# NOMURA GLOBAL FINANCIAL PRODUCTS INC. X-17A-5 (2020-06-01) — Broker-dealer annual report - Company: NOMURA GLOBAL FINANCIAL PRODUCTS INC. - Form: X-17A-5 - Filed: 2020-06-01 - Period: 2020-03-31 - Accession: 0001564206-20-000007 - CIK: 1564206 - File #: 8-69208 - Material weakness: No - Auditor: Ernst & Young - Auditor location: New York, NY - Contact: Christy Schaffner - Phone: 212-667-8903 - Signed by: Eugene Chiulli and William Hughes (Managing Directors) Original filing: https://www.sec.gov/Archives/edgar/data/1564206/000156420620000007/ngfp_fs33120asfc1.pdf --- {0}------------------------------------------------ ### STATEMENT O F FINANCIAL CONDITION Nomura Global Financial Products Inc. March 31, 2020 With Report of Independent Auditors {1}------------------------------------------------ **UNITED STATES SECURITIES AND EXCHANGE COMMISSION Washington, D.C. 20549** ## **ANNUAL AUDITED REPORT FORM X-17A-5 PART IIB** | | | | SEC FILE NUMBER | |--|--|--|-----------------| |--|--|--|-----------------| **8-69208** ### **FACING PAGE** **Information Required of Brokers and Dealers Pursuant to Section 17 of the Securities Exchange Act of 1934 and Rule 17a-5 Thereunder** REPORT FOR THE PERIOD BEGINNING **April 1.2019** AND ENDING **March 31,2020** ## **A. REGISTRANT IDENTIFICATION** NAME OF BROKER-DEALER: **NOMURA GLOBAL FINANCIAL PRODUCTS INC.** ADDRESS OF PRINCIPAL PLACE OF BUSINESS: (Do not use P.O. Box No.) #### **WORLDWIDE PLAZA, 309 WEST 49th STREET** | | (No. and Street) | | |----------|------------------|------------| | NEW YORK | NEW YORK | 10019-7316 | | | | | | (City) | (State) | (Zip Code) | NAME AND TELEPHONE NUMBER OF PERSON TO CONTACT IN REGARD TO THIS REPORT **Christy Schaffner (212) 667-8903** (Area Code - Telephone No.) ## **B. ACCOUNTANT IDENTIFICATION** INDEPENDENT PUBLIC ACCOUNTANT whose opinion is contained in this Report\* **Ernst & Young LLP** | (Name -
ofindividual, state last, first, middle name) | | | | |----------------------------------------------------------|----------|---------|------------| | 5 Times Square | New York | NY | 10036 | | (Address) | (City) | (State) | (Zip Code) | #### **CHECK ONE:** - ^ Certified Public Accountant - Public Accountant Accountant not resident in United States or any of its possessions. #### **FOR OFFICIAL USE ONLY** *\*Claims for exemption from the requirement that the annual report be covered by the opinion of an independent public accountant must be supported by a statement offacts and circumstances relied on as the basis for the exemption. See section 240.17a-12(n).* SEC 1410 (06-02) Potential persons who are to respond to the collection of information contained in this form are not required to respond unless the form displays a currently valid OMB control number. OFFICIAL USE ONLY FIRM IU. NO. {2}------------------------------------------------ #### **OATH OR AFFIRMATION** We, Eugene Chiulli and Richard Lunder, swear (or affirm) that, to the best of our knowledge and belief the accompanying statement of financial condition pertaining to the firm of Nomura Global Financial Products Inc., (the "Company") as of March 31, 2020, is true and correct. We further swear (or affirm) that based upon information available to us, neither the Company nor any partner, proprietor, principal officer or director has any proprietary interest in any account classified solely as that of a customer. **RYAN JAKE LAST Notary Public, State of New York Registration #02LA6337349 Qualified In New York County Commission Expires Feb.** *22£OA\*f* Name: Eugene-SHiulli Title: Chief Financial Officer Name: Richard Lunder Title: Chief Operating Officer This report\*\* contains (check all applicable boxes): - (a) Facing page. - ^ (b) Statement of Financial Condition. - (c) Statement of Income (Loss). - (d) Statement of Cash Flows. - (e) Statement of Changes in Stockholders' Equity or Partners' or Sole Proprietor's Capital. - (f) Statement of Changes in Liabilities Subordinated to Claims or Creditors. - (g) Computation of Net Capital. - (h) Formula for Determination of Customer Account Reserve Requirements of Brokers and Dealers under SEC Rule 15c3-3. - (i) Formula for Determination of PAB Reserve Requirements of Brokers and Dealers under SECRule 15c3-3. - (j) Information Relating to the Possession or Control Requirements under Rule 15c3-3. - (k) A Reconciliation, including appropriate explanation, of the Computation of Net Capital under Rule 15c3-1 and the Computation for Determination of the Reserve Requirements under Exhibit A or Rule 15c3-3. - (I) A Reconciliation between the audited and unaudited Statements of Financial Condition with respect to methods of consolidation. - *S* (m) An Oath or Affirmation. - (n) A copy of the SI PC Supplemental Report. - (o) A report describing any material inadequacies found to exist or found to have existed since the date of the previous audit. - (p) Independent auditor's report on Internal Control. *'For conditions of confidential treatment of certain portions of this filing, see section 240.17a-12.* {3}------------------------------------------------ Nomura Global Financial Products Inc. Statement of Financial Condition March 31, 2020 ### **Contents** | Report of Independent Auditors 1 | | |----------------------------------------------|--| | Statement of Financial Condition 2 | | | Notes to Statement of Financial Condition 3 | | {4}------------------------------------------------ ![](_page_4_Picture_0.jpeg) Ernst & Young, LLP 5 Times Square New York, NY 10036 Tel: +1 212 773 3000 ey.com ### **Report of Independent Auditors** Stockholder and Board of Directors of Nomura Global Financial Products Inc. We have audited the accompanying statement of financial condition of Nomura Global Financial Products Inc. (the "Company") as of March 31, 2020 and the related notes (the "financial statement"). ### **Management's Responsibility for the Financial Statement** Management is responsible for the preparation and fair presentation of this financial statement in conformity with U.S. generally accepted accounting principles; this includes the design, implementation and maintenance of internal control relevant to the preparation and fair presentation of the financial statement that is free of material misstatement, whether due to fraud or error. #### **Auditor's Responsibility** Our responsibility is to express an opinion on this financial statement based on our audit. We conducted our audit in accordance with auditing standards generally accepted in the United States. Those standards require that we plan and perform the audit to obtain reasonable assurance about whether the financial statement is free of material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statement. The procedures selected depend on the auditor's judgment, including the assessment of the risks of material misstatement of the financial statement, whether due to fraud or error. In making those risk assessments, the auditor considers internal control relevant to the entity's preparation and fair presentation of the financial statement in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity's internal control. Accordingly, we express no such opinion. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of significant accounting estimates made by management, as well as evaluating the overall financial statement presentation. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. ### **Opinion** In our opinion, the financial statement referred to above presents fairly, in all material respects, the financial position of the Company at March 31, 2020, in conformity with U.S. generally accepted accounting principles. May 29, 2020 {5}------------------------------------------------ ## Nomura Global Financial Products Inc. Statement of Financial Condition March 31, 2020 *(United States Dollars in Thousands)* | Assets
Cash | | \$
147,667 | |------------------------------------------------------------------------------------------|-----------------|----------------------------| | Deposit with clearing organization | | 27,453 | | Trading assets:
Financial instruments owned (including assets pledged of \$5,329,848) | \$
6,415,630 | | | Derivative financial instruments - customers | 5,049,823 | | | Derivative financial instruments - affiliates | 6,396 | | | | | 11,471,849 | | Collateralized financing agreements: | | | | Securities borrowed | 7,851,893 | | | Securities purchased under agreements to resell | 2,593,037 | | | | | 10,444,930 | | Receivables: | | | | Brokers, dealers and clearing organizations | 1,345,632 | | | Customers | 978,796 | | | Loans receivable from customers at fair value | 193,502 | | | Short term loans receivable from affiliate | 4,471 | | | Accrued interest | 19,776 | | | | | 2,542,177 | | Other assets
Total assets | | \$
73,347
24,707,423 | | | | | | Liabilities and stockholder's equity | | | | Liabilities:
Trading liabilities: | | | | Financial instruments sold, not yet purchased | \$
7,630,990 | | | Derivative financial instruments - customers | 6,230,352 | | | Derivative financial instruments - affiliates | 231,346 | | | | | \$
14,092,688 | | Collateralized financing agreements: | | | | Securities loaned | 3,973,703 | | | Securities sold under agreements to repurchase | 546,557 | | | | | 4,520,260 | | Borrowings from Parent | | 2,712,800 | | Payables: | | | | Customers | 1,491,741 | | | Brokers, dealers and clearing organizations | 213,704 | | | Other payables to affiliates | 10,546 | | | Accrued interest | 11,910 | | | Compensation and benefits | 2,522 | | | | | 1,730,423 | | Other liabilities | | 43,421 | | Subordinated borrowing
Borrowing at fair value | | 700,000
10,420 | | Total liabilities | | 23,810,012 | | | | | | Contingent liabilities and guarantees (see Note 11) | | | | Stockholder's equity: | | | | Common stock, without par value, 2,000 shares authorized, | | | | 1,900 shares issued and outstanding | - | | | Additional paid in capital | 1,258,295 | | | Accumulated deficit | (360,884) | | | Total stockholder's equity | | 897,411 | | Total liabilities and stockholder's equity | | \$
24,707,423 | *See accompanying notes to Statement of Financial Condition.* {6}------------------------------------------------ ## Nomura Global Financial Products Inc. Notes to Statement of Financial Condition March 31, 2020 ## **1. Organization** *.* Nomura Global Financial Products Inc. (the "Company" or "NGFP") is a wholly owned subsidiary of Nomura Holding America Inc. ("NHA" or the "Parent"), which itself is wholly owned by Nomura Holdings, Inc. ("NHI" or "Nomura"), a Japanese corporation. The Company is a Securities and Exchange Commission ("SEC") registered OTC Derivatives Dealer (a special category of broker-dealer engaged in an OTC derivatives business) under section 15(b) of the Securities Exchange Act of 1934 (the "Act"). The Company is also provisionally registered as a swap dealer with the Commodity Futures Trading Commission ("CFTC"). The Company purchases and sells over-the-counter ("OTC") derivatives to assist institutional investors in implementing their trading or hedging strategies. The Company also purchases and sells cash securities and exchange traded derivative positions to hedge its trading positions and enters into principal transactions for its own account. The Company's most significant activity is acting as one of Nomura's predominant client-facing entities for OTC interest rate swaps globally. In certain cases, the Company may hedge the market risk of client facing transactions by entering into offsetting derivative trades with affiliates, including Nomura Securities Co., Ltd. ("NSC") and Nomura Financial Products & Services, Inc. ("NFPS"). The Company also assumes market risk by entering into equity, foreign exchange, and credit derivative transactions, often by entering into derivative trades with affiliates such as Nomura International PLC ("NIP") and NFPS, which often act as the client-facing entities. The Company's affiliate, Nomura Derivatives Products Inc. ("NDPI"), which is also a subsidiary of NHA, acts as a credit enhancement vehicle for NHI's OTC derivatives business, and accordingly also acts as an intermediary between the Company and certain other external counterparties. Substantially all of NDPI's derivative transactions with non-Nomura counterparties are economically hedged with offsetting derivative trades with the Company, leaving NGFP with market risk on such transactions, which it often hedges with affiliates or third parties. In addition, where necessary, NDPI provides guarantees for certain OTC derivatives transactions entered into by the Company, which could require NDPI to make payments to certain of the Company's counterparties if the Company failed to perform. NSC is also a co-guarantor for