pensions - rsm uk · 2017-03-28 · pensions philip briggs . fair value hierarchy • frc published...

PENSIONS WEBINAR – THE PENSIONS

SORP INVESTMENT DISCLOSURES

PENSIONS

Philip Briggs

Fair value hierarchy

• FRC published FRED 62 in March 2016 which changed FRS 102 to bring the

disclosures in relation to the FVH into line with FRS 102.

• This amendment is effective for accounting periods commencing on or after 1

January 2017, with early application permitted.

• Note in accounting policies required if early adopting.

• PRAG Guidance was updated in May 2016.

Fair value hierarchy – our experience of audit issues

• Who has been responsible for making the determination?

• Compliance with the PRAG/Investment Managers Association guidance.

• Is this an appropriate source?

• Consideration and approval of the disclosure.

• Mixed treatment of Bonds and Gilts.

• Treatment of Pooled Investment Vehicles generally consistent.

• Watch out for AVCs.

Fair value hierarchy – our tip

Don’t think of as:

• Level 1 – Easy to price

• Level 2 – Not so easy to price

• Level 3 – Difficult to price

Think of as:

• Level 2 – Straightforward to price

• Level 1 – Very easy to price

• Level 3 – Difficult to price

Investment risk disclosures

Market

Risk

Currency risk

Interest rate risk

Other price risk

Credit risk

‘A retirement benefit plan shall disclose information that

enables users of its financial statements to evaluate the

nature and extent of credit risk and market risk arising

from financial instruments to which the retirement

benefit plan is exposed at the end of the reporting

period.

For each type of credit and market risk arising from

financial instruments, a retirement benefit plan shall

disclose:

a) the exposures to risk and how they arise;

b) its objectives, policies and processes for managing

the risk and the methods used to measure the risk;

and

c) the changes in (a) or (b) from the previous period.

(FRS 102 34.43 – 34.44)’

Investment risk disclosures

Credit risk

Counterparty risk

‘The risk that one party to a financial

instrument will cause a financial loss for

the other party by failing to discharge an

obligation.’ (FRS 102: Glossary)

Market risk

Economic

exposure

risk

Currency risk

Interest rate risk

Other price risk

Credit risk

Investment risk disclosures – credit risk

• Need to determine the counterparty.

• Cash.

• And can the counter part be credit rated?

‘I promise to pay the bearer on

demand the sum of …. pounds.’


• And if your cash is in a bank then the bank will have a credit rating – the Trustees

will have made a decision about credit ratings that they will accept for banks that

they use – wouldn’t they?

Investment risk disclosures – credit risk - equities

• What about Equities?

• Equity represent an ownership interest so there is typically no credit risk.

Investment risk disclosures – credit risk - bonds

• Bonds are debt instruments.

• Bonds are probably the most important investment type to apply a credit risk policy

– so there will be quite a lot to say here.

• Credit risk is such a fundamental aspect of bond valuation that the

trustees/investment manager will have some form of policy and understanding of

bond credit ratings.

Investment risk disclosures – credit risk - properties

• What about Properties?

• Properties represent an ownership interest and so there is no credit risk.

Investment risk disclosures – credit risk - derivatives

• Derivatives are typically investments comprising contractual agreements with

counterparties – so there will be quite a lot to say here.

• Credit risk is such a fundamental aspect of derivative operations that the

trustees/investment manager will have some form of policy and understanding of

counterparty credit ratings and this will link with the collateral requirements.

Investment risk disclosures – credit risk - PIVs

• Credit risk is dependent upon the structure of the PIV.

Anatomy of a CIS

Investment manager

Investment decisions

Custodian

Safekeeping of

investments

Executing transactions

Administrator

Registering of investors

Recording transactions

in units

Depositary

Other governance

oversight

Promoter

Marketing and

distribution Collective

Investment

Scheme

Anatomy of a unit-linked insurance policy

Custodian

Safekeeping of

investments

Executing transactions

Investment manager

Investment decisions

Marketing and distribution

administration

Insurance

Company


And why is this also important?

How safe are your DC assets?

A report from the Security of Assets Working Party.

February 2016


• In a Collective Investment Scheme you own a share of the CIS and therefore it is

like an equity holding and represents an ownership interest and so there is no credit risk.

• Most common types of CIS are Authorised Unit Trusts and Open Ended Investment Companies (OEICs).

• With a unit linked insurance policy the trustees effectively have a contract of insurance with an insurance company.

