Tudor, Pickering, Holt & Co. | International Disclosures

Tudor, Pickering, Holt & Co. International, LLP

TPH 2011 Remuneration Policy Statement

CAPITAL RESOURCES DIRECTIVE
BASEL II PILLAR 3 DISCLOSURE

2010

Introduction

Tudor, Pickering, Holt & Co. International, LLP (TPH International) is classified as a Limited Licence €50,000 firm and, as such, is required to comply with the three Pillars of Basel II (the Capital Requirements Directive). The three Pillars that make up the Capital Requirements Directive are as follows.

Pillar 1 defines the regulatory minimum capital requirements by providing rules and regulations for measurement of credit risk, market risk, and operational risk. The requirement of capital has to be covered by the bank’s own regulatory funds.
Pillar II addresses TPH International’s internal processes for accessing overall capital adequacy in relation to risks (ICAAP). Pillar II also introduces the Supervisory Review and Evaluation Process (SREP), which accesses the internal capital adequacy.
Pillar III complements the other two pillars and focuses on enhanced transparency in information disclosure, covering risk and capital management, including capital adequacy. This document is designed to satisfy the requirements of Pillar 3 by setting out the firm’s risk management objectives and policies.

The aim of Pillar 3 is to encourage market discipline by developing a set of disclosure requirements for investment firms and credit institutions that will allow other market participants to assess key pieces of information on a firm's capital, risk exposures and risk assessment processes. The disclosures are to be made public for the benefit of the market.

The FSA regulations for the disclosures required under Pillar 3 are contained in the Prudential Sourcebook for Banks, Building Societies and Investment Firms (“BIPRU”) chapter 11. These rules allow information which is regarded as immaterial or proprietary/confidential to be omitted from disclosure.

TPH International does not use the IRB Approach when calculating its Credit Risk Capital Component.

TPH International is not subject to consolidated supervision.

All figures in this document are correct at 31/3/11 unless stated otherwise.

Risk Management Policies and Objectives

TPH International is ultimately owned by Tudor, Pickering, Holt & Co., LLC, a US based holding company. The holding company’s other core business is a US integrated broker-dealer, Tudor, Pickering, Holt & Co. Securities, Inc. (“TPH Securities”) and asset management businesses (TPH Partners LLC and TPH Asset Management, LLC). Headquartered in Houston, Texas, this firm is dedicated to the energy industry and provides equity research coverage on approximately 100 US-based energy companies, corporate advisory work (including M&A, fairness opinions and capital raising) as well as underwriting activities.

Where possible, the firm will attempt to manage all the risks that arise from its operations. As the firm is a Limited Licence €50,000 firm it is not usually exposed to Credit Risk, Market Risk (including interest rate risk) or Operational Risk. However, the firm has separately considered the risks associated with its business and these are detailed in this disclosure.

The ways in which the firm manages the risks faced include producing key risk information and indicators to measure and monitor performance and using Management and Board Committees to monitor and control specific risks.

Credit Risk

The FSA definition of credit risk relates to a firm’s proprietary holdings and assets (including debtors). TPH International does not invest on its own account. Thus its credit risk exposures relate principally to cash held on deposit at major banks and to fees due from clients.

TPH International holds credit balances of its own money at HSBC United Kingdom. Additionally, at any given time the balance sheet contains prepayments and accrued income, with amounts being owed by trade suppliers (prepayment) and clients (fees) under contractual arrangements. Credit risk is mitigated by maintaining an open, ongoing relationship with each client and vendor.

Market Risk

The FSA definition of market risk relates to a firm’s proprietary holdings. TPH International does not invest on its own account, thus market risk was accessed and determined not to be a consideration for Pillar 1. However, see separate section below on risk to revenues of market fluctuations.

Operational Risk

The operational risk calculation is not required for a BIPRU limited licence firm (BIPRU 6.1.1R), because TPH International does not enter into those activities covered by operational risk, such as running a trading book and taking positions in it with a number of counterparties.

Business Risk

TPH International is exposed to the effects of operational gearing (operational gearing is the impact of operating with high fixed costs but variable revenue). The Company’s fixed costs include staff costs, premises costs and research facilities such as Bloomberg, however these are all covered by the fixed overheads requirement.

The risk to TPH International is in not achieving the projected revenues or by costs increasing significantly.

