Risk Capital Management

Client Protection

Introduction

Law 7/2024, of 27 May, on the organisation and functioning of financial system operating entities and market abuse, replaces Law 8/2013 on the organisational requirements and operating conditions of financial system entities, investor protection, market abuse, financial collateral arrangements, and over-the-counter derivative and securities financing transactions. In conjunction with Law 7/2013, of 9 May, on the legal regime of the operating entities of the Andorran financial system and other provisions governing financial activity in the Principality of Andorra, this law aligns Andorran legislation with Directive 2014/65/EU on markets in financial instruments, also known as MiFID II; Commission Delegated Regulation (EU) 2017/565 of 25 April 2016, which supplements Directive 2014/65/EU of the European Parliament and Council with regard to organisational requirements and operating conditions for investment firms; and Commission Delegated Directive (EU) 2017/593 of 7 April 2016, which complements the Directive with respect to the safeguarding of clients’ financial instruments and funds, product governance obligations, and rules on the receipt or payment of fees, commissions, or other monetary or non-monetary benefits.

Additionally, this Law also incorporates Commission Delegated Directive (EU) 2021/1269 of 21 April 2021, which amends Delegated Directive (EU) 2017/593 regarding the integration of sustainability factors into product governance obligations, as well as the amendments to Commission Delegated Regulation (EU) 2017/565 introduced by Delegated Regulation (EU) 2021/1253 of 21 April 2021, which modifies Delegated Regulation (EU) 2017/565 with respect to the integration of sustainability factors, risks, and preferences into certain organisational requirements and operating conditions for investment firms.

Client Protection

The aforementioned regulation establishes mechanisms to ensure effective client protection in the financial sector. The main goal is to ensure that financial services are provided in a transparent, fair manner and in the best interest of the client, avoiding abusive practices and conflicts of interest. It also requires financial institutions to provide clear, adequate, and understandable information about the products and services offered, enabling the client to make informed decisions.

The framework is divided into three phases:

  1. Pre-contractual Phase

At the first contact with Risk Capital Management SGP, SAU, the following information is provided:

  • the entity and all the services it can offer the client
  • management and advisory strategies and the risks associated with different types of financial instruments
  • client protection policy
  • safeguarding of client assets
  • order execution policy
  • conflict of interest management policy
  • fees associated with each service provided

2. Contractual Phase

In this phase, the client’s financial situation, investment objectives, knowledge, and experience in financial matters and instruments are assessed.

This evaluation is carried out through two tests:

  • suitability test, to identify the client’s risk profile, financial situation, and investment goals
  • knowledge test, to assess which profile best suits the client according to regulation

The phase concludes with documentation and the formalization of a contract outlining the rights and obligations of both parties.

3. Service Phase

During the service phase, communication channels are established with the client to provide information regarding order execution and periodic updates on portfolio status and performance.

The suitability test will be updated periodically to adjust the risk profile and investment objectives to the client’s current financial situation.

Client Classification Policy

According to Article 30 of Law 7/2024, clients are classified into three categories based on their level of experience and financial knowledge:

  • Retail Clients: They enjoy the highest level of protection, as they are considered to have limited knowledge of financial markets.
  • Professional Clients: They are deemed to have the necessary knowledge and experience to assess the financial risks associated with contracted products.
  • Eligible Counterparties: These are financial institutions or companies with high expertise, receiving a lower level of protection.

The client classification determines the level of information and advice provided when contracting financial products and services.

Risk Capital Management SGP, SAU will notify new and existing clients about any change in their classification as retail clients, professional clients or eligible counterparties.

Clients will be informed, via a durable medium, of the specific category in which they have been classified, as well as of their right to request a different classification and the consequences this may have on their level of protection.

The classification changes covered by the aforementioned article are:

  • Treating as a professional or retail client someone who could, by default, be classified as an eligible counterparty.
  • Treating as a retail client someone who is considered a professional client.

If the firm wishes to consider any of its professional clients as eligible counterparties in accordance with Article 33 of Law 7/2024, it must inform the client, before carrying out any transaction with the said counterparty, that based on the available information, they are considered an eligible counterparty and will be treated as such unless both parties agree otherwise.

Retail clients wishing to be treated as professionals must expressly and in writing waive their retail status and declare that they wish to be treated as professional clients either at all times or only for a specific type of operation or investment service. However, before accepting the waiver, necessary measures must be taken to ensure that the client possesses the competence, experience and knowledge to make their own investment decisions and understand the related risks.

For corporate clients, the assessment must be carried out on the individual authorized to perform transactions on behalf of the client.

The client must meet at least two of the following criteria:

  • They have carried out significant volume transactions in a securities market, at an average frequency of at least ten per quarter over the last four quarters.
  • The value of their portfolio of financial instruments, including cash deposits or financial instruments, exceeds 500,000 euros.
  • They have held, for at least one year, a professional position in the financial sector requiring knowledge of the services or transactions envisaged.