certain of these transactions. The Company collateralizes NDPI under a reimbursement agreement for NDPI's potential exposure under these guarantees. NHI and NSC guarantee the Company's obligations to NDPI under the reimbursement agreement. The Company manages, analyzes and reports on its business on the basis of one operating segment. {7}------------------------------------------------ ## **2. Significant Accounting Policies** ### **Use of Estimates** The Statement of Financial Condition is presented in conformity with accounting principles generally accepted in the United States, which require management to make estimates and assumptions that affect the amounts reported in the Statement of Financial Condition and accompanying notes. Management believes that the estimates utilized in preparing its Statement of Financial Condition are reasonable and prudent. Actual results could differ from those estimates. During times of financial crisis and dislocated markets, such as during the current COVID-19 pandemic, additional use of estimates may be required or existing estimates may be increasingly judgmental. ### **Foreign Currency** Assets and liabilities denominated in non-United States dollar currencies are remeasured into United States dollar equivalents at spot foreign exchange rates prevailing on the date of the Statement of Financial Condition, while revenue and expense accounts are remeasured at the actual foreign exchange rate on the date the transaction occurred. Gains and losses resulting from non-United States dollar currency transactions are included in income. ### **Cash** At times, cash balances will exceed Federally insured levels, however the Company does not believe there is significant credit risk with respect to these balances. The Company defines cash equivalents to be highly liquid investments with original maturities of three months or less, other than those held for trading purposes. At March 31, 2020, the Company did not have cash equivalents. ### **Fair Value Measurements** A significant amount of the assets and liabilities of the Company are carried at fair value on a recurring basis with changes in fair value recognized in income under various accounting literature, principally applicable industry guidance, such as Accounting Standards Codification ("ASC") 940, *Financial Services – Brokers and Dealers* ("ASC 940"), but also, ASC 815, *Derivatives and Hedging* ("ASC 815") and by the fair value option election in accordance with ASC 825, *Financial Instruments* ("ASC 825"). If the Company elects the fair value option for an eligible item, changes in that item's fair value in subsequent reporting periods must be recognized in current earnings. The Company applies the fair value option to loans receivable from customers and borrowings. {8}------------------------------------------------ ASC 820, *Fair Value Measurements and Disclosures* ("ASC 820") defines fair value, establishes a framework for measuring fair value, establishes a fair value hierarchy based on the quality of inputs used to measure fair value and determines disclosures associated with the use of fair value requirements (see Note 5). Assets and liabilities recorded at fair value on the Statement of Financial Condition are categorized for disclosure purposes, based upon the level of judgment associated with the inputs used to measure their fair value. Hierarchical levels are defined by ASC 820 and are directly related to the amount of subjectivity associated with the inputs to fair valuation of these assets and liabilities (see Note 5). *Trading assets* and *Trading liabilities*, including long and short securities positions and contractual commitments arising pursuant to derivatives contracts, are recorded on the Statement of Financial Condition on a trade date basis at fair value, with realized and unrealized gains and losses reflected in income. Derivative financial instruments are presented on a net-by-counterparty basis where evidence that an enforceable legal right of setoff exists, in accordance with ASC 210-20, *Balance Sheet – Offsetting* ("ASC 210-20") and ASC 815-10-45, *Derivatives and Hedging – Overall – Other Presentation Matters* ("ASC 815-10-45"). The fair value is netted across products where allowable in the associated master netting agreements. Also, the Company generally offsets fair value amounts recognized for the right to reclaim cash collateral (a receivable) or the obligation to return cash collateral (a payable) against fair value amounts recognized for derivative instruments that are eligible for offset under the same master netting agreements. ## **Transfers of Financial Assets** The Company accounts for the transfer of a financial asset as a sale when it relinquishes control over the asset by meeting the following conditions outlined in ASC 860, *Transfers and Servicing* ("ASC 860"), (a) the asset has been isolated from the transferor (even in bankruptcy or other receivership), (b) the transferee has the right to pledge or exchange the asset received, or if the transferee is an entity whose sole purpose is to engage in securitization or asset-backed financing activities, if the holders of its beneficial interests have the right to pledge or exchange the beneficial interests held and (c) the transferor has not maintained effective control over the transferred asset. In connection with one of its financing transactions, the Company has not met the legal isolation sale criterion for transferred assets, because the transaction is comprised of a purchase with a total return swap entered into with a transferee in contemplation of the initial transfer, whereby the transferor retains substantially all of the exposure to the economic return on the transferred financial assets throughout the term of the transaction. As a result, this transaction is recorded as *Loans receivable from customers at fair value*. ### **Borrowing at fair value** *Borrowing at fair value* represents a financing transaction documented as a derivative which failed the ASC 815 definition of a derivative due to the significance of the upfront payment required under the contract. {9}------------------------------------------------ ## **Collateralized Financing Agreements** *Securities purchased under agreements to resell* ("resale agreements") and *Securities sold under agreements to repurchase* ("repurchase agreements") are treated as financing transactions and are carried at the amounts at which the securities will be subsequently resold or reacquired plus accrued interest. Repurchase and resale agreements are presented on a net-by-counterparty basis on the Statement of Financial Condition where net presentation is permitted by ASC 210-20. It is the Company's policy to take possession of securities collateralizing resale agreements. Similarly, counterparties take possession of the securities pledged by the Company to collateralize repurchase agreements. Substantially all of these transactions are collateralized by United States government, agency and other sovereign government securities. The Company monitors the market value of the underlying securities as compared to the related receivables or payables, including accrued interest, and typically requests or returns additional collateral when deemed appropriate. *Securities borrowed* and *Securities loaned* are included on the Statement of Financial Condition at the amount of cash collateral advanced or received plus accrued interest*. Securities borrowed* transactions require the Company to deposit cash, letters of credit or other securities with the lender. With respect to *Securities loaned*, the Company receives collateral in the form of cash or other securities. When securities are pledged as collateral for securities borrowed, such transactions are not recorded on the Statement of Financial Condition. The Company monitors the market value of the securities borrowed or loaned against the collateral on a daily basis and additional cash or securities are obtained or refunded as necessary, to ensure that such transactions are adequately collateralized for the Company's risk management purposes. ### **Receivables from and Payables to Customers** Receivables from and Payables to customers include the portion of cash collateral posted to and received from counterparties for derivative transactions, which is not eligible for netting under ASC 815-10-45 or where the cash collateral delivered/received exceeds the related derivative payable/receivable as of the date of the Statement of Financial Condition. During the year ended March 31, 2020, the Company deemed a receivable from customer to be impaired and recorded an allowance for credit loss of \$11.8 million. ### **Receivables from and Payables to Brokers, Dealers and Clearing Organizations** Receivables from and Payables to brokers, dealers and clearing organizations, including affiliates, consist of securities failed-to-deliver/receive, margin with clearing broker-dealers related to exchange traded derivatives and pending trades. Securities failed-to-deliver and receive represent the contract value of securities which have not been delivered or received by the Company on settlement date. Pending trades represent the net amount on unsettled securities transactions. {10}------------------------------------------------ ### **Revenue Recognition** Principal transactions revenues consist of revenues related to realized and unrealized gains and losses on securities and derivative financial instruments. Also included in principal transactions are model reserves and counterparty and own credit risk adjustments on derivative transactions, and changes in fair value of *Borrowing at fair value* and *Loans receivable from customers at fair value*. Interest and dividends income is earned primarily from *Financial instruments owned, Loans receivable from customers at fair value, Securities borrowed, Securities purchased under agreements to resell*, and cash collateral pledged (see Note 6) and is accounted for on an accrual basis. Transfer pricing includes amounts paid and received from affiliate companies under transfer pricing agreements (see Note 4). Additionally, the Company earns fees for certain operational and administrative services provided to related parties; these fees are determined under a service level agreement. Revenues are recognized as earned and are accounted for on an accrual basis (see Note 4). ### **Expenses** Interest and dividends expense is incurred primarily on *Securities loaned*, *Borrowings from Parent, Securities sold under agreements to repurchase*, *Borrowing at fair value* and cash collateral received (see Note 6) and is accounted for on an accrual basis. Service fees with related parties primarily includes sales credits paid to affiliate companies that essentially represent internal commissions to an entity involved in sales efforts. Service fees with related parties also includes costs, for operational and administrative functions outsourced to affiliate companies, primarily NDPI, NHA and Nomura Securities International, Inc. ("NSI"), reduced by reimbursements received from these parties. These fees are determined either under service agreements or an allocation method approved by management (see *Operational and administrative arrangements* in Note 4). Commissions and brokers fees include clearance, execution, transaction and commission fees to affiliates and non-affiliates as incurred and are accounted for on an accrual basis. ### **Income Taxes** Certain income and expense items are accounted for in different periods for income tax purposes as compared to financial reporting purposes. Provisions for deferred taxes are made in recognition of these temporary differences in accordance with the provisions of ASC 740, *Income Taxes* ("ASC 740"). ASC 740 also provides guidance and prescribes a recognition threshold and measurement attribute for financial statement recognition and measurement of uncertain tax positions (see Note 12). The Company's policy is to treat interest and/or penalties related to income tax matters and uncertain tax positions as part of pre-tax income. {11}------------------------------------------------ ### **New Accounting Pronouncements** The Company adopted the following new accounting pronouncements during the year ended March 31, 2020. | Pronouncement | Summary of new guidance | Adoption date
and method of
adoption | Effect on this
Statement of
Financial Condition | |--------------------------|-----------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------------------|-------------------------------------------------------| | ASU 2016-02,
"Leases" | • Replaces ASC 840 "Leases", the current
guidance on lease accounting, and revised
the definition of a lease.
