3.2.2.2 Prototypical European investment firms

150. A large part of the European investment firm sector is not actively trading for its own account and performs asset management as its primary (or sometimes sole) activity. These asset managers therefore have a different balance sheet composition than the securities holding firm described above. Table 3 thus builds upon the stylised example of an investment firm as drafted by the Joint Forum and changes this to accommodate for a typical asset manager1 in the European Union. However, the same prototypical balance sheet can also be found in those investment firms that execute or transmit orders, that give investment advice and that operate an OTF or MTF. As discussed in Chapter 2, most investment services and activities do not result in a balance sheet item besides those balance sheet items related to the normal operations of a business (for instance, office buildings and supplies, goodwill, reserves, software, etc.). The investment activities that do result in specific balance sheet items, i.e. dealing on own account or underwriting, are included in the stylised example of Table 2.

Table 3: Stylised balance sheet for an (European) investment firm

Notes to stylised balance sheet:

151. Compared to an investment firm in Table 2, the firm with own account trading, the investment firm without own account trading has no financial instruments on its balance sheet. As such, the balance sheet of this latter type of investment firm will typically contain fewer items. Although these types of investment firms can manage billions of assets of their clients, in accordance with asset segregation requirements these clients’ assets are not owned by the investment firm and therefore the market risk and (counterparty) credit risk on these financial instruments is borne fully by the client. Clients’ segregated securities only show in the balance sheet of an investment firm if that investment firm uses on-balance asset segregation. Usually, the investment firm will make use of off-balance sheet asset segregation. The specifics of this will be further discussed in Chapter 4. As these investment firms apply asset segregation requirements, usually they will not have any significant receivables from their clients on their balance sheets, besides the fees payable by their clients.

152. The business of these types of investment firms will therefore usually not incur significant balance sheet risks. As discussed in Chapter 2, the most prominent risk for an investment firm is operational risk, which does not have a direct visible impact on the items contained in the investment firm’s balance sheet.

153. One exception to this concerns those investment firms that provide investment credit.2 This granting of credit can be carried out by investment firms, but this will have a major impact on the balance sheet of the investment firm and the financial risks included in that balance sheet. Investment firms providing investment credit will have a loan portfolio on their balance sheet, and possibly a set of financial instruments provided by the clients of the investment firm as collateral for these loans. As discussed in Chapter 2.1.3, provision of this ancillary service of granting credit will introduce significant credit and market risk into the risk profile of that investment firm. From an accounting point of view, collateralised lending may result in a neutral balance sheet entry as the value of the collateral is offset with the (margin) loans provided.