104 | FINANCIAL STATEMENTS | Notes to the Consolidated Financial Statements
36. Financial risk management
Overview The Group has exposure to a number of business risks. The Board of Directors has overall responsibility for the Group’s risk management arrangements, but has delegated the implementation and operation of the Board policies to management. The Group’s risk management policies and the risk management framework for identifying, monitoring and managing risks across the Group, including strategic and operational risks, are outlined in the Directors’ Report on Corporate Governance on page 32.
The Directors consider it appropriate to differentiate between those financial risks which directly impact the Group and those which indirectly impact the Group due to the risks borne by our clients and the consequential impact on the Group’s assets under management and revenues. The Group’s direct or indirect exposure to financial instruments arises from the following financial risks:
• Market risk • Credit risk • Liquidity risk
This note presents information on the Group’s direct or indirect exposure to each of the above risks, the Group’s objectives, policies and processes for measuring and managing risk and the management of the Group’s capital. Note 37 provides numerical analysis of the Group’s financial instrument exposure to such risks, including relevant sensitivity analysis, at the reporting date.
Indirect earnings risk through client assets As an active fund manager, the Group is responsible for managing assets in accordance with the mandates specified by our clients. The assets managed by the Group are subject to varying financial risks (market, credit and liquidity). While these risks could result in financial loss or gain through a change in asset value, these risks and rewards are fully borne by, or fall to the benefit of, our clients.
However, as the majority of the Group’s revenues are quantified as a percentage of assets under management (generally on a quarterly, monthly or daily basis), the Group’s income is impacted by movements in client assets which are caused by the exposure to financial risks. As a result of the direct link of revenues to the value of client assets, the Group’s interests are aligned to those of our clients.
A key risk to our business is that of poor investment performance, which could lead to the subsequent loss of client mandates. A key role of the heads of F&C’s investment functions is to monitor the fund performance achieved by our investment professionals. Where it is considered necessary, actions are taken to change process or personnel with a view to attaining top quartile performance. The Group has the ability to earn performance fees from a number of our clients based on absolute performance or where out-performance of the benchmark or set objective is achieved. These arrangements reinforce the alignment of the Group’s interests with those of our clients.
The key components of financial risk to which our clients are exposed are:
Market risk – the risk of financial loss arising from changes in the market prices of assets. Market risks include exposure to all asset classes, including equities, fixed income products and property as well as currency risk and interest rate risk.
Credit risk – the risk of financial loss if a counterparty to a financial instrument fails to meet its contractual obligations in respect of assets held within client portfolios. Credit risk can vary by asset class and individual instrument.
Liquidity risk – the risk of financial loss to client portfolios because a counterparty does not have sufficient financial resources available and is unable to realise assets in order to meet its obligations as they fall due, or can only realise assets by suffering financial loss.
Direct earnings and capital exposure The Group has direct exposure to the following risks in respect of financial instruments on the Statement of Financial Position:
• Market risk – the risk that the fair value or future cash flows of financial instruments will fluctuate because of changes in market prices. Market risk comprises three types of risk: currency risk, interest rate risk and price risk.
• Credit risk – the risk of financial loss if a counterparty to a financial instrument fails to meet its contractual obligations in respect of financial instruments held by the Group. Credit risk includes investment credit risk, counterparty risk, deposit and loan risks and country risk.
• Liquidity risk – the risk of the Group failing to maintain adequate levels of financial resources to enable it to meet its financial obligations as they fall due. Liquidity risk arises because of the possibility that the Group could be required to pay its liabilities earlier than expected or because of any inability to realise assets in order to meet obligations as they fall due or is only able to realise assets by suffering financial loss.
A fuller analysis follows of the financial risks associated with the Group’s financial instruments, together with the objectives, policies and processes to manage the Group’s exposure to those risks.
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