Regulatory Capital Exposure

Information below is as March 31, 2015. Please note, as of May 2, 2016, EnTrust Capital and the Permal Group combined to form EnTrustPermal.

Introduction

In 2007 and 2008, the UK Financial Conduct Authority’s (“FCA”) new General Prudential Sourcebook and Prudential Sourcebook for Banks, Building Societies and Investment Firms (“BIPRU”) rules came into effect, implementing the Capital Requirements Directive, which is the common framework for implementing Basel II in the European Union. These rules are built on three pillars:

· Pillar 1 – minimum capital requirements;

· Pillar 2 – rules for the Supervisory Review Process, including the Internal Capital Adequacy Assessment Process (“ICAAP”);

· Pillar 3 – rules for the disclosure of risk and capital management, including capital adequacy.

The following is the Permal Group’s Pillar 3 disclosure in accordance with the requirements of the UK FCA’s Rules.

Risk is inherent in the businesses and activities of Permal Group Limited (“PGL; each member of the Permal Group is a “Subsidiary;” collectively the “Group” or “Permal”). Permal’s approach to risk management involves identifying and assessing the risks to which the Group is exposed, and monitoring and managing such risks.

The following sections describe Permal’s approach to risk management:

· Section 1 – PGL’s risk governance strategy, structure and process

· Section 2 – PGL’s categorisations of risk and the principal factors that drive each type of risk faced by the Group

· Section 3 – Monitoring and Reporting of Risk

· Section 4 – Consolidation principles for regulatory capital

· Section 5 – Capital resources

Section 1. Risk Governance, Strategy and Structure

Risk Governance Strategy

As part of its strategy, Permal accepts calculated risks that it deems can result in positive consequences while attempting to mitigate as far as possible those risks that can have a negative impact.

Risk Governance Structure and Process

Permal’s senior management, generally acting through the Executive Committee and/or the RCOC (defined below) (“Senior Management”) has the ultimate responsibility for deciding on limits for and monitoring the Group’s risk exposure, as well as for setting the targets for the capital ratios and risk appetite. Senior Management decides on policies for risk management as well as the internal capital adequacy assessment. All policies are reviewed annually.

The Executive Committee is responsible for setting overall direction of the firm, establishing high level priorities, initiatives, policies and practices.

The Investment Risk Committee has independent oversight of portfolio risks.

The Financial Controls Committee (“FCC”), whose members include the Chairman, Chief Executive Officer, and Chief Financial Officer, meets on a quarterly basis and has responsibility for overseeing the overall risk infrastructure. All reports to the FCC are reviewed and findings are further reported to the Board of Directors of PGL and the Executive Committee on a periodic basis.

The Risk Compliance and Operations Committee (“RCOC”) meets generally on a monthly basis to review, consider and focus on non-investment matters which impact (or could impact) Permal’s business, reputation and clients. Given the broad nature of the RCOC’s remit, it is not appropriate to exhaustively list the areas within its scope. However, as a guide such areas include risks of: compliance, regulatory, trading and execution, valuation, product, client service, IT & Service provider and counterparty, etc. The RCOC has subsumed the previous Counterparty Risk and Valuation Committees.

The Internal Audit Function (“Internal Audit”) is responsible for establishing guidelines and reporting related to the risk process, and reports to the FCC.

The Audit Groups, which are comprised of the internal audit department of Legg Mason Inc., PGL’s external auditors, the Group’s Compliance and Internal Audit Function undertake relevant monitoring checks to confirm that each Subsidiary’s risk policies and procedures are being implemented satisfactorily.

Section 2. Risk Types

Permal has identified different risks that could impact directly or indirectly on the Group’s financial position. Permal aims to mitigate the impact of material risks noted below by implementing control policies and procedures. Other risks (counterparty, credit, market, concentration, interest rate, pension obligation and group risk, etc) are not deemed material enough to rise to the level of requiring inclusion in the list below.

Section 3. Monitoring and Reporting

The Group risk governance structure is designed to provide independent and objective assessments and monitoring of risks.

Permal’s risk monitoring and reporting processes involves risk and policy reviews which are conducted generally every six months or on an as-need basis as risks, assessments and controls and other mitigating factors change. The output from the risk identification and assessment process will be documented on a “Risk Register” following the Group's agreed format. Changes to the Risk Register will be presented to the Risk, Compliance and Operations Committee (“RCOC”) for its review. Upon completion of the review of the Risk Register, the RCOC will review the Group's Risk Management Policy and its risk identification and assessment methodology to determine whether they remain adequate and will inform the Group’s Financial Controls Committee (“FCC”) of its findings. The outcome of the review along with an updated policy, as needed, will be submitted to the RCOC for approval. Any areas of uncertainty will be referred to the FCC and, if necessary, to the Executive Committee for resolution.