• Requires all lessees to recognize a right of use
asset and corresponding lease liability on
balance sheet.
• Lessor accounting is largely unchanged from
current guidance.
• Simplifies the accounting for sale leaseback
and "built-to-suit" leases.
• Requires extensive new qualitative and
quantitative footnote disclosures on lease
agreements. | Modified retrospective
adoption from
April 1, 2019 | No impact. | ### **Future Accounting Pronouncements** The following new accounting pronouncements relevant to the Company will be adopted in future periods: {12}------------------------------------------------ | Pronouncement | Summary of new guidance | Expected adoption date
and method of
adoption | Expected effect on
this Statement of
Financial Condition | | | | | |--------------------------------------------------|------------------------------------------------------------------------------------------------------------------------|-----------------------------------------------------|----------------------------------------------------------------|--|--|--|--| | ASU 2016-13, | • Introduces a new model for recognition and | Modified retrospective | No impact. | | | | | | "Measurement of Credit | measurement of credit losses against certain | adoption from | | | | | | | Losses on Financial | financial instruments such as loans, debt | April 1, 2020 | | | | | | | Instruments" | securities and receivables which are not | | | | | | | | | carried at fair value with changes in fair | | | | | | | | | value recognized through earnings. The | | | | | | | | | model also applies to off balance sheet | | | | | | | | | credit exposures such as written loan | | | | | | | | | commitments, standby letters of credit | | | | | | | | | and issued financial guarantees not | | | | | | | | | accounted for as insurance, which are | | | | | | | | | not carried at fair value through earnings. | | | | | | | | | • The new model based on lifetime current | | | | | | | | | expected credit losses (CECL) measurement, | | | | | | | | | to be recognized at the time an in-scope | | | | | | | | | instrument is originated, acquired or | | | | | | | | | issued | | | | | | | | | • Replaces existing incurred credit losses | | | | | | | | | model under GAAP. | | | | | | | | | Requires enhanced qualitative and | | | | | | | | | quantitative disclosures around credit | | | | | | | | | risk, the methodology used to estimate | | | | | | | | | and monitor expected credit losses and | | | | | | | | | changes in estimates of expected credit | | | | | | | | | losses. | | | | | | | | ASU 2019-12, | • Simplifies the accounting for income taxes by removing | Effective from | Currently evaluating | | | | | | "Simplifying the Accounting
for Income Taxes" | certain exceptions to the general principles in ASC 740
"Income Taxes", such as the exception to the requirement to | April 1, 2021 | the potential impact. | | | | | | | recognize a deferred tax liability for equity method | Modified retrospective | | | | | | | | investments when a foreign subsidiary becomes an equity | adoption for the amendments | | | | | | | | method investment and the exception to the ability not to | related to changes in | | | | | | | | recognize a deferred tax liability for a foreign subsidiary | ownership of foreign entity | | | | | | | | when a foreign equity method investment becomes a | method investments or | | | | | | | | subsidiary. | foreign subsidiaries. | | | | | | | | • Requires an entity to recognize a franchise tax (or similar | | | | | | | | | tax) that is partially based on income as an income-based tax | Full or modified retrospective | | | | | | | | and account for any incremental amount incurred as a | adoption for the amendments | | | | | | | | non-income-based tax. | related to franchise taxes that | | | | | | | | • Makes other minor amendments for simplification and | are partially based on income. | | | | | | | | clarification of income taxes accounting. | | | | | | | | | | Prospective adoption for | | | | | | ### **3. Deposit with Clearing Organization** *Deposit with clearing organization ("restricted cash")* is presented separate from *Cash* in the Statement of Financial Condition, but presented together in the Statement of Cash Flows. It consists entirely of a guarantee deposit with a derivatives clearing organization. This amount is determined by such clearing organization and is subject to change. all other amendments. {13}------------------------------------------------ ### **4. Transactions with Related Parties** The Company's transactions with affiliates include derivative transactions, purchase of various services and financing activities in the form of short term loans to affiliates, loans to affiliate customers, borrowings from Parent and secured financing transactions such as securities borrowed, resale agreements, securities loaned, repurchase agreements and borrowings at fair value. Generally, the Company's derivative positions with affiliates are offset by positions with third parties. As mentioned in Note 1, the Company enters into a significant number of OTC derivatives as a result of acting as an intermediary between its Nomura affiliates, including NSC, NIP, NFPS and non-Nomura parties. Substantially all of NDPI's derivative transactions with non-Nomura counterparties are economically hedged with offsetting derivative trades with the Company. The Company also clears most of its exchange traded derivative activity and some of its OTC derivative activity subject to central clearing ("OTC Centrally Cleared Derivatives") through affiliates such as NIP and NSI. In addition, NDPI provides guarantees for certain OTC derivatives transactions entered into by the Company, which could require NDPI to make payments to certain of the Company's counterparties if the Company failed to perform. NSC is also a co-guarantor for certain of these transactions. The Company collateralizes NDPI under a reimbursement agreement for NDPI's potential exposure under these guarantees. NHI and NSC guarantee the Company's obligations to NDPI under the reimbursement agreement. At March 31, 2020, \$0.2 million in cash collateral was pledged to NDPI in relation to guarantees by the Company. At March 31, 2020, on a counterparty basis, there were no net liabilities on a fair value basis from derivative transactions between the Company and third parties guaranteed by NDPI. ### *Transaction Execution Services Agreement* The Company is a party to a Transaction Execution Services Agreement ("TESA") involving certain other Nomura affiliates ("TESA Affiliates") where the parties to the TESA provide trade execution services ("Services") for certain products to one or more of the other TESA Affiliates in accordance with US transfer pricing regulations and Organization for Economic Co-operation and Development transfer pricing guidelines. The Company pays and receives amounts related to profits on positions as well as interest revenue, less certain deductions for direct and indirect costs related to the revenues ("TESA Revenues"). TESA revenues are determined on a fiscal year to date basis. The Company records these payments and receipts within income. ### *Sales Credits* The Company pays to other Nomura entities sales credits essentially representing an internal commission to an entity involved in sales efforts. Payments are recorded in income. {14}------------------------------------------------ #### *Operational and Administrative Arrangements* The Company reimburses affiliates for the expenses incurred in providing office space and other equipment used by the Company. Additionally, the Company reimburses affiliates for expenses and certain other costs, which the affiliates pay on behalf of the Company and receives reimbursements from affiliates for certain expenses incurred by the Company on the affiliates' behalf. These reimbursements are reflected net, in income. At March 31, 2020, balances with related parties are included in the accompanying Statement of Financial Condition captions (in thousands): ### **Assets** | Derivative financial instruments - affiliates(1) | \$
6,396 | |------------------------------------------------------------------------------------------------------------------------------------------------------|----------------------------------------------| | Securities borrowed | 7,851,893 | | Securities purchased under agreement to resell(1)
Receivables: | 2,593,037 | | Brokers, dealers and clearing organizations
Customers | 748,099
730,424 | | Loans receivable from customers at fair value
Short term loans receivable from affiliate | 118,833
4,471 | | Other assets | 19,982 | | Liabilities | | | Derivative financial instruments - affiliates(1)
Securities loaned
Securities sold under agreements to repurchase(1)
Borrowings from Parent | 231,346
3,973,703
546,557
2,712,800 | | Payables:
Customers | 115,582 | | Brokers, dealers and clearing organizations | 9,132 | | Accrued interest | 6,772 | | Other payables to affiliates | 10,546 | | Subordinated borrowing | 700,000 | (1) Represents amounts after counterparty netting in accordance with ASC 210-20. *Short term loans receivable from affiliate* consists of deposits of \$4.5 million due from NDPI at March 31, 2020. NDPI is required to defer certain settlement payments due by NDPI on derivatives with NGFP for one month after settlement date, using a calculation methodology set forth in a credit rating agency guideline applicable to NDPI. To simplify the arrangement operationally, the Company deposits funds with NDPI ahead of expected settlements of derivatives due by NDPI and NDPI is required to hold these NGFP deposits for one month. This has a similar effect from a cash flow perspective as allowing NDPI to defer {15}------------------------------------------------ cash settlement payments to NGFP within a given month. Interest rates on these deposits ranged from (0.5)% to 1.0% at March 31, 2020. Different interest rates charged reflect the relevant currencies involved. Negative interest rates are attributed to foreign currency deposits on which the Company does not receive interest income but pays a fee instead. Interest income on these loans was immaterial during the year ended March 31, 2020. *Borrowings from Parent* represents one overnight loan totaling \$1.9 billion and one term loan totaling \$837 million payable to NHA. The original maturity of the term loan was May 2020. In May, the loan was extended with a new maturity of August 2020. At March 31, 2020, the interest rate payable on these loans ranged from 0.64% to 2.04%. Different interest rates charged reflect the relevant currencies involved. *Receivables from brokers, dealers and clearing organizations* is primarily comprised of receivables of \$740.9 million from affiliates in relation to cash collateral posted to affiliates in their capacity as clearing broker for the Company on exchange traded derivatives. *Payables to brokers, dealers and clearing organizations* is primarily comprised of amounts payable to NSI in relation to securities loaned/borrowed activity and acting in its capacity as clearing broker for the Company. *Receivables from/Payable to customers* is primarily comprised of excess cash collateral posted to/received from affiliates in relation to derivatives activities. *Loans receivable from customers at fair value* primarily represent transactions with an affiliate which are documented as derivatives, but failed the ASC 815 definition of a derivative due to the upfront payments received on the contracts. ## **5. Fair Value Measurements** ### **The Fair Value of Financial Instruments** A significant amount of the Company's financial instruments are carried at fair value. Financial instruments that are carried at fair value on a recurring basis include *Trading assets* and *Trading liabilities*. Additionally, the Company applies the fair value option to *Loans receivable from customers at fair value* and *Borrowing at fair value.