BlackRock Group Limited

‘Pillar Three’ Disclosure: Capital & Risk Management (Consolidated UK Group including European subsidiaries)

Background The disclosure requirements under ‘Pillar Three’ (as defined by the ‘Basel II’ Framework issued by the Basel Committee on Banking Supervision) has been implemented in the European Union as part of the Capital Requirements Directive, approved by the European Parliament in 2006. It is applicable to firms within the scope of this Directive in the European Union and similar disclosure rules are also applicable in many other jurisdictions. In the UK it is implemented by the FSA through the Prudential Sourcebook for Banks, Building Societies and Investment Firms (BIPRU). The detailed requirements are set out in chapter 11 of BIPRU. BlackRock Group Limited is the parent company of the UK regulatory group (including European subsidiaries) and is subject to consolidated supervision by the FSA. The disclosure below specifically relates to this consolidation group and is in line with the requirements of BIPRU Chapter 11, in so far as they are applicable to its activities.

1. Risk Management Objectives & Policies The Board of Directors of BlackRock Group Limited is committed to maintaining a strong risk management, control and compliance environment and ensuring that an appropriate risk management framework is in place to deliver this. This framework forms an integral part of the firm’s overall approach to aligning business strategy and planning, capital management and risk management. It establishes a context in which risk management approaches and practices are embedded within BlackRock and highlights the key components of risk management which underpin our business operations. Business strategy and planning

Risk Management

Capital Management

In order to assist the Board in discharging its wider responsibilities, it has established an organisational structure which reflects the nature of the risks across the business. The key committee for risk management is the Risk & Controls Committee, a sub-committee of the EMEA Operating Committee. Responsibilities are then allocated to the various functions according to ‘three lines of defence’ as follows: •

Primary responsibility for managing risks rests with the business functions (e.g. Fund Managers, Sales Teams, Operations etc);

•

Risk management and control functions (Legal, Compliance, Finance, Risk & Quantitative Analysis, and Operational Risk departments) are responsible for ensuring that the risk policies and practices are consistent with the risk appetite of the Board and are maintained on an ongoing basis; and

•

Audit functions have the tertiary responsibility for providing the Board with reassurance that the business operates effectively in managing its risks.

As shown below there are three broad categories of risk – investment risk for client portfolios, balance sheet risk and operational risk. Although investment risk for client portfolios does not affect the firm’s capital adequacy in the short-term, in the longer term failure to manage this risk for clients can result in a reduction of earnings and hence audited reserves, which is an important component of capital resources.

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Balance Sheet Risk

Investment Risk for client portfolios Market Risk

Concentration Risk

Credit Risk

Operational Risk

Liquidity Risk

Operational Risk

Counterparty Credit Risk Seed Money Risk

Market Risk

In summary, the policies for addressing the different risk types above are as follows: (i) Investment Risk for client portfolios is addressed by the application of BlackRock’s investment management services to assist in respect of BlackRock’s clients in measuring, monitoring and mitigating market risk. Principal responsibility for this activity has been delegated to the Risk & Quantitative Analysis (RQA) department. There are two main types of investment risk: 1. Market Risk relates to the effect that fluctuations in interest rate, foreign exchange, equity, commodity, and other markets have on client portfolios. It is addressed by BlackRock’s various investment management agreements and fund prospectuses. As such, BlackRock’s responsibility is to manage investment risk as directed by its clients. The RQA team provides an independent review of investment performance both at the portfoliolevel and fund-level on at least a quarterly basis. Investment risk statistics are calculated using BARRA and other equity risk models and the Aladdin risk platform. Performance statistics are calculated using a combination of management tools. The results are presented to divisional management at least quarterly for independent review. 2. Counterparty Credit Risk is the risk that arises due to uncertainty in a counterparty’s ability to meet its obligations. BlackRock’s Counterparty Credit Policies and Operating Procedures have been established to ensure that BlackRock accurately identifies and evaluates counterparty credit risks, and establishes appropriate practices to manage these risks and maintain the overall quality of our clients’ counterparties. Institutions that meet minimum credit criteria, including capital levels and financial ratios, are deemed eligible as counterparties and internal global credit limits are recommended. Daily investment activities are monitored against these credit limits to ensure they are not breached. These are reviewed at a global level by the Global Chief Counterparty Credit Officer. (ii) Balance Sheet Risk is BlackRock’s financial exposure attributable to both internal and external influences. In general, balance sheet risks are addressed by the firm’s adherence to its Capital Management Policy. BlackRock has five main types of balance sheet risk: 1. Concentration Risk is BlackRock’s financial exposure to any single counterparty, which may arise in respect of: (1) Third-party exposures, such as fee income debtors (see Credit Risk) or single investment positions (see Seed Money Risk); and (2) Exposures to other entities in the BlackRock Group, resulting primarily from transfer pricing arrangements that relate to intercompany service fees (see Credit Risk). 2. Investment risk is BlackRock’s exposure as a result of making principal investments as follows: (i) The firm may take positions in its own funds by way of seed money investments. Proposals are considered on a case-by-case basis, by consideration of the principal exposure in relation to the nominated portfolio’s characteristics, as well as the strategic soundness of the investment decision and the redemption criteria. Seed money investments are monitored on an ongoing basis in respect of value and ageing profile, and with particular reference to the redemption criteria as defined at the outset. (ii) The firm may take positions in highly-rated, highly-liquid money market instruments as part of its prudent treasury approach to cash and liquidity management. Such investment takes place within the parameters of carefully monitored criteria in respect of counterparties, amounts, credit ratings and maturity profiles. 3