Section 4. Consolidation principles for regulatory capital

The Group does not prepare consolidated statutory accounts, on the grounds that the Group is consolidated into the accounts of Legg Mason, Inc, PGL’s parent company.

PGL is subject to consolidated supervision under the FCA rules. The following table sets out the Subsidiaries which are consolidated for the purpose of regulatory capital.

Group undertakings included in the capital base:

Name

Ownership %

Country

Consolidation method

Permal Asset Management LLC

100%

USA

Fully consolidated

Permal (PGI) LLC

100%

USA

Fully consolidated

Permal Capital Holding LLC

100%

USA

Fully consolidated

Permal Capital Management, LLC

80%

USA

Fully consolidated

PCM Principals LLC

0%

USA

Fully consolidated

Permal UK Limited

100%

UK

Fully consolidated

Permal Investment Management Services Limited

100%

UK

Fully consolidated

Permal (Isle of Man) Limited

100%

Isle of Man

Fully consolidated

The St James Bank & Trust Company Ltd

100%

Bahamas

Fully consolidated

W&P Fund Services Ltd

100%

Bahamas

Fully consolidated

SaintCo Ltd

100%

Bahamas

Fully consolidated

SJBTC Ltd

100%

Bahamas

Fully consolidated

Permal (Singapore) Pte. Limited

100%

Singapore

Fully consolidated

Permal (Hong Kong) Limited

100%

HK

Fully consolidated

Permal Investment Consulting (Shanghai) Limited

100%

China

Fully consolidated (liquidating)

Permal Business Consulting (Beijing) Company Limited

100%

China

Fully consolidated

Fauchier Partners Management Company Ltd

100%

UK

Fully consolidated (Dissolved in April 2015)

Fauchier Partners Ltd

100%

UK

Fully consolidated (Liquidating)

Permal Group SAS

100%

France

Fully consolidated

Fauchier Partners Corporation

100%

USA

Fully consolidated ( liquidating)

Permal Investment Management Services Limited (“PIMSL”), the Group’s UK-regulated Subsidiary, accounts for the majority of the turnover of the Group and is, therefore, deemed to be a significant Subsidiary. As a result, information is also presented in respect of PIMSL on an individual basis.

Section 5. Capital Resources

Group financial and strategic positions

PIMSL and PGL current capital positions

PIMSL’s turnover from management fees for the financial year 14/15 was USD 267.1 million (FY13/14: USD 284.6 million). Permal’s total assets under management were USD 19.4 billion as of March 31st, 2015 (2014: USD 19.8 billion).

The regulatory capital base of PIMSL, calculated based on the FCA rules applicable to investment firms, is as follows:

In USD’000s

Tier 1 capital

2015

2014

Paid up share capital

13,544

13,544

Share premium

179,000

179,000

Reserves

138,365

45,032

Tier 1 capital before deductions

330,909

237,576

Deductions from tier 1 capital

100,399

0

Tier 1 capital after deductions

230,510

237,576

Tier 2 capital

Perpetual subordinated debt

0

0

Tier 2 capital before deductions

0

0

Deductions from tier 2 capital

(2,248)

(2,248)

Tier 2 capital after deductions

(2,248)

(2,248)

Total capital base

228,262

235,328

The following table sets out the calculation of Group’s regulatory capital base, calculated based on the FCA rules that apply to Banks as at 31 March 2015 and 2014:

In USD’000s

Tier 1 capital

2015

2014

Paid up share capital

2,006

2,006

Share premium

144,403

144,403

Reserves

126,966

90,348

Tier 1 capital before deductions

273,375

236,757

Deductions from tier 1 capital

(86,990)

(107,346)

Tier 1 capital after deductions

186,385

129,411

Tier 2 capital

Upper tier two capital instruments

0

142,699

Tier 2 capital before deductions

0

142,699

Deductions from tier 2 capital

0

(13,288)

Tier 2 capital after deductions

0

129,411

Tier 3 capital

Short term subordinated debt

0

0

Total capital base

186,385

258,822

The Group has the ability to transfer capital within its Subsidiaries without material restrictions.

Regulatory capital requirements (Pillar 1)

Permal Group forms a UK consolidation Group and because the Group includes The St James Bank and Trust Company Ltd. it must apply the FCA’s Prudential Rules that apply to Banks. However, PIMSL is treated as an Investment Firm and must apply the applicable FCA Prudential Rules. As the FCA’s Rules are not the same, the calculations vary.

