The investment firms sector: investment firms continue to have a good appetite for market risk
Three investment firms were operating in the Estonian regulated financial market in the second quarter of 2017, which means the investment firm sector is smaller than the sectors supervised by the Financial Supervision Authority.
At the same time, the regulation of investment firms is as complicated as that of the banks, though an activity licence for an investment firm allows a much more restricted range of activities than that of banks does. The European Banking Authority (EBA) is working on a reform to simplify capital regulation for investment firms, which should help make the sector more popular.
The volume of client assets managed by local investment firms increased by 13% in the second quarter, returning to the 1 billion euro level. As investment firms mostly operate internationally, more than 99% of client assets were owned by non-resident clients.
The investment firms' own assets decreased by 6% over the quarter to 46 million euros. These assets are mostly liquid funds and loans to clients.
The absolute value of the equity, currency and commodities risk positions held by investment funds was 96 million euros in the second quarter, meaning it increased by a factor of 4.4 over the quarter, having fallen by a factor of 3.8 in the first quarter. The total value of the open trading positions was 239% of the own funds of investment firms, and 74% of the market risk position was currency risk. Having such large positions means that risks can very quickly be realised to a large extent. The sector took a loss of 1.2 million euros in the second quarter from differences in exchange rates.
At the same time investment firms made 1.2 million euros in profit in the second quarter, which is the same as in the first quarter. This meant that in the first half of the year they earned 2.4 million euros in profit and that the half-year profit was four times larger than in the first half of the previous year.
Net income in the second quarter was 4.7 million euros, or 8% less than in the first quarter. In the first half of the year net income totalled 9.8 million euros, which is 3% less than a year earlier. Although the sector earned 11.6 million euros in net service fee income from sales of investment services in the first half of the year, which was 15% more than in the first half of the previous year, an extraordinary loss was recorded in the second quarter because of the differences in exchange rates. Overall this meant the income base of the investment firms was smaller than a year earlier.
All the investment firms met the Liquidity Coverage Ratio (LCR) with sufficient margin, and the average indicator for the sector was 141%.
The Common Equity Tier 1 ratio rose from 32% to 33% in the second quarter. This ratio shows how much of their own funds investment firms are holding against their risk positions.
Main development trends and risks
- The main risk to investment firms comes from business models that are built on taking on large-scale market risk. The high levels of leverage mean that even a small shock in financial markets is able to cause large losses in a short time, making active risk management very important.
- Investment firms operating in Estonia mainly provide investment services outside Estonia, and the majority of their clients are non-resident. Holding the assets of non-resident clients and intermediating complex high-frequency transactions bring their own risks however.
- In response to the risk profiles of the investment firms, the Financial Supervision Authority has introduced additional capital requirements for investment firms, by which the average own funds ratio must be around 19%, which is 1.7 times more than the regulatory requirement.