3. Credit Risk is BlackRock’s exposure to a counterparty or a group of connected counterparties failing to meet their obligations, including third-party debtors (fee Income and other debtors) and inter-company debtors. There is no history of losses in respect of third party debtors, as they are carefully monitored through aged debtors analyses and are low risk by nature. As regards intercompany debtors, these amounts are generally settled as they arise, and the amounts owing are carefully monitored, so that concentration risk limits are not breached. 4. Market Risk is applicable to BlackRock in respect of currency risk. Foreign exchange exposures arise operationally in relation to fee income and retrocession payments which are denominated in foreign currencies. These are monitored daily and where significant cash balances in foreign currencies arise, which cannot be matched with forecast outflows, the surplus funds are converted back into the functional currency of the relevant entity at the end of the month. 5. Liquidity Risk is the risk that BlackRock either does not have available sufficient liquid financial resources to enable it to meet its obligations as they fall due, or can secure such resources only at an excessive cost. BlackRock’s approach is to maintain sufficient liquid resources so as to avoid borrowing and the need for contingency funding arising from any liquidity risk to which it may be exposed. General guidelines include holding cash and cash equivalents equal to approximately three months expenditure, and a forecasting model is used to predict cash flows three months forward to assist in determining sufficient liquid capital.

(iii) Operational Risk is BlackRock’s financial exposure resulting from inadequate or failed internal processes, people and systems or from external events. Although Operational Risk is inherent in BlackRock’s investment management activities, BlackRock does not consider it appropriate to have an explicit appetite in respect of Operational Risk, and has a very low tolerance for it. This low tolerance is managed through a proactive approach to identifying Operational Risks and closely monitoring the effectiveness of our risk management and control functions.

2. Scope of Regulatory Reporting The consolidated UK Group reports its regulatory capital requirement to the FSA by applying the ‘aggregation method’ as follows: 1. 2. 3.

For each entity in the Group that is required to report under the Capital Requirements Directive (CRD) on a stand-alone basis, the credit risk, market risk and fixed overhead requirements are considered separately. For all other material entities, even though there is no requirement to report regulatory capital under CRD on a stand-alone basis, the credit risk, market risk and fixed overhead requirements are calculated and considered separately in the same way. The totals of the credit risk, market risk and fixed overhead requirements, being respectively the sum of the separate credit risk, market risk and fixed overhead requirements considered under 1 & 2 above, are then compared, and the capital requirement for the UK Group is deemed to be the higher of the total fixed overhead requirement and the sum of the total credit risk and market risk requirements.

As the total thus calculated is less than the amount of the regulatory capital resources of the UK Group, it is deemed to fulfil its minimum regulatory capital obligations. Likewise, each of the entities in the UK Group (as listed below) has sufficient capital resources in relation to its minimum regulatory capital requirement on a standalone basis. Furthermore, the entities are not subject to any significant impediments, whether practical or legal, to the transfer of resources within the group. Such transfers would normally relate to surplus distributable reserves that are released by dividend payments up the chain of ownership to BlackRock Group Limited, the ultimate parent of the UK Group. Conversely, in the possible event of an anticipated shortage of capital in a particular entity, there are no anticipated impediments to prevent re-capitalisation from the parent entity. Legal entities in the UK Group Capital resources and requirements of the individual entities are not disclosed in sections 3 & 4 below, with the exception of BlackRock Investment Management (UK) Limited, referred to in the tables below as ‘BIM UK’. This is

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the most material entity in the UK Group, whereas the capital amounts for the other entities are relatively small in relation to the group. A further entity, BlackRock Pensions Limited, which reports its capital requirement according to the Prudential Sourcebook for Insurers (INSPRU), is excluded from the scope of consolidation as described in section 2 above. Rather the value of the UK Group’s investment in BlackRock Pensions Ltd, GBP 15m, has been included under ‘Material Holdings’ and so deducted from Capital Resources. This is reflected in the table in section 3 below. BlackRock Investment Management (UK) Limited BlackRock Investment Management International Limited BlackRock Asset Management UK Limited BlackRock International Limited BlackRock (Netherlands) B.V. BlackRock Fund Managers Limited BlackRock Investment Management (Dublin) Limited BlackRock (Luxembourg) S.A. BlackRock (Deutschland) GmbH Mercury Carry Company Ltd. (Isle of Man)