• The insurance company will typically be credit rated – but the complexities of how insurance providers structure their businesses make this quite tricky to pin down.

• Other most likely form of PIV are Shares in Limited Liability Partnerships (ownership interest).

• Other forms of PIV may exist.

• Common industry consensus appears to be that PIVs are unrated – but it is not that simple.


• As PIVs are typically determined to be unrated then relevant credit risk information

relates to the structure and regulatory environment in which the trustees are

investing – so we see the following:

• But as the structures and regulatory environments differ then better quality

disclosure is provided by being more specific and providing an analysis of this.

The Scheme’s holdings in pooled investment vehicles are unrated. Direct credit risk

arising from pooled investment vehicles is mitigated by the regulatory environments

in which pooled managers operate and diversification of investments amongst a

number of pooled arrangements. The Investment Sub Committee, acting on behalf

of the Trustees, manages and monitors the credit risk arising from its pooled

investment arrangements by considering the nature of the arrangement, the legal

structure and regulatory environment.

Investment risk disclosures – credit risk PIVs

So a table works well to demonstrate this.

A summary of pooled investment vehicles by type of arrangement is as follows:

2016

£’000

2015

£’000

Unit linked insurance contracts 800 750

Authorised unit trusts 5,000 5,500

Open ended investment companies 400 450

Shares of limited liabilities partnerships 300 650

Total 6,500 7,350


But a table does not necessarily work as

well to demonstrate overall credit risks.

2016

Investment

grade

£m

Non-

investment

grade

£m

Unrated

£m

Total

£m

Direct

Bonds 14,000 900 600 15,400

OTC derivatives

(fair value)

600 - - 600

Cash 1,500 - - 1,500

Repurchase

agreements

5 - - 5

Unsettled trades 100 - 30 130

Securities on loan 4,500 - - 4,500

Property rent

debtors

- - 8 8

Indirect

Pooled investment

vehicles

50 - 8,500 8,550

20,755 900 9,138 30,693

Analysis of direct credit risk

Investment

grade

£’000

Non-investment

grade

£’000

Unrated

£’000

Total

£’000

At 31 March 2016

Bonds 1,200,000 - - 1,200,000

OTC Derivatives (70,000) - - (70,000)

Longevity swap (50,000) - - (50,000)

Cash 800 - - 800

Money market investments 40 - - 40

Other investment balances (700,000) - 2,000 698,000

Pooled Investment Vehicles - - 800,000 800,000

380,840 - 802,000 1,182,840


Particularly if your table looks like this:

Analysis of direct credit risk

2016

Investment grade Non-investment grade Unrated Total

£ £ £ £

Pooled investment vehicles - - 79,000,000 79,000,000

2015

Investment grade Non-investment grade Unrated Total

£ £ £ £

Pooled investment vehicles 78,000,000 78,000,000

‘A retirement benefit plan shall disclose by class of financial instrument:

a) The amount that best represents its maximum exposure to credit risk at the end of the reporting period. This

disclosure is not required for financial instruments whose carrying amount best represents the maximum

exposure to credit risk.

b) A description of collateral held as security and of any other credit enhancements, and the extent to which these

mitigate credit risk.

c) The amount by which any related credit derivatives or similar instruments mitigate that maximum exposure to

credit risk.

d) Information about the credit quality of financial assets that are neither past due nor impaired.

When a retirement benefit plan obtains financial or non-financial assets during the period by taking possession of

collateral it holds as security or calling on other credit enhancements (eg guarantees), and such assets meet the

recognition criteria in other sections, a retirement benefit plan shall disclose:

a) The nature and carrying amount of the assets obtained; and

b) When the assets are not readily convertible into cash, its policies for disposing of such assets or for retaining them.

(FRS 102 34.45 – 34.46)’

Additional credit risk disclosures.


Investment risk disclosures – market risk

• FRS 102 defines market risk as ‘the risk that the fair value or future cash flows of a

financial instrument will fluctuate because of changes in market prices.’ (FRS 102: Glossary)

• So essentially we are considering the economic exposure risk.

• FRS 102 then states that ‘Market risk comprises three types of risk: currency risk, interest rate risk and other price risk.’ (FRS 102: Glossary)

• Two primary options exist for addressing this disclosure requirement:

– sophisticated strategic basis of disclosure; and

– direct compliance basis.

• Unfortunately too many schemes ended up somewhere in between.