Capital requirements for PIMSL

Based upon its regulatory permissions and scope of activities, PIMSL is subject to the capital requirements for an investment firm. Its capital resources requirement is calculated as the higher of:

· The sum of the credit and market risk charges; and

· The fixed overheads requirement (FOR).

The FOR is calculated as 13 weeks’ expenditure (excluding certain discretionary expenses) based on the most recent accounts.

The capital resources requirement of PIMSL as at 31 March 2015 is USD 17,197,000 (2014: USD 13,380,000).

As such, the regulatory capital base of PIMSL is in excess of the capital resources requirement.

Capital requirements for the Group

The capital requirement for PGL is composed of the sum of credit risk, market risk and operational risk requirements according to the FCA Rules applied to Banks. The following table summarizes these as at 31 March 2015 and 2014:

In USD’000s

2015

2014

Credit risk

26,294

33,871

Market risk

27,619

24,495

Operational risk

32,091

32,889

Total

86,004

91,255

The total capital base of PGL as at 31 March 2014 is USD 186,385,000 (2014: USD 258,822,000). As such, the capital base of PGL is in excess of the regulatory capital requirement.

- Credit risk capital requirement

PGL uses the standardised approach to credit risk, under which the capital requirement is calculated as 8% of the risk weighted exposure amounts. Risk weighted exposures are obtained by multiplying the exposures by the risk weights set out in the FCA rules.

The following table analyses the calculation between the standardized credit risk exposure classes:

In USD’000s

2015

2014

Exposure

Capital requirement

Exposure

Capital requirement

Local authorities

4,142

0

4,591

0

Financial institutions

48,734

780

69,535

1,113

Corporate

228,038

18,243

279,525

22,362

CIU

80,408

6,433

117,506

9,400

Other items

10,469

838

12,445

996

Total

371,791

26,294

483,602

33,871

- Market risk capital requirement

PGL calculates its market risk capital requirement using the interest rate PRR, equity PRR, ICU PRR and foreign currency PRR methods set out in the FCA rules. The following table analyses the market risk capital requirement:

In USD’000s

2015

2014

Interest rate PRR

0

0

CIU PRR

18,905

18,094

Foreign currency PRR

8,714

6,401

Total

27,619

24,495

The capital requirements are calculated as a percentage of the exposure according to FCA handbook. For example, the CIU is 32% and the foreign currency PRR is 8%.

- Operational risk capital requirement (ORCR)

PGL calculates its operational risk capital requirement according to the basic indicator approach (BIA). Under this method, the ORCR is calculated by taking 15% of the 3-year average of the sum of net interest income and net non-interest income.

The capital requirement for operational risk amounts to USD 32,091,000 as of March 31, 2015 (2014: USD 32,889,000)

Internal Capital Adequacy Assessment Process (“ICAAP”)

Under Pillar 2 of the FCA’s capital requirements, the Group has undertaken an assessment of the adequacy of capital based upon all the risks to which the business is exposed (“ICAAP”).

The Executive Committee has determined that the following material risks are faced by the Group and could potentially, in the case of them crystallizing, result in the need for additional capital:

· Unanticipated changes in the markets and/or exchange rates

· Poor performance of client portfolios

· Loss of a key distribution network or a large direct client account, impact of lower fee paying products representing a large portion of the AUM.

· Reputational issues relating to the industry or the Group

Methodology

Senior Management believes that in the case of one or all of the risks crystallizing, the outcome would be the same: a decrease in assets under management due to either negative client investment performance and / or a dramatic increase in net redemptions from the clients. As a result, senior management of the Group has decided to perform a sensitivity analysis of PIMSL’s and PGL’s respective capital requirements based on the variation of the above two sensitivity factors over a 12-month period.

Results

PIMSL has a positive working capital (i.e., it receives its revenues before having to pay its counterparties). This is due to the fact that most of the fee revenues are received monthly, whereas fee payments for third party distribution are paid quarterly. Additionally, PIMSL has a relatively small balance sheet structure to finance in comparison with its gross margin (the majority of client fee revenues and Permal’s fees for distribution are booked under PIMSL’s books).

In summary, PGL’s business model finances itself. PGL’s only capital financing need is related to its balance sheet financing. As a result, in an unchanging balance sheet structure, a combined identical decrease in client portfolio performance and an increase of net redemptions in client accounts will have the same effect whether the variation is 10% or 50%.

Conclusion on PIMSL and PGL respective capital requirements

As at March 31st, 2015 on the basis of unchanged operating fixed costs, financial investments, off balance sheet investments and preferred share dividend:

· PIMSL’s current capital structure would be sufficient, even in the event of risks crystallizing at the same time over a 12-month period as set out above in the Results section. PIMSL’s excess of capital after consumption of capital required to finance operations for the next 12 months would be sufficient.

