Pillar 3 Disclosures
based on 29 February 2020 audited accounts
In 2006, the Basel 2 capital accord revised the existing regulatory capital framework to make it more sensitive to the risk management practices of modern banks and investment firms. The European Union implemented these provisions via the Capital Requirements Directive (‘CRD’), which consists of a three-pillar framework:
- Pillar 1 – sets out the minimum capital requirements comprising base capital resources requirements; credit risk and market risk requirements; and fixed overhead requirement (‘FOR’).
- Pillar 2 – requires firms to undertake an overall internal assessment of their capital adequacy, taking into account all risks to which the firm is exposed and whether additional capital should be held to cover risks not adequately covered by Pillar 1 requirements. This is achieved through the Internal Capital Adequacy Assessment Process (‘ICAAP’) and, potentially, by the Supervisory Review and Evaluation Process of the FCA.
- Pillar 3 – aims to improve market discipline by requiring firms to publish certain details of the risks they are facing, their capital resources and risk management procedures.
The United Kingdom financial regulatory body, the Financial Conduct Authority (‘FCA’), has incorporated the framework into its rules and guidance through the General Prudential Sourcebook (‘GENPRU’) and the Prudential Sourcebook for Banks, Building Societies and Investment Firms (‘BIPRU’).
BIPRU 11 relates specifically to the Pillar 3 disclosure requirements affecting firms subject to the CRD. This document discloses those requirements, as laid out in BIPRU 11.5, detailed below:
- BIPRU 11.5.1R – the risk management objectives and policies for each separate risk referred to under BIPRU 11.5.1R to 11.5.17;
- BIPRU 11.5.2R – the scope of application of directive requirements;
- BIPRU 11.5.3R – information regarding capital resources;
- BIPRU 11.5.4R – information regarding compliance with the BIPRU rules and the overall Pillar 2 rule;
- BIPRU 11.5.7R – 11.5.10R – information regarding credit and counterparty risk;
- BIPRU 11.5.12R – information regarding disclosures relating to market risk;
- BIPRU 11.5.18R – remuneration disclosure.
Information which is regarded as proprietary or confidential, or immaterial, is not included. Information should be considered as material if its omission or misstatement could change or influence the assessment or decision of a user relying on it to make economic decisions. Proprietary or confidential information could include information which, if shared with competitors, would render a firm's investments less valuable or if the information comprises obligations to customers or other counterparty relationships binding a firm to confidentiality.
Scope of Application of Directive Requirements
The Pillar 3 disclosures set out in this document pertain to TCI Fund Management Limited (the ‘Firm’ or ‘TCI’), a BIPRU firm, regulated by the FCA.
The Firm’s immediate parent is TCI Fund Management (UK) Limited (‘TCI LTD’), its intermediate parent is TCI Fund Holdings Limited and the ultimate parent is The Children’s Investment Fund Management (Cayman) Ltd (none of which are regulated). The first two are UK companies, while the ultimate parent is a Cayman Islands company.
Since the implementation of the Alternative Investment Fund Managers Directive ("AIFMD") on 22 July 2013, TCI has been approved by the FCA as an Alternative Investment Fund Manager ("AIFM"). This means that, in addition to having to meet regulatory capital requirements based upon the retention of sufficient regulatory capital to meet an expenditure based requirement, TCI is also subject to a capital requirement based upon its assets under management. Although, as an AIFM, TCI is subject to the capital requirements of the AIFMD, it continues to be categorised as a BIPRU Firm and is still subject to the Pillar 3 disclosure requirements.
For the purposes of the CRD, the Firm is neither consolidated nor deducted from TCI LTD, as per BIPRU 8.5.
There are no current or foreseen material, practical or legal impediments to prompt the transfer of capital resources or repayment of liabilities between the parent undertaking and its subsidiary undertakings. The Firm’s capital resources are in excess of the required minimum and it is not affected by any solo consolidation waiver.
Risk Management Objectives and Policies
The governing body for the risk framework within the Firm is the risk committee, which is appointed by the board of directors of the Firm. The risk committee is responsible for establishing and implementing a risk management framework that takes into account the risks that the Firm is likely to meet. The Firm’s risk management framework incorporates an analysis of the impact of each material risk on the business, the probability of each risk occurring and the procedures in place for mitigation. High level decisions and policy departures and amendments are referred to the management committee for their consideration.
BIPRU 11.5.1R requires the Firm to disclose its strategies and processes for managing credit risk and market risk. These are discussed herein.
