 2010 were ($’000):
CM-UK:
CM-LTD:
DP:
1,405,398
1,191,332
214,066
Table 2 provides a summary of the composition of regulatory capital resources as at 30th June 2010:
Table 2
CM-UK
($’000)
CM-LTD
($’000)
DP
($’000)
597,000
-209,199
200,000
597,000
-220,350
200,000
300,000
11,284
-
Total tier 1 capital:
587,801
576,650
311,284
Tier 2 capital
Surplus provisions:
Subordinated debt:
150,000
150,000
1,284
-
Total tier 2 capital:
150,000
150,000
1,343
Total tier 1 plus tier 2 capital:
737,801
703,237
301,640
7,881
302,000
10,935
-
Total tier 1 plus tier 2 capital after deductions:
729,920
413,715
301,640
Tier 3 capital:
Short term subordinated debt:
Net interim trading book profit and loss:
222,000
-
222,000
-
1,106
Total capital before deductions:
960,333
635,715
308,973
Deductions from total capital:
1,149
543
606
Total capital after deductions:
950,771
635,171
313,068
Tier 1 capital
Called up share capital:
Retained earnings and other reserves:
Perpetual non-cumulative preference shares:
Deductions from total of tier 1 and tier 2 Capital
Material holdings:
Other:
7
Tier 1 Capital
CM-LTD:
Tier 1 capital includes of 597 million US$1.00 and 2 GB£1.00 ordinary shares fully paid up and 200 million
perpetual, non-cumulative preference shares of $1.00, fully paid-up. The preference shares are callable, at the
option of the Company from December 2012. Only the ordinary shares carry voting rights and are wholly
owned by SMBC.
DP:
Tier 1 capital consists of 300 million $1.00 ordinary shares fully paid-up, wholly owned by CM-LTD.
CM-Asia:
CM-LTD holds 2 million $1.00 ordinary shares in CM-Asia, the subsidiary’s entire issued share capital. CMAsia is not subject to any standalone capital requirements but is consolidated within the consolidated
prudential returns of CM-UK.
Tier 2 Capital
CM-LTD’s long term subordinated loan facilities can be drawn until 30th June 2015 and mature 30th June
2020. Under FSA rules subordinated loan capital cannot exceed 50% of tier 1 capital and, in the last five
years to maturity dated subordinated loans must be amortised on a straight line basis.
Tier 3 Capital
CM-LTD’s short term subordinated loan facilities can be drawn until 31st October 2013 and mature 31st
October 2015. Under FSA rules short term subordinated loan capital must be amortised on a straight line
basis over the last two years to maturity.
CM-UK regularly stresses its financial resources to model the potential effect of extreme impact events on the
Group’s capital and its capital resources requirement.
7. Capital Resources Requirement
CM-UK determines its minimum regulatory capital charge (Pillar 1) on a daily basis using a capital calculator
compliant with BIPRU rules. A summary report is then distributed to the Capital Management Committee.
Table 3 provides a summary of the overall minimum capital requirement (Pillar 1) for each regulated entity
and the group.
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Table 3
Credit risk:
Operational risk:
Counterparty risk (table 4):
Market risk
Interest rate PRR:
Foreign currency PRR:
Concentration risk:
Capital resources requirement
Surplus / (Deficit) of own funds1:
Solvency Ratio2:
CM-UK
($’000)
2,003
2,955
107,225
CM-LTD
($’000)
1,212
92,023
DP
($’000)
1,923
1,743
15,203
613
88
36,351
149,235
341
40
33,285
126,901
272
48
15,798
34,987
801,536
508,270
278,081
637.09%
500.53%
894.83%
Credit Risk
CM-UK calculates its credit risk capital requirement on non-trading book exposures using the Foundation
Internal Ratings Based (FIRB) approach. Relevant exposures are to financial institutions.
Operational risk
CM-UK calculates its operational risk requirement using the basic indicator approach.
Counterparty risk
Counterparty credit exposure arises from the risk that parties are unable to meet their payment obligations
under financial derivative contracts. As at 30th June 2010 CM-UK had posted cash collateral of
$1,269,653,000 to cover its liabilities over derivative contracts in line with general market prices and, in turn,
held collateral of $1,523,360,000. CM-UK does not have a public rating however, in the event of a credit
downgrade in the public rating of either the parent bank or of the publicly rated, bankruptcy remote subsidiary
DP there will be the potential for various liquidity events such as collateral calls or terminations upon
downgrade. CM-UK therefore continuously monitors this position.
Table 4 shows CM-UK’s counterparty credit risk charge broken out by exposure class.
