Business review Risk management
Treasury and funding risks
3i's funding objective is that each category of investment asset is broadly matched with liabilities and shareholders' funds according to the risk and maturity characteristics of the assets, and that funding needs are met ahead of planned investment.
Credit risk
3i's financial assets are predominantly unsecured investments in unquoted companies. The Group considers the maximum credit risk to be the carrying value of the asset. An increase in concentration of the portfolio in a particular sector or geography could increase credit risk. Likewise large or unexpected increases in interest rates could increase credit risk, particularly in companies which are highly leveraged.
The portfolio is well diversified and, for this reason, credit risk exposure is managed on an asset-specific basis by individual investment managers.
The Group's remaining financial assets are mainly in the form of deposits with banks of a credit rating of AA or better. Counterparty limits are set and closely monitored.
Liquidity risk
The Group invests from its own balance sheet using cash generated from its investing activities and its core funding. The Group also has available to it undrawn committed facilities. In addition to funding from its own balance sheet, the Group periodically raises third-party funds to co-invest in mid-market buyout transactions. It also invests indirectly through funds administered by third parties, or quoted investment vehicles.
Unexpected changes in the levels of investment and divestment activities or in interest rates could impact the availability of funds required for investment needs or to meet obligations as they fall due.
To address this, a range of cash flow forecasts are produced and updated on a regular basis for each business line and for the Group as a whole. The Board reviews the Group's financial resources every six months. This includes consideration of the currency hedging and maturity profile aspects, as well as liquidity, of the Group's current and forecast financial position.
Price risk
The valuation of unquoted investments depends upon a combination of market factors and the performance of the underlying asset. The Group does not currently hedge the market risk inherent in the portfolio but manages asset performance risk on an asset specific basis, as described earlier.
Foreign exchange risk
3i reports in sterling and pays dividends from its sterling profits. The Group seeks to reduce structural currency exposures by matching assets denominated in foreign currency with borrowings in the same currency. The Group makes some use of derivative financial instruments to effect foreign exchange management. The current policy is to hedge the main currency exposures in the range of 90%–100%.
Interest rate risk
3i has a mixture of fixed and floating-rate assets. The assets are funded with a combination of shareholders' funds and borrowings according to the risk characteristics of the assets. The Board seeks to minimise interest rate exposure by considering the average life profile of the various asset classes and adopting a portfolio approach to the interest rate hedging structure. Some derivative financial instruments are used to achieve this objective.