In addition, GENPRU 1.2.30 (2) lists several risk categories, for the management of which the Firm must have in place sound, effective and complete processes, strategies and systems. From those listed, the Firm identifies currently credit, market, and operational risk as the major ones applicable given the nature and scale of the business. All other risks identified, including business risk, liquidity risk, reputational risk, pension risk etc., are reviewed regularly as part of the Firm’s ICAAP and are considered to have less significant impact. Any perceived changes to the level of materiality of these risks are acted upon as appropriate.
Calculation of Capital Requirement
The Firm is required to calculate its overall capital requirement as the highest of the Pillar 1 capital requirement, risk quantification through the ICAAP (Pillar 2) and the wind-down requirement. The Pillar 2 requirement is TCI’s own assessment of the minimum amount of capital deemed adequate to be held against the identified risks.
Pillar 1 Capital Requirement
The Pillar 1 minimum capital requirement is calculated as the higher of the base capital requirement, credit plus market risk capital requirement or the fixed overhead requirement. As at 29 February 2020, TCI’s Pillar 1 capital requirement was $14m, inclusive of the Firm’s Individual Capital Guidance ("ICG") adjustment.
The components of the Pillar 1 capital requirement are as follows:
The Firm is exposed to credit risk through its cash deposits, trade debtors, group balances and prepayments. With regards to credit exposure arising from the Firm’s monthly management fees, there is minimal risk of default or late payment as these are collected directly from the offshore manager. In addition, the risk of the non-payment of management and incentive fees from the funds is mitigated by the appointment of an independent funds’ administrator.
The Firm will hold all cash with banks with whom the Firm has strong, well-established relationships and which typically have a minimum Moody’s or S&P rating of investment grade. It does not have any external investments.
The Firm uses the standardised approach to calculating credit risk exposures, i.e. 8% of the risk weighted credit exposure. Under this approach the Firm calculates its Pillar 1 credit risk capital requirement to be $8m.
The Firm’s exposure to foreign exchange risk arises through those of its assets and liabilities that are not denominated in US Dollars and through its earnings and expenses in currencies other than US Dollars. Market risk arising from a currency mismatch between the Firm’s management fees and its functional currency is immaterial since the majority of the management and incentive fees are received in US Dollars which is the functional currency of the Firm. There is marginal foreign bank account currency exposure which is not considered to be significant or material and the Firm does not believe it is necessary to hedge this exposure. The group has investments in the fund as part of a retention programme for senior members of group entities. Due to the nature of the contractual relationship, the Firm considers that fluctuations in this investment will not have an impact on the capital, as the assets and contractual liabilities will fluctuate in line with each other.
The Firm uses the general rule in BIPRU 7.5 for calculating market risk exposures, i.e. 8% of the risk weighted market exposure. Under this approach the Firm calculates its Pillar 1 foreign currency PRR and market risk capital requirement to be $25k.
Fixed Overhead Requirement
The Firm has determined the Fixed Overhead Requirement (FOR) to be $7.8m.
Pillar 2 Capital Requirement - Internal Assessment of Capital Adequacy
The Firm makes an internal assessment of its capital adequacy by considering the capital required to cover unexpected losses which might arise from, amongst others, the following risk types:
- Credit Risk
- Market Risk
- Operational Risk
- Regulatory Risk
- Reputational Risk
- Business Risk
As at 29 February 2020, the Firm’s ICAAP capital requirement was $12m.
The total value of tier 1 capital resources as at 29 February 2020 per the audited financial statements was $55m. The tier 1 capital consists of $15k share capital, $54m non-distributable reserves and $1.7m capital held in a share-premium account. No tier 2 or 3 capital resources is held.
As at 29 February 2020, TCI’s wind-down requirement was lower than the Firm’s Pillar 1 and Pillar 2 capital requirement. As such, the highest figure was that under Pillar 1 (ICG adjusted) and the Firm held a surplus capital of $41m.
FCA Remuneration Code (the ‘Code’)
In accordance with the Financial Conduct Authority AIFM Remuneration Code as described in SYSC 19B of the FCA Handbook and in accordance with The European Securities and Markets Authority’s (ESMA) Guidelines on sound remuneration policies under the AIFMD, the Firm has a remuneration policy which is consistent with and promotes sound and effective risk management.
The Firm's remuneration policy applies across the group to senior management, staff engaged in control functions and risk takers whose professional activities have a material impact on the risk profile of the Firm and the funds it manages, and any other staff receiving total remuneration that takes them into the same remuneration bracket as senior management.