Example

investment

classifications

Sophisticated strategic approach Direct Compliance approach

Equities Match disclosure to the strategic investment decisions based on

economic exposure – consider any hedging strategies. Other price

risks are more granular than those referred to in FRS 102. May also

link to wider risks such as covenant, funding or longevity risks.

Overseas domiciled equities link to currency risk – all

equities link to Other price risks.

Bonds Match disclosure to the strategic investment decisions based on




Overseas domiciled bonds link to currency risk – all

bonds link to interest rate risks.

Derivatives Match disclosure to the strategic investment decisions based on




The links to currency , interest rate and other risks is

likely to be relatively clear based on the nature of the

derivative – ie forex contracts or interest rate swaps.

PIVs Adopt a look through approach to consider the underlying exposures

within the PIVS.

At a high level cross reference each PIV or groups of

PIVs to currency, interest rate and other risks – also

linking to the existence of indirect credit risk enhances

the credit risk disclosures.



• But remember the requirement is that: ‘A retirement benefit plan shall disclose

information that enables users of its financial statements to evaluate the nature and

extent of credit risk and market risk arising from financial instruments to which the

retirement benefit plan is exposed at the end of the reporting period.’ (FRS 102

34.44)

• This means some form of quantification.

• Two primary options exist for addressing this disclosure requirement:

– the vague % exposure basis; and

– direct amount basis.

Market risk disclosures examples

Investment risk

disclosures – market

risk examples.

(iii) Currency risk

The scheme is subject to currency risk because some of the Scheme’s investments are held in

overseas markets, either as segregated investments or via pooled investment vehicles. The

Trustees have set a benchmark limit to overseas currency exposure of 15% of the total portfolio

value which is achieved through a currency hedging policy. This was the net currency exposure at

the year-end.

(ii) Currency risk

The Trust is subject to currency risk because

some of the Trust’s investments are held in

overseas markets via pooled investment

vehicles. The Trustee limits overseas currency

exposure through a currency hedging policy.

The Trust’s total net unhedged exposure by

major currency at the year end was as follows:

2015 2014

£’000 £’000

Currency

Euro 8,000 3,000

Japanese Yen 17,000 2,200

US Dollar 135,000 230,000

Example Market risk disclosures – typical PIV approach.


Credit Risk Market risk

Direct Indirect Currency Interest

rate

Other

price

05.04.2016 05.04.2016

Pooled investment vehicles

- UK Equity Y N N N Y 4,700,000 5,000,000

- Overseas Equity Y Y Y N Y 4,800,000 5,100,000

- UK Corporate Bonds Y Y Y Y N 6,000,000 6,000,000

- UK Index-Linked Gilts Y Y N Y Y 3,000,000 3,000,000

- Diversified Growth Y Y Y Y Y 2,000,000 1,500,000

Total Investments 20,500,000 20,600,000

The following table summarises the extent to which the various classes of investments are

affected by financial risks:

Investment risk disclosures – qualitative

‘A retirement benefit plan shall disclose information

that enables users of its financial statements to

evaluate the nature and extent of credit risk and market

risk arising from financial instruments to which the

retirement benefit plan is exposed at the end of the

reporting period.



disclose:

a) The exposures to risk and how they arise;

b) Its objectives, policies and processes for

managing the risk and the methods used to

measure the risk; and

c) The changes in (a) or (b) from the previous period.

(FRS 102 34.43 – 34.44)’

Market

Risk

Currency risk

Interest rate risk

Other price risk

Credit risk

Investment risk disclosures – quantitative






reporting period.



disclose:






(FRS 102 34.43 – 34.44)’

Market

Risk

Currency risk

Interest rate risk

Other price risk

Credit risk

Investment risk disclosures – don’t forget in year 2






reporting period.



disclose:






(FRS 102 34.43 – 34.44)’

Market

Risk

Currency risk

Interest rate risk

Other price risk

Credit risk

Investment risk disclosures – final points

• Fully insured arrangements require particular consideration.

• More sophisticated financial instruments require deeper consideration – ie Repos,

special purpose vehicles.

• For DC investments the sophisticated strategic approach is unlikely to be

appropriate.

• Annuity policies are financial instruments and form part of the investment strategy.

• AVCs need to be considered.

• Much time and costs have been wasted approaching these disclosures from

strategic investment principles rather than compliant financial reporting principles.

• As experience grows and practice develops we hope clients will be challenged to

improve.

QUESTIONS

AND ANSWERS?

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pensions - rsm uk · 2017-03-28 · pensions philip briggs . fair value hierarchy • frc published...

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