Man Group plc - Annual Report 2007

The qualitative risk appetite statements address:

• regulatory risk;
• reputation risk;
• operational risks in the execution of business plans; and
• risk related decision making, especially in relation to new business opportunities.

The Group’s medium-term plan is also reviewed by the Board and GRC and subjected to sensitivity analysis to assess its impact on the risk appetite metrics.

Risk categorisation
The Group categorises risks as shown in the chart below.

Reputational Risk can result from events in any category and is measured through the business risk model.

Strategic and business risks
These are the risks that the Group’s profitability may be eroded by changes in the business environment or by failures in its choice of strategy or execution of strategy. They are inherent to Man’s business model and how well this is adapted to the business environment in which we compete. Strategic risk is distinguished from business risk in that it includes risks that are considered to arise over a longer timeframe and, should they arise, to be long lasting and fundamental in their effect whereas business risk is considered to be more of a cyclical phenomenon. Both risks would be manifested by an unexpected decline in revenues which could not be offset by a corresponding reduction in costs. They also include the reputation impact on the business model of events arising in the other risk categories.

Asset Management
Strategic and business risks in Asset Management include:

• persistent poor performance affecting the alternative investments sector generally or the specific funds managed by Man;
• regulatory change which significantly impacts the attraction of alternative investments for either private or institutional investors;
• an inability to access capacity in underlying investment management content;
• concentration or over-dependence on too few business relationships, either in terms of distribution channels or after-sales product service provision; and
• margin pressure due to market consolidation or entry of a dominant new competitor, particularly in the fund of funds business.

These scenarios may singly or in combination reduce new sales and product margin levels, and also increase redemption rates on existing products.

Risks at Group level include:

• the consequences of a failed or poorly executed acquisition;
• increases in the effective corporate tax rate;
• a prolonged fall in the value of the US dollar, the currency in which most of the Group’s revenues arise, against either sterling or, to a lesser extent, the Swiss franc; and
• losing key people or teams resulting in the erosion of corporate knowledge or capability that is not readily replaceable.

The principal strategic and business risks referred to above, and the underlying drivers of such risks, are monitored by management and regularly discussed at Divisional and Group Boards. The potential impact of these risks on the Group’s earnings is modelled through specific stress scenarios as part of the planning process.

In the course of Man’s continuous and detailed monitoring of industry, competitive and regulatory themes, we do not see any current indications that our business is not well adapted to the business environment in which we compete. The fundamental downside strategic and business risks as broadly defined above have not impacted our business during the period under review. The Group also reviews the need to hold economic capital to cover the risk that, at a 99.9% confidence interval, the Group’s revenues are insufficient to cover its costs (excluding the effect of any possible losses resulting from any of the other risk categories). Since a Group loss did not arise in any of the scenarios of extreme shocks that were modelled, it is not considered necessary to hold capital for business risks. This result is due to the Group's low cost: income ratio of 35%.

The Board is responsible for determining the long-term strategy and the markets in which the Group will operate. Its strategic planning process includes qualitative and quantitative assessments of the risks inherent in the divisional medium-term plans and downside stress tests to ensure that adequate capital and liquidity would be available in the event of any of the strategic risks crystallising. Regular reports are provided by management to the Asset Management Executive Committee or Board and to the Group Board on the Group’s progress in respect of key strategies, plans and any initiatives to mitigate specific strategic risks.

Monthly financial reporting to the Board includes comparison against budget and forecasts for the full financial year, together with a review of key performance indicators including monitoring of the cost to income ratio and commentary by the CEO of Asset Management. Any material capital or non-budgeted expenditure requires approval by the Board, as do significant acquisitions, which are also subject to due diligence by the Group’s corporate finance team and review by the GRC.

Business risk is mitigated by the diversification of the revenue stream within Asset Management between the private investor and institutional segments and across several fund styles and also to the extent that the costs of the Group are variable with respect to revenues. The bonus pool, which in 2007 amounted to 46% of total operating expenses in Asset Management (2006: 46%), is directly proportional to an agreed internal measure of profit and so provides this element of mitigation.

Since revenues are principally in US dollars, appropriate hedges, using mainly forward foreign exchange contracts, are put in place for the following year in accordance with criteria approved by the Board to fund non-dollar expenses that can be forecast with reasonable certainty.

Our reputation is a key component of our ability to achieve our strategic objectives. In common with other financial services businesses, our success depends not only on the effective management of the risks outlined above, but also on maintaining our reputation among many stakeholders – our staff, shareholders, investors in funds, distributors, lenders, regulators, key business partners and the general public – for the way in which we conduct our business. The Group’s activities are also subject to supervision by market regulators in many countries and the Group is lead-regulated on a worldwide basis by the FSA in the UK.

Reputation risk necessarily requires a somewhat different approach from other risks. The Corporate Responsibility team addresses key business risks in the Summary Corporate Responsibility section of this Annual Report and in our full Corporate Responsibility Report, (which will be issued shortly before the AGM in July 2007). Key business risks of people, customers and the environment are analysed and reported against key performance indicators. The Corporate Responsibility Report, which reflects our risk based approach to corporate responsibility, is also available via our website. Our Corporate Responsibility Manual and Ethical Policy are also publicly available on our website. More detailed policies address issues such as our responsibilities to our people, investors and customers, sales and trading practices, new products, potential conflicts of interest, money laundering, ‘know your customer’ requirements, ‘whistle-blowing’ and confidentiality and privacy. These policies and procedures are reviewed frequently to ensure that they remain consistent with our high standards and meet or exceed regulatory requirements.

The Group aims to ensure that appropriate structures are in place to protect the interests of investors in the funds managed by the Group and regulatory compliance is a major focus across the Group in terms of business practice, culture and employee awareness.

Brokerage
Strategic and business risks within Brokerage result from its exposure to the risk of volume or margin pressure for reasons that include:

• a general decline in volumes in the markets and products in which Man offers execution and clearing services;
• margin pressure due to market conditions or competitor actions;
• diminishing client franchise due to either disintermediation by exchanges or other competitors applying innovations in technology;
• competitive pressure resulting in an adverse change in the economic terms of incentive structures offered to retain producer teams or the network of introducing brokers; and
• macro-economic changes such as a fall in interest rates, which would reduce the income earned on balances held on behalf of customers.

Mitigation of these risks is provided by the diversification of the Brokerage revenue stream between many financial products and across many geographical regions. These risks are also managed according to the same principles and with similar processes to those referred to above for Asset Management. Brokerage hedges part of its portfolio against the risk of falling interest rates. After taking into account the effects of hedging, it is estimated that a 1% decline in interest rates reduces Brokerage revenues by approximately $10 million.

Operational risk
Operational risk is the risk that the Group suffers a loss directly or indirectly from inadequate or failed internal processes, people, systems or external events. It is inherent in all the Group’s business and support activities, and comprises a large number of disparate risks including losses resulting from events such as human error, IT failures, fraud, legal risk and external threats. It does not include the indirect consequence for the Group’s reputation and any losses resulting from this, which are treated, for capital purposes, as a component of business risk.

View 'Risk categorisation' chart

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