The highest level of protection is granted when a professional client enters into a written agreement with the financial system entity stating that they will not be treated as a professional for the purposes of the applicable conduct rules. The agreement must specify the services, operations, or type of products it covers.

Financial Products and Services Classification Policy

Risk Capital Management SGP, SAU primarily offers the following services:

  • Financial advisory
  • Discretionary and individualized portfolio management

Regulations require that financial products be classified according to their complexity and risk:

  • Complex Products: These are those that require more in-depth analysis. Law 7/2024 classifies the following as complex products:
    • Option contracts, futures, swaps, forward interest rate agreements, and other derivative contracts related to securities, currencies, interest rates or yields, emission rights, or other derivative instruments, financial indices, or financial measures that may be settled in kind or in cash.
    • Option contracts, futures, swaps, forward interest rate agreements, and other derivative contracts related to commodities that must be settled in cash or that may be settled in cash at the discretion of one of the parties for reasons other than default or another event leading to the termination of the contract.
    • Option contracts, futures, swaps, and other derivative contracts related to commodities that may be settled by physical delivery, provided they are traded on a regulated market, a multilateral trading facility, or an organized trading facility (OTF), except for wholesale energy products traded on an OTF that must be settled by physical delivery.
    • Option contracts, futures, swaps, forward interest rate agreements, and other derivative contracts related to commodities that may be settled by physical delivery, not mentioned in the previous points and not intended for commercial purposes, that exhibit the characteristics of other derivative financial instruments, considering, among other things, whether they are cleared through recognized clearing houses or are subject to regular margin adjustments.
    • Credit risk transfer derivatives.
    • Contracts for differences.
    • Option contracts, futures, swaps, forward interest rate agreements, and other derivative contracts related to climatic variables, transportation costs, emission allowances, inflation rates, or other official economic statistics, that must be settled in cash or that may be settled in cash at the discretion of one of the parties (for reasons other than default or another event leading to the termination of the contract), as well as any other derivative contract related to assets, rights, obligations, indices, and measures not mentioned in the previous points, that exhibit the characteristics of other derivative financial instruments, considering, among other things, whether they are traded on a regulated market or a multilateral trading facility, whether they are cleared through recognized clearing houses, or are subject to regular margin adjustments.
    • Emission rights.
    • Shares admitted to trading on a regulated market or an equivalent market in a third country or on a multilateral trading facility (MTF), when it concerns shares in collective investment undertakings other than UCITS and shares that incorporate derivatives.
    • Bonds and debentures or other forms of securitized debt, admitted to trading on a regulated market, an equivalent market in a third country, or an MTF, that incorporate derivatives or have a structure that makes it difficult for the client to understand the risks involved.
    • Money market instruments that include derivatives or have a structure that makes it difficult for the client to understand the risks involved.
    • Units and shares of UCITS.
    • Structured deposits, excluding those that have a structure that makes it difficult for the client to understand the risks involved regarding the return or the cost of exiting the product before its maturity.
    • Other non-complex financial instruments as established in Article 36 quater of Law 7/2024.
  • Non-Complex Products: Instruments not included in the complex classification and that meet the following characteristics:
    • There are frequent opportunities to sell, redeem, or otherwise liquidate this instrument at prices publicly available to market participants and that are market prices or prices offered or validated by systems independent of the issuer.
    • It does not involve actual or potential liability for the client that exceeds the cost of acquiring the instrument.
    • It does not incorporate a clause, condition, or triggering event that could substantially modify the nature or risk of the investment or the payment profile, such as investments that incorporate a right to convert the instrument into a different investment.
    • It does not include explicit or implicit exit costs that effectively make the investment illiquid, even if there are technically frequent opportunities to sell, redeem, or otherwise realize it.
    • Adequately complete information about its characteristics is publicly available, which is normally well understood, allowing an average retail client to make an informed judgment to decide whether to engage in a transaction in this instrument.

This classification determines whether a client can access certain products based on the result of the suitability test or whether a second assessment is necessary to verify that the product is appropriate for the client and demonstrates an understanding of the complexity and risks associated with the product.

Policy on Financial Instruments and Associated Risks

Risk Capital Management SGP, SAU bases its policy on financial instruments on the return/risk parity.

Return is the yield generated from the investment, while risk is the probability that the investment’s return differs from the expected return.

Based on the results of the suitability test and the analysis of these two metrics, a relationship is established that maximizes return and minimizes risk, aligning with the characteristics of the investor’s profile, which is determined by:

  • Financial situation: Economic capacity or cash flow needs at all times to meet personal obligations.
  • Time horizon: Knowing the period in which the investment returns are expected.
  • Objectives: Determining the expected return on invested capital and over what time frame, based on the risk profile.
  • Risk sensitivity: Determining the risk aversion and the level of losses the investor is willing to assume, considering associated risks.
  • Knowledge and expectations: Assessing the investor’s experience and knowledge regarding financial instruments and their expectations with these instruments.

