Regulatory Disclosures
Goldman Sachs Group Holdings (U.K.) (“GSGHUK) Pillar 3 Qualitative disclosures for 2008
Goldman Sachs Group Holdings (U.K.) and its subsidiaries (“GSGHUK”) are an integrated part of The Goldman Sachs Group, Inc. (“GS Group”). Disclosures made in the Annual Report for GS Group in relation to; Accounting Policies, Risk Management and Equity Capital, are fully applicable to GSGHUK. The Annual Report can be found in the link below.
Goldman Sachs Financials
Further disclosures relevant to Pillar 3 can be found in the annual financial statements for GSGHUK. These are prepared on a consolidated basis for Goldman Sachs Group Holdings (U.K.) and its subsidiaries.
The basis of consolidation for accounting purposes is materially consistent with that used for regulatory purposes, except for the inclusion of quasi subsidiaries for accounting purposes. These are not included in the regulatory consolidation, and their non-inclusion has no material impact on the regulatory capital position of GSGHUK.
Additional disclosures required by Pillar 3 specific to GSGHUK (not in the GSGHUK Financial Statements)
GSGHUK has been approved by the Financial Services Authority in the United Kingdom to use the Advanced Internal Ratings Based approach for Credit Risk, and the Internal Models Method for the measurement of exposure on OTC derivative and secured funding transactions.
The Credit Department is the department responsible for managing GS Group’s credit risk. The Credit Department is independent from the business units and reports to the CFO. It produces internal credit ratings for all risk counterparties, based on counterparty-specific credit reviews.
The credit review of a counterparty represents an independent judgement of the Firm’s risk appetite to trade with each counterparty, and incorporates (among other factors) the capacity and willingness of a counterparty to meet its obligations. Counterparty reviews are performed in accordance with guidelines specified by the Credit Department’s various Industry Committees and the depth of review depends on several factors including size and volume of exposure.
There is a global and regional governance structure with responsibility for approving all material aspects of the credit ratings and estimation processes. This includes both global and regional committees, including Firmwide Risk Committee, Credit Policy Committee (CPC) and Counterparty Focus Committee (CFC). The Firmwide Risk Committee, amongst its other risk management functions, approves sovereign credit risk limits and credit risk limits by ratings group. The CPC, authorised by the Firmwide Risk Committee, establishes and reviews broad credit policies and parameters that are implemented by the Credit Department. In addition, Internal Audit assesses compliance with regulatory requirements and internal policies, and performs a review of credit systems.
Models and Methodologies
The inputs to Basel II capital calculations for GSGHUK are primarily:
Probability of Default (PD) - The determination of PD for any given counterparty is derived from the internal credit rating which is mapped to the average default probabilities of external rating agencies (S&P and Moody’s).
Loss Given Default (LGD) - The determination of LGD for any given counterparty is derived from external rating agency data for each country and industry type.
Exposure at Default (EAD) - The firm calculates a variety of model-based exposure metrics for OTC derivatives and secured funding trades, among them the Effective Expected Positive Exposure (EEPE).
EEPE is the average of potential positive credit exposure, calculated for the first year of the portfolio.
Wrong-way risk
Wrong-way risk arises from positive expected correlation between EAD and PD to the same counterparty, and GS ensures this risk is avoided or appropriately mitigated through collateral or other mitigants. Stress testing is utilised to identify any wrong-way risk in existing portfolios and risk mitigants and /or adjustments to capital are employed to reflect any existing wrong-way risk.
Factors impacting loss experience
The global economic climate and financial system stability had deteriorated significantly during the second and third quarter of 2008, and as economies globally are slowing during the fourth quarter of 2008 there is an evident increase in default rates across many industries. Our internal client base, skewed towards higher quality (highly rated) counterparties, is less sensitive (though not immune) to the global economic environment, and our collateralisation terms significantly reduce any loss experience. Further disclosure relating to credit risk is outlined in the Annual Report.
Credit Risk Mitigation
GSGHUK uses Legal documentation allowing for netting, collateral collection and early termination rights as primary risk mitigants. The firm also uses credit derivatives as a credit risk mitigation tool. These are transacted with counterparties who are in the most part highly rated financial institutions.
A general discussion of credit risk mitigation policies and techniques is presented in GS Group’s Annual Report.
Value at Risk (“VaR”) Models
Subsidiaries of GSGHUK have been approved by the FSA to use VaR models for the calculation of capital requirements for market risk. Further information in respect of these approvals can be found on the FSA website.
Operational Risk
GSGHUK and its subsidiaries have adopted the standardised approach for the calculation of capital requirements for Operational Risk.