· PGL’s current capital structure would be sufficient even in the event of a combined identical variation over a 12-month period as set out above in the Results section. PGL’s excess of capital after consumption of capital required to finance operations for the next 12 months would be sufficient.

Furthermore, note that Permal Group holds with Societe Generale an unused committed credit revolving facility of USD 15 million with maturity date July 30 th , 2018, which could be drawn down by any Subsidiary if necessary.

A 12-month period is expected to provide Senior Management with sufficient time to take the appropriate action in terms of balance sheet and profit and loss restructuring (for example, liquidation of seed money investments, among other liquid asset sales and fixed cost reductions).

As a result of the above, Senior Management has assessed that PIMSL and PGL are sufficiently capitalised for the risks to which they are exposed.

Pillar 3 remuneration disclosures for the Permal Group (“Permal”)

April 2014 – March 2015

Decision making process for remuneration policy

Permal has a Compensation Committee which meets regularly to consider human resource issues relating to terms and conditions of employment, compensation and retirement benefits. Within the authority delegated by the Board, the Compensation Committee is responsible for:

· Reviewing and approving remuneration policy and structures for all employees designed to ensure alignment with the Company’s business strategy, objectives, values, risk appetite and long-term interests.

· Overseeing implementation of the remuneration policy and an annual review of the implementation of remuneration policy is conducted.

· Reviewing and approving all remuneration decisions for Executive Committee members, Permal’s Code Staff and employees with remuneration over a pre-determined amount.

· Approving all individual bonus awards taking into account both current and future risks to Permal’s prudential soundness.

· Remuneration of senior officers working in control functions designed to ensure that their remuneration aligns to remuneration policy.

· Variable remuneration decisions designed to ensure that decisions consider financial and non-financial metrics, and the performance of the individual and Permal.

· Review and approval of severance payments, guarantees and buyouts.

· Approval of any disclosure that is from time to time to a regulator or any other relevant authority relating to the remuneration policy.

There were 9 resolutions passed by the Compensation Committee during the financial year ending 31 March 2015.

The members of the Compensation Committee for the period April 2014 to March 2015 were Isaac Souede (Chairman), Thomas DeLitto (Senior EVP – through June 2014 only) and Omar Kodmani (CEO). Isaac Souede was Chairman of the Committee throughout the period.

External consultants

Consultants are used from time to time to advise on specific issues.

During the year, the EVP – COO – CFO provided regular briefings to the Committee and the Committee received advice on the implications of the remuneration policy on risk and risk management from the Global Head of Risk, the General Counsel (Head of Compliance) and Director of Human Resources.

Role of the relevant stakeholders

The Compensation Committee takes full account of the company’s strategic objectives in setting remuneration policy and is mindful of its duties to its shareholder and other stakeholders. The Committee seeks to preserve shareholder value by ensuring the successful retention, recruitment and motivation of employees.

In line with the Financial Conduct Authority (“FCA”) regulations, 131 employees were designated as “Code Staff”, defined as SIFs, heads of significant business functions, heads of support and control functions and risk takers.

This group is defined with reference to managerial responsibility to influence Permal’s overall risk profile. This does not include portfolio managers or sales staff without wider executive responsibilities, as these are not deemed to have a material impact on Permal’s risk profile given the control structures in place and the agency nature of the Permal’s business.

The Code Staff list is reviewed annually or following a material change in personnel.

The link between pay and performance for Code Staff

The Executive Committee and Compensation Committee take into account, when determining remuneration awards, the need to ensure an appropriate ratio between fixed and variable pay to ensure that Permal can operate a fully flexible incentive policy. This includes the potential non-payment of bonuses should Permal’s performance and/or the performance of specific individuals require it.

If all or part of the business has made a loss, or if an employee breaches accepted risk or compliance behaviour and the Compensation Committee believe it to be appropriate, Permal has the ability to withhold a bonus payment.

The bonus pool is calculated in accordance with the Net Revenue Sharing Agreement “NRSA” signed among the Group’s parent company, Legg Mason Inc, and the principal officers of Permal.

Legg Mason, Inc. may issue stock options to certain directors and key employees of Permal. Options under Legg Mason’s employee stock plans have been granted at prices not less than 100% of the fair market value. Options are generally exercisable in equal increments over 3 to 5 years and expire within 5 to 10 years from the date of grant.

Aggregate remuneration cost for Code Staff

The aggregate remuneration expenditure in respect of Code Staff was £8.1 million2 for the period (all Code Staff being classified as senior management or risk takers). These individuals have overall responsibility for Fund Management and Private Equity.