* In all cases, fair value is determined in accordance with ASC 820, which defines fair value as the amount that would be exchanged to sell a financial asset or transfer a financial liability in an orderly transaction between market participants at the measurement date. It assumes the transaction occurs in the Company's principal market, or in the absence of the principal market, the most advantageous market for the relevant financial asset or liability. {16}------------------------------------------------ ## **Valuation Methodology for Financial Instruments Carried at Fair Value on a Recurring Basis** The fair value of financial instruments is based on quoted market prices including market indices, broker or dealer quotations or an estimation by management of the expected exit price under current market conditions. Certain OTC contracts have bid and offer prices that are observable in the market. These are measured at the point within the bid-offer range which best represents the Company's estimate of fair value. Where quoted market prices or broker or dealer quotations are not available, prices for similar instruments or valuation pricing models are considered in the determination of fair value. Where quoted prices are available in active markets, no valuation adjustments are taken to modify the fair value of assets or liabilities that are marked using such prices. Certain instruments may be measured using valuation techniques, such as valuation pricing models incorporating observable parameters, unobservable parameters or a combination of both. Valuation pricing models use parameters which would be considered by market participants in valuing similar financial instruments. Valuation pricing models and their underlying assumptions impact the amount of unrealized gains and losses recognized. The use of different valuation pricing models or underlying assumptions could produce different financial results. Valuation uncertainty results from a variety of factors, including the valuation technique or model selected, the quantitative assumptions used within the valuation model, the inputs into the model, as well as other factors. Valuation adjustments are used to reflect the assessment of this uncertainty. Common valuation adjustments include model reserves, credit adjustments, close-out adjustments, and other appropriate instrument-specific adjustments, such as those to reflect transfer or sale restrictions. The degree of adjustments is largely judgmental and is based on an assessment of the factors that management believes other market participants would use in determining the fair value of similar financial instruments. The type of adjustments taken, the methodology for the calculation of these adjustments and the inputs for these calculations are reassessed periodically to reflect current market practice and the availability of new information. For example, the fair value of certain financial instruments includes adjustments for credit risk; both with regards to counterparty credit risk on positions held and the Company's own creditworthiness on positions issued. Credit risk on financial assets is significantly mitigated by credit enhancements such as collateral and netting arrangements. Any net credit exposure is measured using available and applicable inputs for the relevant counterparty. The same approach is used to measure the credit exposure on the Company's financial liabilities as is used to measure counterparty credit risk on the Company's financial assets. Valuation pricing models are calibrated to the market on a regular basis by comparison to observable market pricing, comparison with alternative model and analysis of risk profiles and inputs used are adjusted for current market conditions and risk. The Model Validation Group ("MVG") within the Risk Management Division reviews pricing models and assesses model appropriateness and consistency independently of the {17}------------------------------------------------ front office. The model reviews consider a number of factors about a model's suitability for valuation and sensitivity of the models used for a particular product. ## **Fair Value Hierarchy** All financial instruments measured at fair value, including those carried at fair value using the fair value option, have been categorized into a three-level hierarchy (the "fair value hierarchy") based on the transparency of valuation inputs used by the Company to estimate fair value. A financial instrument is classified in the fair value hierarchy based on the lowest level of input that is significant to the fair value measurement of the financial instrument. A financial instrument valued using a combination of Level 1, 2 and 3 inputs would be classified as a Level 3 financial asset or liability where the Level 3 inputs are significant to its measurement. The three levels of the fair value hierarchy are defined as follows, with Level 1 representing the most transparent inputs and Level 3 representing the least transparent inputs: *Level 1 –* Unadjusted quoted prices for identical financial instruments in active markets accessible by the Company at the measurement date. *Level 2 –* Inputs other than quoted prices included within Level 1 that are observable either directly or indirectly for substantially the full term (contractual life) of the asset or liability. *Level 3 –* One or more inputs to the valuation methodology are unobservable and significant to the fair value measurement. The following table presents information about the Company's financial assets and financial liabilities measured at fair value on a recurring basis, as of March 31, 2020, within the fair value hierarchy (dollars in thousands): {18}------------------------------------------------ | | | | | | Counterparty and
Cash Collateral | | | | | | | | | | |---------------------------------------------------|---------|-----------|----|-------------|-------------------------------------|----|---------------|----|---------------|--|--|--|--|--| | | Level 1 | | | Level 2 | Level 3 | | Netting(1) | | Total | | | | | | | Assets
Derivatives: | | | | | | | | | | | | | | | | Interest rate contracts | \$ | 1,004 | \$ | 197,202,966 | \$
314,082 | \$ | - | \$ | 197,518,052 | | | | | | | Foreign exchange contracts | | - | | 20,330,545 | 29,440 | | - | | 20,359,985 | | | | | | | Equity contracts | | - | | 8,845,873 | 239,691 | | - | | 9,085,564 | | | | | | | Credit contracts | | - | | 1,119,278 | 1,365 | | - | | 1,120,643 | | | | | | | Netting | | - | | - | - | | (223,028,025) | | (223,028,025) | | | | | | | Total derivatives | | 1,004 | | 227,498,662 | 584,578 | | (223,028,025) | | 5,056,219 | | | | | | | Equity securities
U.S. and foreign government, | | 3,668,039 | | 95,896 | - | | - | | 3,763,935 | | | | | | | agency and municipal securities | | 2,413,016 | | 238,679 | - | | - | | 2,651,695 | | | | | | | Total trading assets | \$ | 6,082,059 | \$ | 227,833,237 | \$
584,578 | \$ | (223,028,025) | \$ | 11,471,849 | | | | | | | Loans receivable from
customers(2) | \$ | - | \$ | 137,239 | \$
56,263 | \$ | - | \$ | 193,502 | | | | | | | Liabilities | | | | | | | | | | | | | | | | Derivatives: | | | | | | | | | | | | | | | | Interest rate contracts | \$ | - | \$ | 199,505,615 | \$
311,106 | \$ | - | \$ | 199,816,721 | | | | | | | Foreign exchange contracts | | - | | 20,227,919 | 27,401 | | - | | 20,255,320 | | | | | | | Equity contracts | | - | | 9,600,155 | 173,462 | | - | | 9,773,617 | | | | | | | Credit contracts | | - | | 1,113,138 | 1,372 | | - | | 1,114,510 | | | | | | | Netting | | - | | - | - | | (224,498,470) | | (224,498,470) | | | | | | | Total derivatives | | - | | 230,446,827 | 513,341 | | (224,498,470) | | 6,461,698 | | | | | | | Equity securities
U.S. and foreign government, | | 7,137,758 | | 107,112 | 6 | | - | | 7,244,876 | | | | | | | agency and municipal securities | | 386,114 | | - | - | | - | | 386,114 | | | | | | | Total trading liabilities | \$ | 7,523,872 | \$ | 230,553,939 | \$
513,347 | \$ | (224,498,470) | \$ | 14,092,688 | | | | | | | Borrowing at fair value(2) | \$ | - | \$ | 10,420 | - \$ | \$ | - | \$ | 10,420 | | | | | | (1) The amount offset under counterparty netting of derivative assets and liabilities and cash collateral netting against derivatives. (2) Items for which the Company elected the Fair value option under ASC 825. #### Valuation Methodology by Major Class of Financial Asset and Liability The following table describes the valuation methodology used by the Company to estimate fair value for major classes of financial assets and financial liabilities, together with the significant inputs which determine classification in the fair value hierarchy: {19}------------------------------------------------ | Product/Instrument | Valuation methodology, inputs and assumptions | Valuation Hierarchy Classification | | | | | | |---------------------------------|------------------------------------------------------------------------------|--------------------------------------|--|--|--|--|--| | U.S. and foreign government | Valued using quoted market prices, broker or dealer | Level 1 when traded in active | | | | | | | and municipal securities | quotations, or alternative pricing sources. | markets | | | | | | | | | Level 2 or 3 when traded in less | | | | | | | | | active markets | | | | | | | Equity securities | Listed securities: | Level 1 or 2 | | | | | | | | Valued using quoted prices for identical securities where | | | | | | | | | available. Listed equities traded in inactive markets are valued | | | | | | | | | using the exchange price as adjusted to reflect liquidity and | | | | | | | | | bid/offer spreads. | | | | | | | | Loans receivable from customers | Transactions documented as derivatives that failed the ASC 815 | Level 2 or 3 | | | | | | | | definition of a derivative are valued in the same manner as interest rate | | | | | | | | | and credit contracts. | | | | | | | | | Financing transactions that are deemed a failed purchase are valued using an | | | | | | | | | internal DCF model whose inputs are applicable benchmark yield curve and | | | | | | | | | credit spreads. | | | | | | | | | | | | | | | | | Derivatives | Exchange-traded derivatives (excluding equity contracts). | Level 1 when valued using unadjusted | | | | | | | | | exchange price | | | | | | | | | Level 2 when valued using models | | | | | | | | Exchange-traded equity derivatives are valued using option models. Use | Level 2 | | | | | | | | of a model valuation is more representative of fair value than exchange | | | | | | | | | price because of the higher volume and frequency of trading in the | | | | | | | | | underlying equity instruments compared to the derivative. | | | | | | | | | | | | | | | | | | OTC derivative transactions are valued using DCF techniques as well | Level 2 or 3 | | | | | | | | as options models such as Black-Scholes and Monte Carlo simulation. | | | | | | | | | Valuation adjustments are also made to model valuations in order | | | | | | | | | to reflect counterparty credit risk on derivative assets and the | | | | | | | | | Company's own creditworthiness on derivative liabilities. | | | | | | | | | | | | | | | | | | Equity contracts significant inputs may include: | | | | | | | | | • Equity prices
• Volatilities | | | | | | | | | • Dividend yields