Discretionary costs could be removed to an extent in order to preserve profitability, however due to the operational gearing effect, a significant fall in revenues would feed through to the bottom line. Significant reductions in turnover could arise as a result of:

Risk to revenues of market fluctuations, or significant decrease of interest in the energy sector; Loss of a significant portion of the client base; Inability to attract new clients; or Competitive or economic pressure to reduce charge levels. Each of these is dealt with in turn below.

1. Risk to revenues of market fluctuations or decline in interest in the energy sector
Market risks relate to external factors such as a cycling away from the energy sector or flat equities market for a sustained period (years). These factors could cause the institutional clients to significantly contract their business, thereby reducing TPH International's ability to grow a revenue stream. The diversity of the firm's target market base, breadth of its research offerings, and management experience through other down markets helps mitigate these risks.

2. Loss of a significant portion of the client base

It is clear that a significant reduction in the client base of TPH International could have a significant effect on the firm’s income. As noted above, the diversity of the firm's target market base and the breadth of its research offerings helps mitigate these risks.

3. Inability to attract new clients

TPH International’s experienced staff have numerous contacts within the industry and actively seek out new client opportunities. Should there be any indications of particular difficulties in obtaining new clients, the firm will proactively seek out new opportunities. The short-term effect of this would be a likely reduction in the total amount of income.

Past experience has shown that investor appetite for equity investments (and therefore research advice) can reduce dramatically when markets fall, but can return equally as quickly when markets start to rise. In recent times this has been accentuated by the very low returns available on cash.

4. Competitive or economic pressure to reduce charge levels

TPH International provides competitive levels of service and fees to its clients and has also positioned itself in the market to offer fee structures that are very competitive given the level of service and depth of industry knowledge.
It is possible that a new market entrant could establish itself and offer lower rates than TPH International. However, any such new rival would likely experience losses in the start up phase and would have to build up critical mass in terms of clients. Even in this case, it is not certain that TPH International would lose clients or be obliged to reduce its charge levels as the services it provides are aimed to set it apart from other firms.

Risk Management Function

Structure

TPH International’s risk management procedures are the ultimate responsibility of the Board.

The Board will not permit or approve any action which it perceives to pose a risk to TPH International’s reputation and as a result cause any significant loss of revenue or cause any significant unplanned expenditure. Similarly, the Board has set a zero error target for the performance of all services and activities. The Board requires the firm to operate within strict process controls, designed to facilitate ethical behaviour and deliver service levels that do not give rise to client dissatisfaction.

The Board operates a risk management policy that assumes the business should be profitable in all normal operating conditions. The Board has no appetite to accept operating losses, unless such losses were short-term in nature and were planned for as part of a significant investment programme within the Firm. A key risk trigger to initiating mitigating action will be any unplanned operating loss incurred. The Firm’s forecast budget and scenario and stress testing (see appendices) demonstrates that the Firm has the capacity to withstand a significant level of losses in most trading conditions for a period of 5 year(s).

Capital Resources

TPH International has Pillar 1 capital only. Capital is held to ensure a suitable operating margin is maintained in excess of the higher of the Pillar 1 Base Capital Requirement or the Fixed Overhead Requirement. The firm’s Pillar 1 capital after deductions was £196,708. The firm’s Base Capital Requirement is €50,000 (£43,000 approximately), and its Fixed Overheard Requirement is £126,753. As such, the firm has sufficient capital resources in excess of its capital requirements.

Integration Into Business Strategy

It is the intention of the firm to maintain sufficient capital resources to allow it to continue to operate profitably in providing services to the energy industry, and to provide a reasonable return for the shareholders of the firm. In order to maintain this capital the firm must generate and retain profits that will add to the firm’s financial reserves.
Internal Capital Adequacy Assessment Process (“ICAAP”)

The ICAAP combines Pillar 1 and Pillar 2 requirements and involves a detailed analysis of the various elements of the business to understand the need for capital in the forthcoming period. Various models are tested in the process to identify areas where additional capital may be required to manage the risks to which the firm is exposed. The ICAAP is refreshed annually during the budget process or during the year in the event of a significant change in strategy direction/business plan or other material event that was not foreseen during the budget process.

The result of the ICAAP is challenged by a party independent of the preparation of the ICAAP and this is ultimately reviewed and approved by the firm’s governing body to ensure that there is sufficient capital within the firm to meet our future plans and anticipated risks.