Financial instruments involve different types of risks, summarized as:

  • Intrinsic risk: The inherent level of risk associated with an investment, depending solely on the nature of the financial instrument.
  • Strategic and business risk: Exposure to one or more events that may affect the achievement of objectives defined in the development of a business and/or the Company’s activities.
  • Reputational risk: Arises from the obligation to adhere to ethical principles established in the Company’s code of ethics, as well as compliance with obligations and requirements established by current legislation.
  • Solvency risk: Difficulty in meeting long-term debts, regardless of the ability to pay current bills.
  • Money laundering/terrorism financing risk: Originates from the possibility of converting, possessing, acquiring, or transferring assets, knowing their criminal origin, with the purpose of concealing and covering up the illicit origin of the goods or involved persons. Terrorism financing is understood as the provision, deposit, or distribution of goods intended to be used wholly or partially in the commission of any terrorism crimes typified in the penal code.
  • Residual risk: The remaining risk after implementing appropriate strategies and mechanisms for the total or partial mitigation of identified inherent risks.
  • Credit or counterparty risk: The possibility that the issuer of a financial asset cannot fulfill its obligations.
  • Concentration risk: Refers to an exposure that could potentially lead to losses compromising an entity’s solvency or questioning the ability to maintain operations of a specific business activity, as well as losses in a wealth portfolio due to the materialization of a risk factor.
    Risk concentrations can take multiple forms, typically including exposures to:
    • Individual counterparties,
    • Groups of individual counterparties, linked or related entities,
    • Counterparties in given geographies,
    • Specific sectors,
    • Specific products,
    • Service providers, and
    • External, internal, or financial risk factors.
  • Liquidity risk: Difficulty in selling an asset without generating significant losses.
  • Operational risk: Internal errors, technological failures, or fraud. Includes legal and regulatory risk, which is the possibility of incurring legal or administrative sanctions, significant financial losses, or reputational damage due to non-compliance with laws, regulations, internal norms, and codes of conduct applicable to non-banking financial entities.
  • Leverage risk: Leverage is a strategy used to increase exposure to a particular risk factor. It may involve using credits or any other financing technique that allows increasing exposure to a risk factor. This can lead to faster increases in both gains and losses.
  • Market risk: Changes in financial asset prices due to economic or market conditions.
  • Interest rate risk: Changes in interest rates that negatively affect the value or financial costs.
  • Currency risk: Exchange rate differences affect the valuation of assets acquired in foreign currency.
  • Country risk: Economic, political, or social factors inherent to a country negatively affect investments made in that territory.
  • Price risk: The value of an asset decreases, causing economic losses for the investor or the company.
  • Others: Includes technological risk (direct dependence on tools and applications in regular activity), business continuity risk (situations that may severely, critically, and significantly affect the development of a company’s fundamental processes), systemic risk (financial system instability caused by idiosyncratic events or conditions in financial intermediaries), and actuarial risk (the possibility that an unforeseen event may materialize at a different speed than initially predicted in stochastic models).

Entities must inform clients about these risks before they contract any financial product.

Asset Safeguarding Policy

Article 12 of Law 7/2024 specifies that financial institutions must adopt measures to ensure the security of clients’ assets, including:

  • The separation between clients’ assets and those of the institution.
  • The assignment of accurate records to avoid confusion or loss.
  • The selection of reliable custodians for asset safekeeping.

These measures ensure that clients’ assets are protected in the event of the financial institution’s insolvency.

The nature of Risk Capital Management SGP, SAU’s activity, being an independent investment financial entity, does not authorize it to conduct proprietary trading or act as a custodian. This ensures independence and prevents the misuse of financial assets for proprietary purposes.

During the pre-contractual phase, Risk Capital Management SGP, SAU provides clients with its asset protection and safeguarding policies.

Conflict of Interest Policy

Section 2 of Article 13 of Law 7/2024 defines that “a conflict of interest is understood to exist in the provision of a service when the financial system’s operational entity, the persons referred to in the previous section (section 1, art.13), or another client or clients have an interest in the provision of the service, or in its outcome, that differs from the interest of the client to whom the service is provided and may cause harm to the latter, or when another client or clients may gain or avoid a loss and there is a possibility of a concomitant loss for the client to whom the service is provided.”

Risk Capital Management SGP, SAU has appropriate policies, procedures, and organizational measures to prevent and eliminate potential conflicts of interest to preserve the interests of clients and the Company.

In resolving conflicts of interest that cannot be avoided through the application of the general duty of abstention previously mentioned, the following rules will be considered:

  • In the event of a conflict between the Company and a client, the client’s interest must be safeguarded
  • In the event of a conflict between clients:
    • Favoring any of them will be avoided;
    • Under no circumstances will operations carried out by some clients be disclosed to others;
    • Encouraging a client to carry out a transaction to benefit another will not be permitted.

Order Execution Policy

To ensure the best execution of client orders, financial institutions must adopt measures to:

  • Select markets and intermediaries that offer the best prices and conditions.
  • Minimize costs and ensure prompt execution.
  • Periodically review their policies to ensure efficiency.

These guidelines are part of Risk Capital Management SGP, SAU’s commitment to enhancing transparency and investor protection in the financial sector.