• Correlations | | | | | | | | | Interest rate contracts significant inputs may include: | | | | | | | | | • Interest rates
• Volatilities | | | | | | | | | • Forward foreign
• Correlations | | | | | | | | | exchange ("FX") rates | | | | | | | | | Credit contracts significant inputs may include: | | | | | | | | | • Interest rates
• Default probabilities | | | | | | | | | • Credit spreads
• Volatilities | | | | | | | | | • Recovery rates
• Correlations | | | | | | | | | • Loss severities | | | | | | | | | FX contracts significant inputs may include: | | | | | | | | | • Interest rates
• Spot FX rates | | | | | | | | | • Forward FX rates
• Volatilities | | | | | | | | Borrowing at fair value | Value driven by the fair value of the underlying referenced securities for | Level 2 | | | | | | | | transaction documented as a derivative that failed the ASC 815 definition of | | | | | | | | | a derivative. | | | | | | | | | | | | | | | | {20}------------------------------------------------ ### **Valuation Processes** In order to ensure the appropriateness of any fair value measurement of a financial instrument used within this Statement of Financial Condition, including those classified as Level 3 within the fair value hierarchy, the Company operates a governance framework which mandates determination or validation of a fair value measurement by control and support functions independent of the trading businesses assuming the risk of the financial instrument. Such functions within the Company with direct responsibility for either defining, implementing or maintaining valuation policies and procedures are as follows: - The Product Control Valuations Group ("PCVG") has primary responsibility for determining and implementing valuation policies and procedures in connection with the determination of fair value measurements. While it is the responsibility of front office traders in the Company's trading businesses to price its financial instruments, the PCVG is responsible for independently verifying or validating these prices. In the event of a difference in opinion or where the estimate of fair value requires judgment, the valuation used within this Statement of Financial Condition is made by senior management independent of the trading businesses. The PCVG reports to the Head of Product Control and ultimately to the NHA Chief Financial Officer; - The Accounting Policy Group defines the Company's accounting policies and procedures in accordance with US GAAP, including those associated with determination of fair value. This group reports to the NHA Chief Financial Officer; - The MVG within the Risk Management Division validates the appropriateness and consistency of pricing models used to determine fair value measurements independently of those who design and build the models. This group reports to the NHA Chief Risk Officer. The fundamental components of this governance framework over valuation processes within the Company, particularly around Level 3 financial instruments, are the procedures in place around independent price verification, pricing model validation and revenue substantiation. The valuation of financial instruments and determination of the provision for credit losses are more difficult when severe economic and market shocks occur such as in the current market environment due to the COVID-19 pandemic. Dislocations between asset prices, higher volatility, reduced price transparency and deterioration in the credit worthiness of borrowers requires greater use of judgment. Increases in collateral calls and disputes on the valuation of derivative positions and in some cases, collateral has become more challenging. ### *Independent Price Verification Processes* The key objective of the independent price verification processes within the Company is to verify the appropriateness of fair value measurements applied to all financial instruments within the Company. In {21}------------------------------------------------ applying these control processes, observable inputs are used whenever possible and when unobservable inputs are necessary, the processes seek to ensure the valuation methodology and inputs are appropriate, reasonable and consistently applied. The independent price verification processes aim to verify the fair value of all positions to external sources on a regular basis. The process involves obtaining independent data such as trades, marks and prices from external sources and examining the impact of marking the positions at the independent prices. Where third-party pricing information sourced from brokers, dealers and consensus pricing services is used as part of the price verification process, consideration is given as to whether that information reflects actual recent market transactions or prices at which transactions involving identical or similar financial instruments are currently executable. If such transactions or prices are not available, the financial instrument will generally be classified as Level 3. Where there is a lack of observable market information around the inputs used in a fair value measurement, the PCVG and the MVG will assess the inputs used for reasonableness considering available information including comparable products, volatility surfaces, curves and past trades. Additional valuation adjustments may be taken for the uncertainty in the inputs used, such as correlation and where appropriate, trading desks may be asked to execute trades to evidence market levels. ### *Model Review and Validation* For more complex and illiquid financial instruments, pricing models are used to determine fair value measurements. Before models are put into official use, the MVG is responsible for validating their integrity and comprehensiveness independently from those who design and build them. As part of this validation process, the MVG analyzes a number of factors to assess a model's suitability and to quantify model risk by applying model reserves and capital adjustments. Valuation models are developed and maintained by the front-office and risk models by the Risk Methodology Group within the Risk Management Division. Some models may also be developed by third party providers. The Risk Methodology Group has primary responsibility for the ongoing refinement and improvement of risk models and methodologies. All models are also subject to an annual re-approval process by MVG to ensure they remain suitable. ### *Revenue Substantiation* PCVG also ensures adherence to the Company's valuation policies through daily and periodic analytical review of net revenues. This process involves substantiating revenue amounts through explanations and attribution of revenue sources based on the underlying factors such as interest rates, credit spreads, volatility, FX rates etc. In combination with the independent price verification processes, this daily, weekly, monthly and quarterly review substantiates the revenues made while helping to identify and resolve potential booking, pricing or risk quantification issues. {22}------------------------------------------------ #### *Quantitative Information Regarding Significant Unobservable Inputs and Assumptions* The following table presents quantitative information about the significant unobservable inputs and assumptions used by the Company for certain Level 3 financial instruments as of March 31, 2020 (dollars in thousands): | Class of financial instrument | Fair value | Valuation
technique(s) | Unobservable
inputs | | Level 3 Input or
Range of Inputs | |----------------------------------------------|--------------|---------------------------|------------------------------------------------|------------|-------------------------------------------------| | Derivatives, net:
Interest rate contracts | \$
2,976 | Discounted cash flow | Interest rates
Volatilities
Correlations | (2) | (0.1)% - 1.1%
46.9% - 72.3%
(1.0) - 0.94 | | Foreign exchange contracts | \$
2,039 | Option models | Interest rates
Volatilities
Correlations | | (0.1)% - 0.8%
8.6% - 13.8%
0.16 - 0.80 | | Equity contracts | \$
66,229 | Option models | Dividend yield
Volatilities
Correlations | (1)
(2) | 0.0% - 10.0%
21.7% - 144.7%
(0.78) - 0.93 | | Credit contracts | \$
(7) | Discounted cash flow | Correlations | | 0.6 | | Loans receivable from
customers(3) | \$
56,263 | Discounted cash flow | Credit spreads | | 3.6% - 4.8% | (1) The majority of the inputs are centered around the middle of the range. (2) The range of correlations moves from positive to negative because the movement of some pairs is very closely related in the same direction causing highly positive correlations while others generally move in opposite directions causing highly negative correlations. (3) Items for which the Company elected Fair value option under ASC 825. #### *Sensitivity of Fair Value to Changes in Unobservable Inputs* For each class of financial instrument described in the above table, changes in each of the significant unobservable inputs and assumptions used by the Company will impact the determination of a fair value measurement for the financial instrument. The sensitivity of these Level 3 fair value measurements to changes in unobservable inputs and interrelationships between those inputs as described below impact the determination of a fair value measurement for the financial instrument. Where the Company is long the underlying risk of a derivative, significant increases (decreases) in the underlying of the derivative, such as interest rates or dividend yield in isolation, would result in a {23}------------------------------------------------ significantly higher (lower) fair value measurement. Where the Company is short the underlying risk of a derivative, the impact of these changes would have a converse effect on the fair value measurements reported by the Company. Where the Company is long optionality, or correlation, significant increases (decreases) in volatility or correlation will result in a significantly higher (lower) fair value measurement. Where the Company is short optionality, or correlation, the impact of these changes would have a converse effect on the fair value measurements. *Loans receivable from customers* – Significant increases (decreases) in credit spreads used in DCF valuation technique would result in a significantly lower (higher) fair value measurement. The following table explains increases and decreases, including gains and losses, of Level 3 financial assets and financial liabilities measured at fair value on a recurring basis for the year ended March 31, 2020. Financial instruments classified as Level 3 are derivatives, loans receivable and resale agreements valued using significant unobservable parameters. These financial instruments are often economically hedged with instruments within Level 1 or Level 2 of the fair value hierarchy and the gains or losses below do not reflect the offsetting gains or losses for these hedging instruments. Level 3 instruments are at times measured using both observable and unobservable inputs. Fair value changes presented below, therefore, reflect realized and unrealized gains and losses resulting from movements in both observable and unobservable parameters. | | Ope ning
b a la nc e
a s o f Ap ril
1, 2 0 19 | | P urc ha s e s Is s u a n c e s | | S a le s | S e ttle me n ts ( 1) | To ta l
u n re a liz e d
a nd
re a liz e d
g a ins /
(lo s s e s ) | Tra n s fe rs
into
Le ve l 3 | Tra n s fe rs
o ut o f
Le ve l 3 | Ba la nc e
a s o f
Ma rc h 3 1,
