Risks, risk management and capital adequacy

TAALERI’S RISK MANAGEMENT AND RISK POSITION

The task of risk management is to identify, assess, measure, treat and control risks in all Taaleri Group’s businesses that influence the realization of the Group’s strategic and operative goals, as well as to oversee that the principles approved by the Taaleri Plc Board of Directors are complied with. Risk management aims to mitigate the likelihood of unforeseeable risks being realized, and their influence on and the threat they present to Taaleri Group’s business operations. Risk management supports achievement of strategic goals by promoting better utilization of opportunities in all activities and more efficient distribution of risk-taking capacity to the different functions and projects within the defined risk appetite framework.

Taaleri Group’s risks are divided into five main categories: strategic and business risk, credit risk, liquidity risk, market risk and operational risk (including compliance risk). In addition, Taaleri follows the development of political risks. The principles of Taaleri's risk and capital adequacy management are described in note 36 to the 2018 financial statements.

The risk capacity of the Taaleri Group consists of a properly optimized capital structure, profitability of business operations and qualitative factors, including good corporate governance, internal control and proactive risk and capital adequacy management. Taaleri Group’s attitude towards risk-taking is based on careful consideration of an adequate risk/return relationship. Taaleri Plc’s Board of Directors has decided that the Group may not in its activities take a risk that jeopardizes the target level set for the company’s own funds. 

Segment-specific risks

The main risks of Taaleri’s Wealth Management segment consist mainly of operational risks and, to a slight extent, credit risks. The result of the Wealth Management segment is influenced by the development of assets under management, which depends on the progress of the private equity funds’ projects and the development of the capital markets. The profit development is also influenced by the realization of performance fee and commission income tied to the success of investment operations. On the other hand, private equity fund management fees are based on long-term contracts that bring in a steady cash flow.

The insurance and investment activities carried out by Garantia Insurance Company are central to Taaleri's risk position. The principal risks associated with Garantia’s business operations are credit risks arising from guaranty operations, and the market risk regarding investment assets covering technical provisions. Garantia’s capital adequacy is strong and its risk position has remained stable, even though the outlook in construction sector weakened during the first half of the year. At the end of June 2019, Garantia’s claims ratio was 21.1 per cent and the claims incurred in relation to gross exposure remained at a low level 0.05 per cent. The share of fixed income investments in Garantia’s investments was 86 per cent. Standard & Poor's Global Ratings Europe Limited (S&P) credit rating for Garantia is A- with stable outlook.

The Energia segment’s objective is to channel assets under management to renewable energy production projects and to other energy projects supporting sustainability. The goal is to internationalize and expand energy business operations considerably, which naturally grows risks relating to the growth and internationalization of the operations. The Energia segment’s earnings are impacted by its success in finding suitable projects, its ability to identify all risks related to renewable energy’s international development, construction, financing and operations, and its success in the internationalization of its operations. The Energia segment’s earnings are also affected by the success of its own investments in development-stage energy projects.

The most significant risks of the Other Operations consist primarily of private investments and financing granted by Taaleri Investments Ltd as well as of credit risks related to Taaleri Plc’s granted loans and receivables from credit institutions. The Other Operations’ returns consist of the fair value changes in investments and of profits/losses gained in connection with the sales of its investments. The returns and income of the Other Operations may thus vary significantly between periods under review.

Taaleri falls within the sphere of regulation of large customer risks defined in the EU Capital Requirements Regu-lation. At the end of the January-June 2019 review period, Taaleri’s largest single customer risk was 20.4 (22.3) per cent of the Group’s own funds and the liabilities of any (single) customer entity did not exceed the 25 per cent limit set by law. 

Capital adequacy of Taaleri

Capital adequacy under the Act on the Supervision of Financial and Insurance Conglomerates

Within the Taaleri Group, the regulatory capital according to the Act on Credit Institutions (610/2014) and the EU Capital Requirements Regulation (CRR) (No 575/2013 of the European Parliament and of the Council) is deter-mined and disclosed to the supervised parties operating in the Financing sector. Taaleri applies the standardized approach in the regulatory capital calculation of the credit risk capital requirement. Taaleri has changed to the standardized approach in the calculation of the operational risk capital requirement from the previously used basic indicator method as of 31 December 2018.