Under the FCA and ESMA guidelines the Firm has determined that it is not a ‘significant firm' and consequently has not set up a remuneration committee; however the Firm's governing body undertakes this role. The decisions of the governing body on setting remuneration are based on, amongst other things, risk management, supporting business strategy, objectives, values and interests and avoiding conflicts of interest, governance, control functions, and measurement of performance.
The Firm’s governing body considers remuneration in the context of a wider agenda including retention, recruitment, motivation and talent development and the external market environment. It also receives updates on regulatory developments and general remuneration issues, as well as market and bench marking data.
Information on the Link between Pay and Performance
The various components of total remuneration (which comprise base salary and variable bonus) are considered and are balanced appropriately having regard to the overall Firm performance and fund performance and is less focussed on individual profit and loss.
Firm performance and the input of the individual are the significant contributors to the determination of variable bonus awards. The principal objective in determining variable bonus awards is to reward individual contribution to the Firm whilst ensuring that such payments are warranted given business results. In this context performance can include financial and non-financial measures, risk measures and other relevant factors. There is a focus on differentiation so that any rewards are determined according to the contribution of individuals. Bonus pools and individual awards are subject to the discretion of the board of directors and it is possible that in any year no variable bonus will be awarded, either at all, or to particular individuals.
There are deferral arrangements in place for certain group staff, the purpose of which is to support a performance culture where those staff recognise the importance of sustainable (and sustained) Firm and individual performance. The payment of a significant proportion of the performance award for those in receipt of a variable compensation award above a level set (at the discretion of the board of directors) may be required to be deferred and the sum involved invested in funds managed by the Firm which vest at a future point in time. This arrangement encourages sound risk management whilst aligning the longer-term interests of participants with those of investors.
Quantitative Information on Remuneration
The Firm considers that it has a single business area (investment management). The aggregate remuneration of the individuals within the TCI group engaged in this business area for the period was $163m, comprising 20 Code staff. The remuneration of 9 senior management personnel includes the aggregate fixed remuneration of $2m and $19m of total variable remuneration which comprise of $14m cash and $5m in the form of shares. The remuneration of the rest of the Code staff includes the aggregate fixed remuneration of $6m and $136m of total variable remuneration which comprise of $83m cash and $52m in the form of shares. Of the total variable remuneration, $54m was deferred and unvested; $2m of this was attributable to the senior management personnel and $52m to the rest of the Code staff.
UK Stewardship Code Disclosure Statement
Under COBS 2.2.3 of the FCA Handbook, all FCA authorised firms are required to make a public disclosure in relation to the nature of their commitment to the above Code ("the Code"), a revised version of which was published by the Financial Reporting Council ("FRC"), and which came into effect in January 2020.
The Code defines stewardship as the responsible allocation, management and oversight of capital to create long-term value for clients and beneficiaries leading to sustainable benefits for the economy, the environment and society. Firms may either comply with the Code or choose not to comply with certain aspects of the Code, in which case an explanation of non-compliance is required. If a firm does not commit to the Code, it must state, in general terms, its alternative investment strategy.
Although the Firm supports the Code's objectives, the Firm has taken the decision not to commit to the specific principles of the Code.
Investment approach and engagement
The Firm invests in various asset classes and jurisdictions globally. The current policy of the Firm in engaging with issuers and their management is determined by the Chief Investment Officer and the investment team. The Firm takes a consistent approach to engaging with the issuers and their management in all the jurisdictions in which the Firm invests.
As part of our investment process the Firm assesses a range of ESG factors, particularly climate change risk. The Firm believes that climate change-related risks, in particular a company’s greenhouse gas (GHG) emissions, will have a material effect on a company’s long-term profitability, sustainability and investor returns. These risks include regulation, taxation, competitive disadvantage, brand impairment, financing, physical asset impairment and litigation.
We actively engage on ESG to help us understand, quantify and influence a company’s exposure to climate-change related risks and the way in which it is managing those risks.
We require companies in which we invest to make appropriate and timely public disclosure of carbon and other GHG emissions. Such disclosure should include targets for emissions intensity reduction and absolute level reduction.
The Firm will commonly publish on its website the correspondence with these companies.
The Firm communicates closely with its funds and the fund investors as to the discussions with and our requirements of those companies through newsletters and other investor communications, in addition to the correspondence placed on the Firm’s website.