2020 | |-------------------------------------------------------------------------|--------------------------------------------------------|-----|---------------------------------|------|-----------------|------------------------|-----------------------------------------------------------------------------------|------------------------------------|----------------------------------------|-----------------------------------------------| | | | | | | | (Dollars in thousands) | | | | | | De riva tive s: | | | | | | | | | | | | Inte re st ra te
c ontra c ts, ne t | \$
6,003 | \$ | - | - \$ | - \$ | \$
(2,093) | \$
(4,785) | 4,965 \$ | (1,114) \$ | 2,976 \$ | | Fore ign e xc ha nge
c ontra c ts, ne t | 1,642 | | - | - | - | (246) | (1,408) | 2,051 | - | 2,039 | | Equity c ontra c ts, ne t | (119,081) | | - | - | - | (12,768) | 85,945 | 26 | 112,107 | 66,229 | | Cre dit c ontra c ts, ne t | | - 4 | | - | - | - | (11) | - | - | (7) | | Tota l de riva tive s | \$
(111,432) \$ | | - | - \$ | - \$ | \$
(15,107) | 79,741 \$ | 7,042 \$ | 110,993 \$ | 71,237 \$ | | S e c uritie s purc ha se d
unde r a gre e me nts
to re se ll (2) | \$
199,721 | \$ | - | - \$ | \$
(199,721) | \$
- | - \$ | - \$ | - \$ | - \$ | | Loa ns re c e iva ble from | | | | | | | | | | | | c ustome rs (2) | \$
116,700 | \$ | - | - \$ | \$
(338) | \$
- | 301 \$ | - \$ | (60,400) \$ | 56,263 \$ | (1) All cash payments or receipts on derivatives are included within Settlements. (2) Items for which the Company elected Fair value option under ASC 825. {24}------------------------------------------------ ## **Transfers Between Levels of the Fair Value Hierarchy** ### *Transfers From Level 2 to Level 3:* - Approximately \$5.0 million of net interest rate assets were transferred from Level 2 to Level 3 as inputs (volatilities and correlations) became unobservable. - Approximately \$2.1 million of net FX contract assets were transferred from Level 2 to Level 3 as inputs (volatilities) became unobservable. ## *Transfer from Level 3 to Level 2:* - Approximately \$1.1 million of net interest rate assets were transferred from Level 3 to Level 2 as inputs (volatilities and correlations) became observable. - Approximately \$112.1 million of net equity contract liabilities were transferred from Level 3 to Level 2 as inputs became observable. Volatility became observable due to the shortening duration of certain options. Correlations became observable due to market events. - Approximately \$60.4 million of loans receivable from customers were transferred from Level 3 to Level 2 as credit spreads became less significant to the valuation. ## **Fair Value Option for Financial Assets and Liabilities** The Company carries certain eligible financial assets and liabilities at fair value through the election of the fair value option permitted by ASC 815 and ASC 825. When the Company elects the fair value option for an eligible item, changes in that item's fair value are recognized within income. Election of the fair value option is irrevocable unless an event that gives rise to a new basis of accounting for that instrument occurs. Interest and dividend income and expense arising from financial instruments for which the fair value option has been elected are recognized within income. The financial assets elected for the fair value option by the Company and the reasons for the election are as follows: • *Loans receivable from customers at fair value –* The fair value option was elected for transactions documented as derivatives that failed the ASC 815 definition of a derivative. These transactions were recorded as financing transactions with embedded derivatives and are managed within a fair valued derivative portfolio. These positions are valued in the same manner as the underlying derivatives in the transactions. Also included in *Loans receivable from customers* is a transaction where the legal isolation sale criterion for transferred assets was not met, because the transaction comprised of a purchase with a total return swap entered into with the transferor in contemplation of the initial transfer, whereby the transferor retains substantially all of the exposure to the economic return on the transferred financial assets throughout the term {25}------------------------------------------------ of the transaction. The Company elected the fair value option for these loans because they are risk managed on a fair value basis. • *Borrowing at fair value –* The fair value option was elected for transactions documented as derivatives that failed the ASC 815 definition of a derivative. These transactions were recorded as financing transactions with embedded derivatives which reflect the performance of the referenced investments. The fair value option was elected for these transactions as the Company risk manages the positions on a fair value basis. ## **Estimated Fair Value of Financial Instruments not Carried at Fair Value** Certain financial instruments are not carried at fair value on a recurring basis on the Statement of Financial Condition since they are neither held for trading purposes nor elected for the fair value option. These are typically carried at contractual amounts due or amortized cost. The carrying value of the majority of the following financial instruments will approximate fair value since they are liquid, short-term in nature and/or contain minimal credit risk. These include *Cash, Deposits with clearing organization, Short term loans receivable from affiliate, Securities purchased under agreements to resell, Securities borrowed, Borrowings from Parent, Securities sold under agreements to repurchase* and *Securities loaned.* However, the fair value of other financial instruments may be different than carrying value if they are longer term in nature or contain more than minimal credit risk. All of these financial assets and financial liabilities would be generally classified as Level 2 or Level 3 within the fair value hierarchy. As of March 31, 2020, there were no longer dated instruments with a material difference between fair value and carrying value. The following table presents carrying values, estimated fair values and classification within the fair value hierarchy of those fair values for financial instruments which are carried on a basis other than fair value within our Statement of Financial Condition as of March 31, 2020. Financial instruments carried at fair value on a recurring basis are separately reported in the tables above. {26}------------------------------------------------ | | | | | | | | | Fair value by Level | | | | |--------------------------------------|------------------------|-----------|----|---------------|----|---------|----|---------------------|----|---------|--| | | Carrying value | | | Fair value | | Level 1 | | Level 2 | | Level 3 | | | | (Dollars in thousands) | | | | | | | | | | | | Assets: | | | | | | | | | | | | | Cash and cash equivalents | \$ | 147,667 | \$ | 147,667 | \$ | 147,667 | \$ | - | \$ | - | | | Deposit with clearing | | | | | | | | | | | | | organization | | 27,453 | | 27,453 | | 27,453 | | - | | - | | | Securities borrowed | | 7,851,893 | | 7,
851,893 | | - | | 7, 851,893 | | | | | Securities purchased under | | | | | | | | | | | | | agreements to resell (1) | | 2,593,037 | | 2,
593,037 | | - | | 2, 593,037 | | - | | | Receivables from customers, brokers, | | | | | | | | | | | | | dealers and clearing organizations | | 2,324,428 | | 2,
324,428 | | | | 2,
324,428 | | | | | Short term loans receivable | | | | | | | | | | | | | from affiliate | | 4,471 | | 4,471 | | - | | 4,471 | | - | | | Liabilities: | | | | | | | | | | | | | Securities loaned | | 3,973,703 | | 3,973,703 | | - | 3, | 973,703 | | - | | | Securities sold under | | | | | | | | | | | | | agreements to repurchase(1) | | 546,557 | | 546,557 | | - | | 546,557 | | - | | | Payables to customers, brokers, | | | | | | | | | | | | | dealers and clearing organizations | | 1,705,445 | | 1,705,445 | | | | 1,705,445 | | | | | Borrowings from Parent | | 2,712,800 | | 2,712,800 | | - | 2, | 712,800 | | - | | | Subordinated borrowing | | 700,000 | | 700,000 | | - | | 700,000 | | - | | (1) Represents amounts after counterparty netting in accordance with ASC 210-20. ### **Assets and Liabilities Measured at Fair Value on a Nonrecurring Basis** In addition to the financial instruments carried at fair value on a recurring basis, the Company also carries other financial instruments at fair value on a nonrecurring basis, where the primary measurement basis is not fair value. Examples of such financial instruments include *Receivables from brokers, dealers and clearing organizations* and *Receivables from customers*. Fair value is only used in specific circumstances after initial recognition such as to measure impairment. During the year ended March 31, 2020, the Company recorded an \$11.8 million allowance for credit loss on a receivable from a customer. ### **6. Derivative Instruments and Hedging Activities** In the normal course of business, the Company enters into transactions in derivative instruments in order to meet the financing and hedging needs of its customers, to reduce its own exposure to market, credit and liquidity risks, and in connection with its proprietary trading activities. These financial instruments may include interest rate and credit default swaps, exchange traded and OTC options, futures, forwards, and FX contracts. Risks arise from unfavorable changes in interest rates, foreign currency exchange rates or the market values of the securities underlying the instruments, as well as the possible inability of counterparties to meet the terms of their contracts. The credit risk associated with these contracts is typically limited to the cost of {27}------------------------------------------------ replacing all contracts on which the Company has recorded an unrealized gain. All of the Company's derivative transactions are for trading purposes. The Company enters into OTC derivatives, which are negotiated and settled bi-laterally with the derivative counterparty. In addition, the Company enters into certain exchange traded derivatives such as futures and options, and cleared OTC derivative contracts with central counterparties ("CCP"). Exchange traded contracts are generally standardized contracts traded on an exchange and cleared by the CCP. OTC centrally cleared contracts are those contracts which are traded bi-laterally and then novated to a CCP for clearing. The fair value of all derivatives and associated cash collateral is recorded on a net-by-counterparty basis on the Statement of Financial Condition where the Company believes a legal right of offset exists under an enforceable master netting arrangement. The following table quantifies the volume of the Company's derivative activity recorded within *Trading asset*s and *Trading liabilities* on the Statement of Financial Condition as of March 31, 2020, through a disclosure of notional amounts, in comparison with the fair value of those derivatives. All notional and fair value amounts are disclosed on a gross basis, prior to counterparty and cash collateral netting (in thousands): | | | | Derivative Assets | | Derivative Liabilities | |---------------------------------|------------------------|----------------|-------------------|----|------------------------| | | Contract / Notional(1) | | Fair Value | | Fair Value | | Interest rate contracts | \$ | 17,698,490,727 | \$
197,518,052 | \$ | 199,816,721 | | Foreign exchange contracts | | 702,334,976 | 20,359,985 | | 20,255,320 | | Equity contracts | | 185,848,997 | 9,085,564 | | 9,773,617 | | Credit contracts | | 122,509,908 | 1,120,643 | | 1,114,510 | | Gross derivative instruments(2) | \$ | 18,709,184,608 | \$