CRD regulated CRD regulated CRD regulated CRD regulated CRD regulated Other material entity Other material entity Other material entity Other material entity Other material entity

3. Capital Resources The amount and type of capital resources of both BlackRock Investment Management Limited (‘BIM UK’) and the UK Group as at 31 Dec 2007 are set out in the table below: Resources Tier One Capital

Tier Two Capital Tier Three Capital Less deductions

Ordinary share capital Share premium Audited reserves Other reserves Non-fixed-term cumulative preference shares None Material holdings

Total

BIM UK (largest entity) GBP million 159.0 0.0 39.4 0.0 0.0

UK Group (consolidated) GBP million 56.1 155.9 68.4 7.0 56.1

0.0

0.0

-15.0

-16.1

183.4

327.4

4. Minimum Capital Requirements The minimum capital requirements are established with reference to the Credit risk, Market risk and Fixed Overhead Requirements under the Pillar 1 rules for ‘limited licence’ groups in the UK. The group applies the standardised approach to credit risk, which in practice means that balance sheet asset exposures are risk-weighted at 1.6% or 4% or 8%, depending on the type of counterparty, or 12% for fee income debtors that are over ninety days past due. It is not the group’s policy to post provisions in respect of overdue items, since the firm has no history of bad debt losses. As at 31 December 2007 market risk applied only to foreign exchange risk, calculated as 8% of the net long and net short open positions in each non-GBP denominated currency. 5

The fixed overhead requirement is calculated as one quarter of annual expenditure not including variable elements such as incentive-based compensation. The amounts as at 31 Dec 2007 are summarised in the table below: Capital Requirements

BIM UK (largest entity) GBP million

UK Group (consolidated) GBP million

27.6 1.9

34.6 10.0

Up to 12% of exposure amount

29.5

44.6

Market risk (2)

8% of net open positions

6.4

5.4

Fixed Overhead Requirement (3)

25% of non-variable annual expenses

51.2

(higher of 1+2 & 3)

51.2

Credit risk (standardised approach) Sundry debtors Seed money & other investments Total Credit risk (1)

Total

63.2 63.2

The firm considers that the detailed disclosures required under BIPRU 11.5.are immaterial and therefore, in accordance with BIPRU 11.3.5 and BIPRU 11.4.1, not required. Seed investments are included in credit risk as above, the balance sheet amounts being determined on an historic cost basis. The investments are undertaken, usually at the inception of a new fund, in order to ensure that investment capital is available to the fund in the short-term, until sufficient client assets are forthcoming. The amount of seed investments as at 31 Dec 2007 are as follows: Seed Investments

Seed investments in total

Historic cost amount GBP million

Unrealized gains/(losses) GBP million

Market Value GBP million

78.0

2.0

80.0

Realised gains and losses on Seed investments Whereas the firm monitors the value of its seed investments on a monthly basis, there is no recognition of investment gains until the point of sale. In the accounting period ended 31 December 2007, the amount of realised gains thus recognised on sale, was GBP 2.2 million. As regards the recognition of losses, if these are material, then the losses would have to be realised by re-stating the investments at market value, since UK accounting principles require that such investments are shown at the lower of cost and market value. There were no such losses in the accounting period ended 31 December 2007, and therefore the amount of realised losses was nil.

5. Internal assessment of Risk The minimum capital requirements are calculated in accordance with the ‘Pillar One’ rules. There is also an internal capital adequacy assessment process (ICAAP) in accordance with ‘Pillar Two’ requirements. The latter approach is to test the sufficiency of the capital requirement as calculated under Pillar One as follows: 1.

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The credit and market risk capital requirements are tested by an internal analysis including liquidity risk, and counterparty concentration risk.

2. 3.

The fixed overhead requirement is tested by estimating the amount of liquid resources that would be needed to ensure an orderly winding-down of the firm in a distressed situation, using a short-term cash flow model. The overall capital adequacy is tested in relation to the probability-weighted losses resulting from various adverse scenarios, either arising from external factors (such as an economic recession) or from the materialisation of business and operational risks, as identified in the firm’s ‘Risk Register’, which is ascertained through a rigorous internal risk assessment process).

This approach ensures an exhaustive consideration of all significant risks relevant to the firm, and is based on wide consultation with senior managers across all the different functions. The results of these assessments, undertaken in full at the end of each year and reviewed and updated each quarter, currently indicate that the Pillar One requirement is greater than any resulting capital requirement thus calculated. Therefore no additional Pillar Two requirement is considered necessary.

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