Man Group plc - Annual Report 2007

Regulatory capital
The Group is subject to minimum capital requirements set by various regulators of its worldwide businesses. The Financial Services Authority (FSA) supervises the Group on a consolidated basis and the Group submits returns to the FSA on its capital adequacy. Various subsidiaries within each of Brokerage and Asset Management are directly regulated by the FSA or supervisors in other countries, which set and monitor their capital adequacy.

The FSA has divided its definition of capital, into categories, or tiers, reflecting different degrees of permanence of the capital, its ability to absorb losses, where it ranks in the event of winding up and whether there are any fixed costs, i.e. obligations to pay interest or dividends.

Tier 1 capital is the highest ranking form of capital, comprising items of permanent capital which have no fixed cost – such as the Group’s fully paid-up share capital, reserves (excluding revaluation reserves) and audited retained earnings. From this the FSA requires firms to deduct their intangible assets and some other less significant items.

Tier 2 capital includes the longer term forms of debt capital, which may carry a fixed cost, and reserves of a less permanent nature. Tier 2 is subdivided to distinguish between:

• undated forms of capital (including revaluation reserves) 21 which fall into Upper Tier 2
• dated forms of capital (such as the Group’s subordinated debt) which fall in Lower Tier 2.

The extent to which items falling within Tier 2 may qualify as capital is restricted. In aggregate, it may not exceed Tier 1 capital net of deductions, and the Lower Tier 2 component must not exceed 50% of the same measure. Firms have to deduct certain material shareholdings from their total of their qualifying Tier 1 and Tier 2 capital.

Tier 3 capital brings together shorter term debt capital and least permanent reserves, and may only be used to meet the regulatory capital requirements arising from market risk in the trading book. Man Group’s Tier 3 capital consists of the unaudited post-tax profits of Brokerage.

Group’s regulatory capital position
	Unaudited 31 March 2007 $m	Audited 31 March 2006 $m
Share capital and reserves*	3,330	2,788
Less goodwill and other intangibles:
• Asset Management	(1,405)	(1,320)
• Brokerage	(294)	(236)
Available Tier 1 Group capital	1,631	1,232
Tier 2 capital - subordinated debt	610	610
Tier 2 capital - revaluation reserves	120	70
Own funds	2,361	1,912
Tier 3 capital and other deductions – interim trading book profits less other deductions:
• Asset Management	(193)	(17)
• Brokerage	117	5
Group Financial Resources	2,285	1,900
Less Financial Resources Requirement (including liquidity adjustments):
• Asset Management	(432)	(377)
• Brokerage	(1,163)	(1,023)
Group Financial Resources Requirement	(1,595)	(1,400)
Net excess of Group capital	690	500
* Excludes retained profits for the second half of the financial year as these were unaudited as at 31 March.

In the table above, the Group Financial Resources Requirement represents the minimum amount of Financial Resources (regulatory capital) that the Group must hold on a consolidated basis in order to meet the capital adequacy requirements of the FSA. This capital is intended to be available to absorb unexpected losses and is calculated in accordance with standard regulatory formulae that relate primarily to credit and market risk.

Within Tier 1 capital, share capital and reserves includes: $396 million relating to the excess of retained earnings over shareholder distributions and share repurchases in 2007 and $332 million relating to the issue of shares on the partial conversion of the Group’s exchangeable bonds in July 2006.

This increase more than offsets the increased deduction for goodwill and other intangibles. The increase in intangibles predominantly relates to a $52 million increase in unamortised sales commissions and $51 million to an increase in goodwill, the majority relating to the Group’s acquisition of USFE.

Tier 2 capital is largely unchanged since the prior year. The increase in other deductions in Asset Management to $193 million relates to material holding deductions. The increase in Tier 3 interim trading book profits in Brokerage is largely the result of recognising significant exceptional integration costs in Brokerage in March 2006.

Asset Management’s regulatory capital requirements increased mainly as a result of increased proprietary investment in fund products (for seeding, liquidity and other purposes). The rise in Brokerage’s requirements is the result of business growth.

The Group is also required to maintain adequate resources to ensure that there is no significant risk that it cannot meet its liabilities as they fall due i.e. to address liquidity risk. While additional amounts of regulatory capital are required in respect of less liquid assets, holding capital does not form the principal element of the Group’s approach to liquidity risk management. Rather this is based on the Group’s ability to access committed financing facilities, as detailed in the ‘Available liquidity’ section of the Risk Management review.

Economic capital
Economic capital is a statistical risk methodology that estimates the amount of capital the Group needs to absorb very severe unexpected losses. It is calculated to a confidence level consistent with the Group’s minimum target credit rating for credit, market, operational and business risks, and takes account of the diversification benefits within and between risk categories and the businesses.

Economic capital provides a consistent metric which enables the aggregation and comparison of risk between risk types and businesses. It does, however, involve a number of assumptions and judgements and we continually enhance our economic capital methodology. Economic capital may, therefore, change as a result of changes in the underlying risks or due to improvements in our methodology for measuring them. During 2007 we amended our confidence level to a more conservative 99.9% to provide a better reflection of the Group’s target credit rating.

At 31 March 2007 the Group estimated that its economic capital requirement was $765 million (2006: $675 million). The composition of this capital requirement by risk type and business is shown in Figures 34 and 35.

The financial resources available to the Group to meet its economic capital requirement comprise shareholders’ equity net of goodwill and the reserves in the Employee Trust schemes. This differs from the regulatory measure of financial resources in that it:

• excludes debt capital, but includes unaudited second half after tax profits, net of the proposed final dividend; and
• gives full value to capitalised sales commissions (which are deducted in full from regulatory financial resources as an intangible asset).

The Group estimated that its surplus economic capital at 31 March 2007 was $1.7 billion (2006: $1.3 billion).

Future developments
In June 2004 the Basel Committee on Banking Supervision issued a new capital adequacy framework (referred to as Basel II), which is intended to replace the existing framework for determining regulatory capital. In Europe, Basel II is implemented via the CRD, which applies to credit institutions and investment firms, and which came into force on 1 January 2007. In the UK, the CRD is embodied in the FSA’s GENPRU and BIPRU rules which are incorporated in its Prudential Sourcebook.

GENPRU introduced changes to the definition of financial resources with effect from 1 January 2007. There are, however, transitional arrangements in 2007 which allow the Group to remain on the FSA’s previous rules to determine minimum regulatory capital requirements until 1 January 2008. The Group will be adopting the Standardised Approach for calculating its credit and operational risk capital requirements from that date. Quantitative modelling shows that the regulatory capital requirement is likely to increase, principally as a result of the introduction of the new category relating to operational risk. However, current forecasts indicate that the Group will continue, including in various stressed scenarios, to have capital surplus to regulatory requirements when the new rules take effect in 2008.

Impact of the intended separation of Brokerage
On 30 March 2007, the Board announced its intention to separate Brokerage by way of an initial public offering on the New York Stock Exchange in the third calendar quarter of 2007. The directors have concluded that Asset Management and Brokerage would be best positioned to maximise future returns and growth opportunities by pursuing focused independent strategies and having appropriate individual capital structures. In the financial statements, Brokerage has been classified as a discontinued operation which, together with the separate analysis of the income statement and balance sheet of continuing and discontinued operations in this review, will allow readers a better understanding of the results and financial position of the continuing business.

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