228,084,244 | \$ | 230,960,168 | (1) Represents the total contract/notional amount of the derivative assets and liabilities outstanding. (2) Notional amounts include notionals related to futures contracts of approximately \$178.4 billion. The unsettled variation margin on these futures contracts (excluded from the table above) is included in *Receivables from brokers, dealers and clearing organizations* and *Payables to brokers, dealers and clearing organizations,* on the Statement of Financial Condition. ### **Offsetting of Derivatives** The Company enters into master netting agreements with substantially all of its derivative counterparties. Where legally enforceable, these master netting agreements give the Company, in the event of default by the counterparty, the right to liquidate securities held as collateral and to offset receivables and payables with the same counterparty. For purposes of the Statement of Financial Condition, the Company offsets derivative assets and liabilities and cash collateral held with the same counterparty where it has such a legally enforceable master netting agreement. {28}------------------------------------------------ The following table presents information about offsetting of derivative instruments and related collateral amounts in the Statement of Financial Condition as of March 31, 2020, by type of derivative contract, together with the extent to which master netting agreements entered into with counterparties, central clearing counterparties or exchanges permit additional offsetting of derivatives and collateral in the event of counterparty default. Amounts below exclude futures contracts, which are settled daily. The unsettled variation margin on futures contracts is included in *Receivables from brokers, dealers and clearing organizations* and *Payables to brokers, dealers and clearing organizations*, respectively, on the Statement of Financial Condition. Derivative transactions which are not documented under a master netting agreement or are documented under a master netting agreement for which the Company does not have sufficient evidence of enforceability are not offset in the following table. | | | Derivative | Derivative | | | | | |-----------------------------------------------------------------------------------|------------------------|---------------|------------|---------------|--|--|--| | | | Assets | | Liabilities | | | | | | (dollars in thousands) | | | | | | | | Interest rate contracts | | | | | | | | | OTC settled bilaterally | \$ | 197,517,048 | \$ | 199,734,769 | | | | | OTC centrally cleared | | - | | 81,952 | | | | | Exchange-traded | | 1,004 | | - | | | | | Foreign exchange contracts | | | | | | | | | OTC settled bilaterally | | 20,359,985 | | 20,255,320 | | | | | OTC centrally cleared | | - | | - | | | | | Exchange-traded | | - | | - | | | | | Equity contracts | | | | | | | | | OTC settled bilaterally | | 5,813,477 | | 5,711,780 | | | | | OTC centrally cleared | | - | | - | | | | | Exchange-traded | | 3,272,087 | | 4,061,837 | | | | | Credit contracts | | | | | | | | | OTC settled bilaterally | | 1,102,795 | | 1,096,382 | | | | | OTC centrally cleared | | 17,848 | | 18,128 | | | | | Exchange-traded | | - | | - | | | | | Total gross derivatives balances(1) | | 228,084,244 | | 230,960,168 | | | | | Less: Amounts offset in the statement of financial condition(2) | | (223,028,025) | | (224,498,470) | | | | | Total net amounts reported on the face of the statement of financial condition(3) | | 5,056,219 | | 6,461,698 | | | | | Less: Additional amounts not offset in the statement of financial condition | | | | | | | | | Financial instruments and non-cash collateral(4) | | (153,168) | | (414,306) | | | | | Net amount | \$ | 4,903,051 | \$ | 6,047,392 | | | | (1) Includes all gross derivative asset and liability balances irrespective of whether they are transacted under legally enforceable master netting agreement or whether the Company has obtained sufficient evidence of enforceability of the master netting agreement. As of March 31, 2020, the gross balance of derivative assets and derivative liabilities which are not documented under master netting agreements or are documented under master netting agreements for which the Company has not yet obtained sufficient evidence of enforceability was \$3,810 million and \$4,570 million, respectively, of which \$3,273 million and \$4,062 million, respectively were exchange-traded. {29}------------------------------------------------ - (2) Represents amounts offset through counterparty netting of derivative assets and liabilities as well as cash collateral netting against net derivatives under legally enforceable master netting and similar agreements in accordance with ASC 815. As of March 31, 2020, the Company offset a total of \$8,737 million of cash collateral receivables against net derivative liabilities and \$7,267 million of cash collateral payables against net derivative assets. - (3) Net derivative assets and net derivative liabilities are generally reported within *Trading assets* and *Trading liabilities*, respectively on the Statement of Financial Condition. - (4) Represents securities collateral which is not permitted to be offset on the face of the Statement of Financial Condition in accordance with ASC 210-20 and ASC 815 but which provide the Company with a legally enforceable right of offset in the event of counterparty default. Amounts relating to derivative and collateral agreements where the Company does not have the legal right of offset or has not yet obtained sufficient evidence of enforceability of such offsetting rights are excluded. As of March 31, 2020, a total of \$825 million of cash collateral receivables and \$1,492 million of cash collateral payables have not been offset against net derivatives. Of this amount, \$463 million of cash collateral receivables and \$1,328 million of cash collateral payables were not offset because they represent collateral amounts in excess of the related counterparty exposure. The remaining amounts were not eligible to be offset, because they related to agreements for which the Company lacked evidence of enforceability. Cash collateral receivables and cash collateral payables are reported within *Receivables from customers* and *Payables to customers*, respectively on the Statement of Financial Condition. ### **Derivatives entered into in contemplation of sales of financial assets** At the balance sheet date, the Company did not have any outstanding transactions that comprise a transfer of a financial asset recorded as a sale with an agreement (for example, a total return swap or similar derivative) entered into with the transferee in contemplation of the initial transfer, whereby the Company retains substantially all of the exposure to the economic return on the transferred financial asset throughout the term of the transaction. ## **7. Collateralized Financing Agreements** The Company enters into collateralized transactions including resale agreements, repurchase agreements, securities borrowing and securities lending transactions, mainly to finance trading inventory positions and to obtain securities for settlement. These transactions are documented under industry-standard master netting agreements which reduce the Company's credit exposure to the affiliates as they permit the close-out and offset of transactions and collateral amounts in the event of default of the affiliate counterparties. In order to support the enforceability of the close-out and offsetting rights within these agreements, the Company has obtained external legal opinions. In all of these transactions, the Company either receives or provides collateral, including government, agency, and equity securities. In most cases, the Company is permitted to use the securities received to {30}------------------------------------------------ secure repurchase agreements, enter into securities lending transactions or to cover short positions with counterparties. In repurchase and resale transactions, the value of collateral typically exceeds the amount of cash transferred. Collateral is generally in the form of securities. Securities borrowing transactions generally require the Company to provide the affiliate counterparties with collateral in the form of cash or other securities. For securities lending transactions, the Company generally receives collateral in the form of cash or other securities. The Company monitors the market value of the securities borrowed or loaned and requires additional cash or securities, as necessary, to ensure that such transactions are adequately collateralized for the Company's risk management purposes throughout the life of the transactions. Resale agreements and repurchase agreements with the same counterparty are offset in the Statement of Financial Condition where the specific criteria defined by ASC 210-20 are met. The following table presents information about offsetting of these transactions in the Statement of Financial Condition, together with the extent to which master netting agreements entered into with the affiliate counterparties permit additional offsetting in the event of counterparty default (in thousands): | | Assets | | | | | Liabilities | | | | | |-------------------------------------------------------------------------------------|-----------------|----------------------|-----------------------------------------|-------------|--------------------------|-------------|---------------------------------------|-------------|--|--| | | | Resale
agreements | Securities
borrowing
transactions | | Repurchase
agreements | | Securities
lending
transactions | | | | | Total gross balance | \$
4,758,538 | | \$ | 7,851,893 | \$ | 2,712,058 | \$ | 3,973,703 | | | | Less: Amounts offset in the statement | | | | | | | | | | | | of financial condition (1) | | (2,165,501) | | - | | (2,165,501) | | - | | | | Total net amounts reported on the face of the | | | | | | | | | | | | statement of financial condition (2) | | 2,593,037 | | 7,851,893 | | 546,557 | | 3,973,703 | | | | Less: Additional amounts not offset in the
statement of financial condition: (3) | | | | | | | | | | | | Financial instruments and non-cash collateral | | (2,592,745) | | (7,207,576) | | (546,122) | | (3,973,703) | | | | Cash collateral | | - | | - | | - | | - | | | | Net amount | \$ | 292 | \$ | 644,317 | \$ | 435 | \$ | - | | | (1) Represents amounts offset through counterparty netting of resale agreements and repurchase agreements in accordance with ASC 210-20. (2) Resale agreements and securities borrowing transactions are reported within *Collateralized financing agreements* on the Statement of Financial Condition as *Securities purchased under agreements to resell* and *Securities borrowed*, respectively. Repurchase agreements and securities lending transactions are reported within *Collateralized financing agreements* on the Statement of Financial Condition as *Securities sold under agreements to repurchase* and *Securities loaned*, respectively. {31}------------------------------------------------ (3) Represents amounts which are not permitted to be offset on the face of the Statement of Financial Condition in accordance with ASC 210-20 but which provide the Company with the right of offset in the event of counterparty default. ### **Maturity analysis of repurchase agreements and securities lending transactions and Securities transferred in repurchase agreements and securities lending transactions** The following tables present analyses of the total gross balance of liabilities recognized in the Statement of Financial Condition for repurchase agreements and securities lending transactions by remaining contractual maturity of the agreement and class of securities transferred as of March 31, 2020. Amounts reported are shown prior to counterparty netting in accordance with ASC 210-20 (in thousands): | Maturity analysis | | | | | | |----------------------------------------------------------|------------------------------|--------------------|--------------|--------------|------------------------------| | | Overnight and | | 90 days - | Greater than | | | | open (1) | Up to 30 days | 1 year | 1 year | Total | | Repurchase agreements