Table 4
Standardised approach3
- Corporate exposures:
Internal ratings based approach - foundation4
- Central governments and central banks:
- Financial institutions:
- Corporate exposures:
Counterparty credit risk requirement:
CM-UK
($’000)
CM-LTD
($’000)
DP
($’000)
30,472
26,329
4,143
29,150
47,604
107,226
18,748
46,946
92,023
10,402
658
15,203
The following tables show CM-UK’s consolidated counterparty credit exposure including the impact of
1
The surplus / (deficit) of own funds is defined as the excess of total capital after deductions over the capital resources
requirement.
2
The solvency ration is the ration of total capital after deductions to the capital resources requirement.
3
The Standardised Approach is used for non-Japanese corporate customer exposures and is calculated as risk weighted
asset x 8%.
4
The foundation IRB approach is used for all other asset classes. The charge is calculated as risk weighted asset x 8%.
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netting contracts and the offset of collateral held. CM-UK calculates all exposures using the counterparty
credit risk mark-to-market method.
Table 5
Gross
positive fair
value of
contracts
$m
Potential
future
credit
exposure
$m
Netting
benefits
$m
Netted
current
credit
exposure
$m
2,672
932
-418
3,186
Mark to market
method
Net
derivatives
Collateral
credit
held*
exposure
$m
$m
-1,607
3,186
* In line with industry practice CM-UK adjusts counterparty risk weights rather than deducting collateral held
from the exposure when calculating risk weighted assets.
The following table shows the notional of the credit derivative positions held by CM-UK:
Table 6
Notional credit derivative transactions
Own credit portfolio
Intermediation activities
Purchased
$m
Sold
$m
Purchased
$m
Sold
$m
Single name credit default swaps
-
-
75
75
Basket credit default swaps
-
-
8,537
8,537
Total return swaps
-
-
-
-
Total
-
-
8,612
8,612
Credit derivative product type
Wrong Way Risk
Specific wrong way risk arises when a transaction is structured in such a way that the counterparty exposure is
positively correlated with the probability of default of that counterparty e.g. the counterparty has collateralised
its exposure with its own, or related party, stock. CM-UK has no such exposures. General wrong way risk
arises when counterparty exposure is correlated, for non-specific reasons, with the market, or general
economic factors, that affect the value of the counterparty’s trades. CM-UK will look to identify such factors
in its initial credit analysis and monitors accordingly.
Market risk
The market risk capital charge is calculated using the Standard Interest Rate PRR method. Any foreign
currency exposures are subject to a market risk charge calculated using the foreign currency PRR method.
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Concentration risk
It is CM-UK policy to hedge all exposures with offsetting transactions undertaken either with CM-INC. or a
third party. Material concentration risk capital charges relate to exposures to CM-INC. related to these hedge
trades.
8. Credit Risk Mitigation
CM-UK recognises that total credit risk, the aggregation of credit, counterparty and concentration risk, and in
particular concentrations of counterparty credit risk, constitutes the greatest risk it faces. It is only in relation
to credit that large, un-hedged risks are taken.
CM-UK has three major ways of addressing credit risk:
•
•
•
fundamental credit analysis and control by the relevant credit departments of SMBC;
a credit reserve based upon market fair value; and
active involvement of management, through the front office, of pursuing credit mitigation.
CM-UK Management takes responsibility for instilling the correct culture in the front office and the front
office is required to understand and incorporate credit comprehensively in its approach to risk. All trades are
conducted under ISDA Master Agreements allowing CM-UK to net counterparty exposures across products.
Collateral agreements are considered and pursued from a credit risk view per se and also from the standpoint
of liquidity risks and as a way to cut down required dealing margins, to make CM-UK more competitive
One of the principal activities of CM-LTD is to act as an intermediary between its associate company, CMINC., and the market in a range of OTC derivative transactions including interest rate and currency swaps,
foreign exchange forwards and interest rate and currency options. Where CM-LTD has acted as its
intermediary CM-INC. guarantees any exposure to the third party. As of 30th June 2010 the guarantee from
CM-INC. covered derivative contracts with a gross replacement cost of $687,855,628.
CM-UK management has also reviewed the possibilities for mitigating credit risk through the use of the
financial strength of the wider SMBC Group. Following the general deterioration of the credit markets and
the widening of credit spreads from 2007 CM-UK management considered that it was necessary to cap, as far
as possible, the potential impact of this on CM-LTD’s prudential capital. The risk mitigation technique
considered most appropriate to achieve this goal was the purchase of a guarantee from SMBC covering the
five counterparty names (eight separate trades) that analysis showed to have a material and disproportionate
impact on prudential capital. As at 30th June 2010 the parental guarantee covered derivative contracts with a
gross replacement cost of $1,075,521,789. The parental guarantee is collateralised.
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