Taaleri Group’s target level for the own funds of the Financing sector is 1.3 times the internal risk-based capital requirement, calculated on the basis of the pillar 1 minimum capital requirement and additional pillar 2 risk-based capital requirement. 

The Finnish Financial Supervisory Authority has on 31 January 2019 given Taaleri Plc permission pursuant to Article 49 (1) of the EU Capital Requirements Regulation (EU) 575/2013 (CRR). The permission entitles Taaleri Plc to not deduct the investments in the own funds instruments of Garantia Insurance Company Limited from the consolidated common equity Tier 1 capital (CET1) of the investment services firm. Instead of deduction, investments in the insurance company should be risk-weighted in accordance with CRR Article 49 (4). The permit is for a fixed term and is valid until 31.12.2020.

With the permission Garantia’s acquisition expense of EUR 60.4 million can be left undeducted. The impact on the result accumulated by the insurance company investment is not included in the consolidated Common Equity Tier 1 of the investment service company. Equity investments include the Group’s internal insurance company investment of EUR 60.4 million with a risk-weight of 100 per cent. If the CRR 49 permission were not applied and using the alternative calculation method where the insurance company investment are deducted from the Common Equity Tier 1 and including the result of the review period, the consolidated Common Equity Tier 1 of the investment service company would be EUR 18.6 million on 30 June 2019

Taaleri’s financing sector’s Common Equity Tier 1 with the CRR 49 permission is EUR 70.3 (57.1) million, from which the profit of January-June 2019, EUR 4.4 (21.3) million, is deducted. The risk-weighted commitments were EUR 241.9 (229.6) million, of which the share of credit risk was EUR 153.4 (150.0) million and the share of operational risk EUR 88.6 (79.6) million according to the standardized approach. The Financing sector’s capital adequacy ratio was 29.1 (24.9) per cent.

Capital adequacy of RaVa conglomerate, 
EUR thousand

30 June 2019 31 Dec. 2018
Shareholders’ equity of the Taaleri Group 118732 122381
Goodwill and other intangible assets -6648 -7164
Non-controlling interests 739 -1661
Planned distribution of profit - -8505
Conglomerate's own funds, total 112823 105051
     
Financing business’ requirement for own funds 10930 11156
Insurance business’ requirement for own funds 47045 45327
Minimum amount of own funds of the Conglomerate total 57975 56483
     
Conglomerate’s capital adequacy 54848 48567
Conglomerate’s capital adequacy, ratio 194,6 % 186.0 %

Capital adequacy according to the Act on Credit Institutions and the EU Capital Requirements Regulation (Basel III)

Within the Taaleri Group, the regulatory capital according to the Act on Credit Institutions (610/2014) and the EU Capital Requirements Regulation (CRR) (No 575/2013 of the European Parliament and of the Council) is determined and disclosed to the supervised parties operating in the Financing sector. Taaleri applies the standardised approach in the regulatory capital calculation of the credit risk capital requirement. Taaleri has changed to the standardised approach in the calculation of the operational risk capital requirement from the previously used basic indicator method as of 31 December 2018.

Taaleri Group’s target level for the own funds of the Financing sector is 1.3 times the internal risk based capital requirement, calculated on the basis of the pillar 1 minimum capital requirement and additional pillar 2 risk-based capital requirement. 

The Finnish Financial Supervisory Authority has 31 January 2019 given Taaleri Plc permission pursuant to Article 49 (1) of the EU Capital Requirements Regulation (EU) 575/2013 (CRR). The permission entitles Taaleri Plc to not deduct the investments in the own funds instruments of Garantia Insurance Company Limited from the consolidated common equity tier capital (CET1) of the investment services firm. Instead of deduction, investments in insurance company should be risk-weighted in accordance with CRR Article 49 (4). The permit is for a fixed term and is valid until 31.12.2020.

With the permission Garantia’s book acquisition expense of EUR 60.4 million can be left undeducted. The impact on the result accumulated by the insurance company investment is not included in the consolidated Common Equity Tier 1 of the investment service company. Equity investments include the Group’s internal insurance company investment of EUR 60.4 million with a risk-weight of 100 per cent. With the result of the review period, the consolidated Common Equity Tier 1 of the investment service company would be EUR 16.6 million on 31 December 2018, if the CRR 49 permission were not applied, and the alternative calculation method where the insurance company investment would be deducted from the Common Equity Tier 1 would be used.

