Risks and uncertainties
Within the Corporate Finance operating segment, seasonal variations are significant. This means that sales and results of operations vary during the year.
The Corporate Finance operating segment relies on the credit market functioning efficiently. In turn, the credit market affects the market for property transactions, which is Catella’s principal market in Corporate Finance. Corporate Finance is also very personnel intensive and relies on key employees. If several key employees decided to leave Catella, this could affect the Group’s sales and results of operations.
In the Asset Management and Banking operating segment, various kinds of risk arise, such as credit risk, market risk, liquidity risk and operating risk. Policies and instructions have been established for controlling and limiting risk-taking in the operations in terms of issuing credit and other operating risks.
The Group’s asset management and banking operations are conducted within the Asset Management and Banking operating segment, which includes lending coincident with client purchases of securities and properties in Europe. Trading in this operating segment is primarily on behalf of clients for client transactions. All transactions that are implemented on behalf of clients are controlled by instructions from the client, or through agreed investment rules or fund provisions. Catella does not bear any risk in terms of the progress of clients’ financial instruments, other than due to non-compliance with agreed instructions. Several subsidiaries in the operating segment are regulated by the supervisory authority in the country in which they have their legal domicile.
The banking operation, and the credit card and acquiring operation are conducted within the auspices of the subsidiary Catella Bank S.A., is exposed to risks including credit and counterparty risk, as well as changes to regulatory structures relating to its operations. The Bank’s sales and results of operations can be negatively affected by potential regulatory changes, and altered credit ratings of its clients and counterparties. The bank has limited currency exposure to foreign currency transactions. Currency exposure is hedged using derivative instruments. Financial risks are mainly managed through continuous measurement and follow-up of financial progress. Financial risks also arise because the Group is in need of external funding and uses various currencies. The Group’s financial risks, which mainly comprise financing and liquidity risk, interest rate risk, currency risk and credit/counterparty risk, are described in Note 3 in the Annual Report.
A number of companies in the Catella Group conduct operations that are under the supervision of regulatory financial authorities in their respective domestic markets. In addition, Catella’s consolidated financial situation is under the supervision of CSSF in Luxembourg since 31 March 2016. Existing regulatory frameworks and rapid regulatory changes are complex in general, and specifically with regard to Catella’s banking operations. These regulatory framework place stringent, and in future even more stringent, demands on the routines and procedures, and liquidity and capital reserves, of the operations under supervision. Compliance with these regulatory frameworks is a pre-condition for conducting operations subject to supervision. Catella continuously seeks to ensure compliance with existing regulatory frameworks and to prepare for future compliance with coming regulatory changes.
The preparation of financial statements requires the Board and Group management to make estimates and judgements. Estimates and judgements affect the Income Statement and Balance Sheet, as well as disclosures regarding contingent liabilities, for example. Actual outcomes may differ from these estimates and judgements, due to changed circumstances or conditions. More information on critical estimates and judgements is presented in Note 4.
Financial instruments are mainly used in the Asset Management and Banking operating segment, as follows:
Use of financial instruments
In Asset Management and Banking, active trading is conducted in all types of security and currency on behalf of clients and managed funds. In addition, the bank advises its clients on financial matters as follows:
Short-term investments: deposit accounts with automatic payment of accrued interest and principal at maturity.
Mid-term investments: at the client’s request, investments in equities, fund units and bonds adapted to the client’s risk profile with an investment horizon of three to five years.
Management of funds and discretionary management: investments in accordance with each fund’s provisions or investment directives based on the manager’s judgement.
The operating segment does not trade in or take positions on its own behalf in financial instruments apart from with the intention of limiting the currency exposure that arises in Catella Bank’s card operation and within IPM’s investment services in discretionary management and fund management. Due to the operating segment’s prudent policy for issuing credit and trading in financial instruments, exposure to risks is limited. The operating segment is mainly exposed to credit risk and market price risk.
There is some currency exposure within Catella Bank’s card operation, and IPM relating to transactions in foreign currency. These companies use currency swaps and forward contracts to limit this risk as follows:
Currency forwards are agreements to purchase or sell various currencies for future delivery, including undelivered spot transactions.
Currency swaps are agreements to swap a future cash flow in one currency for another. Swaps result in a financial exchange of currencies.
The hedging transactions described above are of a financial nature and are not recognised as hedges in accordance with the accounting standard IAS 39 Financial Instruments.
Other risks in the Group include operating, strategic, political, reputational and commercial risks.
Operating risk is the risk of a loss due to internal causes (data error, mistakes, fraud, incomplete compliance with laws and internal regulations, other deficiencies in internal controls etc.) and events in the surrounding world (natural disasters, external crime, etc.) The Group has established procedures and controls to minimise operating risk. There are especially significant operating risks in the subsidiary Catella Bank, where there are significant volumes/transactions using real-time systems that require 24-hour availability. For traditional insurable risks such as fire, theft, liability, etc., the Group judges that it has satisfactory protection through its existing insurance cover.
Parts of the Group’s operations require permits and are subject to regulation by the financial supervisory authority of each country. Existing regulatory frameworks and the progress of regulatory frameworks is complex generally, and specifically for Catella’s banking operations. Such regulations place high and growing demands on licensable operations, routines and processes as well as liquidity and capital reserves. Observance of these regulatory frameworks is a pre-condition for conducting licensable operations. Catella works continuously to ensure compliance with existing regulatory frameworks and prepares for compliance with future regulatory changes. In instances of subsidiaries being unable to satisfy the standards set by regulatory structures, this may have a negative impact on the Group’s results of operations and the value of the Group’s assets.
Reputational risk is the risk that the Group’s reputation is damaged on the market, in the media or with clients, which could have a negative impact on Group profit. Reputational risk also increases as the Group grows and becomes a larger player on the market. Catella currently believes that its reputation is strong and its client base is broad.
Catella holds equities, funds and loan portfolios. Its most significant investment is in the subsidiary European Equity Tranche Income (“EETI”), which has invested in securitised European loans primarily with exposure to housing. The loan portfolios held by EETI are described further in Notes 3 and 23 in the Annual Accounts. In addition to the financial risks described in these Notes, EETI is exposed to political risk. Retroactive changes to legislation could have a negative impact on the value of EETI’s investments. It is difficult to determine precisely how such changes would influence consumer behaviour and it is possible that the degree of prepayment would increase and affect the expected cash flow from the investments.
Other political risks include potential changes in regulations that affect the Group’s operations and how they are conducted. Should subsidiaries be unable to meet the requirements arising from any new regulations, this could have a negative impact on the Group’s results of operations and on the value of the assets in these subsidiaries. No assessment can be made of any impact from this risk.
Strategic risk and other risks
Strategic risk could result from institutional changes and changes in fundamental market conditions that may occur. Legal and ethical risks are based in part on external regulations, mainly legislation and regulations, guidelines and instructions of supervisory authorities regarding operations, and in part on the requirements of the business community that operations be conducted on confidence-building grounds. Catella actively works with trade organisations, legal networks and other contacts to be able to control and adapt the companies’ operations to changes in strategic risks at an early stage. Processes in the operations are subject to internal regulations. Continuous training, control and follow-up in terms of regulatory compliance are arranged by the Risk and Legal/Compliance units, which together with management, are responsible for continuously updating regulations.
Continued investments in infrastructure and improvements to routines and processes were made in the banking operations during the year, focusing on ensuring stability to enable future growth. The extensive work was also intended to increase efficiency and improve margins in the existing operations.