Taaleri’s Financing sector’s Common Equity Tier 1 with the CRR 49 permission is EUR 57.1 (48.8) million, from which the profit of year 2018, EUR 21.3 (19.2) million, is deducted. The risk-weighted commitments were EUR 229.6 (217.2) million, of which the share of credit risk was EUR 150.0 (145.6) million and the share of operational risk EUR 79.6 million according to the standardized approach (according to the basic indicator method approach 2017:  EUR 71.6 million). The Financing sector’s capital adequacy ratio was 24.9 (22.5) per cent.

Financing sector’s capital adequacy        
(with the CRR 49 special permission)                                   
30 June 2019 31 Dec. 2018
Common Equity Tier before deductions 80295 86321
Deductions from the Common Equity  Tier    
Goodwill and intangible assets -6298 -6228
Non-controlling interests 739 -1662
Profit of the review period -4436 -21318
Common Equity Tier (CET1) 70300 57113
Additional Tier 1 before deductions - -
Deductions from the Additional Tier 1 - -
Additional Tier 1 (AT1) - -
Tier 1 capital (T1 = CET1 + AT1) 70300 57113
Tier 2 capital before deductions - -
Deductions from the Tier 2 capital - -
Tier 2 capital (T2) - -
Total capital (TC = T1 + T2) 70300 57113
Total risk-weighted commitments (total risk) 241939 229622
- of which the share of credit risk 153359 150023
     - of which insurance company holdings 60350 60350
- of which the share of operative risk 88581 79599
- of which the share of other risks - -
Common Equity Tier (CET1) in relation to the amount of total risk (%) 29,1 % 24.9 %
Tier 1 capital (T1) in relation to the amount of total risk (%) 29,1 % 24.9 %
Total capital (TC) in relation to the amount of total risk (%) 29,1 % 24.9 %

Solvency according to the Insurance Companies Act (Solvency II)

Garantia continues to have strong capital adequacy. Garantia’s own funds at the end of June 2019 were EUR 105.6 (103.3) million. The solvency capital requirement including the capital add-on was EUR 47.0 (44.2) million and excluding the capital add-on EUR 27.2 (26.4) million. Garantia’s solvency ratio, or the ratio of basic own funds to the solvency capital requirement, including the capital add-on, was 224.5 (31 Dec. 2018: 233.4) per cent and excluding the capital add-on 388.5 (31 Dec. 2018: 390.7) per cent. The increase in own basic funds was mainly a result of the growth in the fair value of investment assets. The growth in the solvency capital requirement was primarily the result of the increase in the capital add-on, set by the Financial Supervisory Authority. 

Garantia’s own funds are formed in full of unrestricted Tier 1 basic own funds. Garantia does not apply the transition arrangements in defining its basic own funds and Garantia’s own funds do not include items classified as ancillary own funds. Garantia does not use the matching adjustment or the volatility adjustment in the technical provisions calculation. Garantia applies the standard formula for the Solvency Capital Requirement calculation. Garantia does not use simplified calculation in the standard formula’s risk modules or sub-modules, or company-specific parameters instead of the parameters of the standard formula. Garantia does not apply the transition arrangements of technical provisions or market risk calculations. 

On 17 June 2019, the Financial Supervisory Authority confirmed Garantia’s capital add-on, or the increase in solvency capital requirement, at EUR 19.8 million; it was previously EUR 17.8 million. In its decision, the Financial Supervisory Authority stated that the prerequisites described in the capital add-on decision given on 12 June 2018 still  exist. Back then, the Financial Supervisory Authority stated that the risk profile of Garantia’s non-life underwriting risk module differs from the underlying assumptions in the standard formula for the solvency capital requirement calculation because the standard model does not adequately recognize guaranty insurance risks. The Financial Supervisory Authority also reiterated its view that the requirement to use the internal model is not appropriate in Garantia’s case. The capital add-on is valid and will remain in effect until further notice. The Financial Supervisory Authority assesses the amount of the capital add-on at least once a year.

Based on the Insurance Companies Act that came into force on 1 January 2016, the Solvency II capital adequacy regulations do not fall within the sphere of statutory auditing.