Securities lending transactions | \$
2,547,231
3,973,703 | \$
164,827
- | \$
-
- | \$
-
- | \$
2,712,058
3,973,703 | | Total gross recognized liabilities (2) | \$
6,520,934 | \$
164,827 | \$
- | \$
- | \$
6,685,761 | *Security analysis* | | Repurchase
agreements | Securities
transactions | Total | | | |---------------------------------------------------|--------------------------|----------------------------|-----------|-----------------|--| | Equity securities | \$
- | \$ | 3,876,414 | \$
3,876,414 | | | U.S. and foreign government and agency securities | 2,685,010 | | - | 2,685,010 | | | Bank and corporate debt securities | 27,048 | | 97,289 | 124,337 | | | Total gross recognized liabilities (2) | \$
2,712,058 | \$ | 3,973,703 | \$
6,685,761 | | (1) Open transactions do not have an explicit contractual maturity date and are terminable on demand by the Company or the counterparty. (2) Repurchase agreements and securities lending transactions are reported within *Collateralized financing agreements* on the Statement of Financial Condition as *Securities sold under agreements to repurchase* and *Securities loaned*, respectively. The total gross recognized liabilities reported for repurchase agreements and securities lending transactions are consistent with the total gross balances reported in the offsetting disclosures above. {32}------------------------------------------------ ### **Collateral received by the Company** The Company receives collateral in the form of securities in connection with resale agreements, securities borrowed and derivative collateral agreements. When the Company borrows securities, it collateralizes the lender by pledging cash or other securities. At March 31, 2020, the fair value of securities received as collateral where the Company is permitted to sell or repledge the securities was \$12.6 billion and the fair value of the portion that had been sold or repledged was \$10.0 billion. ### **Collateral pledged by the Company** The Company pledges firm-owned securities to collateralize repurchase agreements and securities loaned transactions. In addition, the Company pledges firm-owned securities as collateral in connection with derivative transactions. Pledged securities that can be sold or repledged by the secured party are \$5.3 billion at March 31, 2020 and are disclosed in parenthesis as pledged within *Trading assets* on the Statement of Financial Condition. At March 31, 2020 the Company had pledged \$240 million of *Trading assets* owned as collateral which the secured party does not have the right to sell or repledge. ## **8. Receivables from and Payables to Brokers, Dealers and Clearing Organizations** Receivables from and payables to brokers, dealers and clearing organizations consist of the following at March 31, 2020 (in thousands): | | | Receivables | Payables | | | |-----------------------------------------|----|-------------|----------|---------|--| | Pending trades, net | | 389,515 | \$ | - | | | Securities failed-to-deliver/receive | | 200,867 | | 197,578 | | | Receivables from / payables to brokers, | | | | | | | dealers and clearing organizations | | 755,250 | | 16,126 | | | | \$ | 1,345,632 | \$ | 213,704 | | Receivables from/payables to brokers, dealers and clearing organizations primarily include cash collateral deposited with broker-dealer affiliates in their capacity as clearing brokers for the Company's exchange traded derivative trades as well as unsettled variation margin. Pending trades represent the net amount receivable on unsettled regular-way securities transactions. Securities failed-to-deliver and receive represent the contract value of securities which have not been delivered or received by the Company on settlement date. ### **9. Subordinated Borrowing** The Company's subordinated borrowing is a term borrowing with NHA covered by an agreement approved by the SEC and is included by the Company in regulatory net capital, as defined, under the SEC's Uniform Net Capital Rule ("SEC Rule 15c3-1"). The borrowing agreement contains an evergreen provision that {33}------------------------------------------------ automatically extends the maturity by one year unless specified actions are taken prior to maturity date. To the extent that such borrowings are required for the Company's continued compliance with minimum regulatory net capital requirements, repayment is deferred. Borrowing at March 31, 2020 is as follows (dollars in thousands): | Lender | Par Value | Type | Maturity Date | Interest
Rate | |--------|---------------|------|-------------------|------------------| | NHA | \$
700,000 | Term | December 16, 2020 | Variable | ## **10. Off-Balance Sheet Risks and Concentration of Credit and Market Risks** ## **Financial Instruments with Off-Balance Sheet Risk** The Company has sold securities it does not currently own and will therefore be obligated to purchase such securities at a future date. The Company has recorded this obligation within *Trading liabilities* on the Statement of Financial Condition at March 31, 2020, at the fair value of such securities and will incur a loss if the fair value of the securities increases subsequent to March 31, 2020. Generally, the Company limits this risk by holding offsetting securities, futures or options positions. ## **Credit Risk** The Company is engaged in various trading and brokerage activities with counterparties which include domestic financial institutions, multinational corporations, banks, investment funds, security exchanges and clearing organizations. A substantial portion of the Company's securities transactions are collateralized. The Company's exposure to credit risk associated with the nonperformance of these customers and counterparties in fulfilling their contractual obligations may be directly impacted by volatile or illiquid trading markets. Credit risk arises from a failure of a counterparty to perform according to the terms of the contract. The Company's exposure to credit risk at any point in time is approximated by the fair value of the contracts reported as assets. These amounts are reported on a net-by-counterparty basis consistent with ASC 815-10- 45. The Credit Risk Management ("CRM") department manages the credit risk exposure that arises from transactions. The CRM department is an independent control function. The Company's process for managing credit risk includes: - Evaluation of likelihood that a counterparty defaults on its payments and obligations; - Assignment of internal credit ratings to all active counterparties; {34}------------------------------------------------ - Approval of extensions of credit and establishment of credit limits; - Measurement, monitoring and management of the firm's current and potential future credit exposures; - Setting credit terms in legal documentation including margin terms; - Use of appropriate credit risk mitigants including netting, collateral and hedging; - Active communication and co-operation with various stakeholders such as Trading units, Operations, Legal department, Compliance and Finance. The credit quality of the Company's derivatives portfolio is summarized in the table below, according to internally-defined ratings which are comparable to Standards and Poor's ratings. For the purpose of this table, credit exposure is defined as non-affiliate counterparties with which the Company has a positive fair value position, after netting in accordance with ASC 815-10-45. | | Percent of | |-----------------------|------------| | Internal Rating | Total | | AAA | 1% | | AA | 10% | | A | 14% | | BBB | 21% | | BB | 22% | | B and lower | 29% | | Unrated | 3% | | Total internal rating | 100% | | | | The Company's concentration of credit risk arises from its gross exposure to financial institutions. The following table presents the Company's concentration of exposures arising out of OTC derivative transactions. The gross fair value of derivative assets represents the maximum amount of loss due to credit risk that the Company would incur if the counterparties of the Company failed to perform in accordance with the terms of the instruments and if any collateral or other securities the Company held in relation to those instruments proved to be of no value (in millions): | Industry
Concentration | Gross Fair
Value | | Netting
Agreements | Impact of
Collateral | Net Exposure | | |---------------------------|---------------------|---------|-----------------------|-------------------------|--------------|-----| | Financial institutions | \$ | 222,832 | \$
(215,413) | \$
(7,068) | \$ | 351 | {35}------------------------------------------------ ## **Credit Event Contingencies** The Company enters into certain OTC derivatives where the related collateralization provisions contain credit-risk-related contingent features. These features are clauses that would require the Company to post additional collateral or settle the instrument upon occurrence of a credit event, the most common of which would be a downgrade in the long-term credit rating of NHI or NSC. The aggregate fair value of all derivative instruments with credit-risk-related contingent features that are in a net liability position on March 31, 2020 was \$3.4 billion with related collateral pledged at that date of \$3.1 billion. In the event of a one-notch downgrade to the long-term credit rating of NHI or NSC, the Company would not need to post additional collateral. ## **Use of Credit Derivatives** In the normal course of business, the Company enters into credit derivatives, primarily with an affiliate company, as part of its trading activities for credit risk mitigation, proprietary trading positions and for client transactions. Credit derivatives are derivative instruments in which one or more of their underlyings are related to the credit risk of a specified entity (or group of entities) or an index based on the credit risk of a group of entities and that expose the seller to potential loss from credit risk related events specified in the contract. The types of credit derivatives used by the Company are those linked to the performance of a credit default index and single-name credit default swaps. The Company actively monitors and manages its credit derivative exposures. Where credit protection is sold, risks may be mitigated by purchasing credit protection from other third parties either on identical underlying reference assets or on underlying reference assets with the same issuer which would be expected to behave in a correlated fashion. The Company quantifies the value of these purchased contracts in the following table in the row titled "Protection purchased." These amounts represent purchased credit protection which generally act as a hedge against the Company's written exposures. To the extent the Company is required to pay out under the written credit derivative, a similar amount would generally become due to the Company under the purchased protection. The following table presents information about the Company's written credit derivatives and the related protection purchased at March 31, 2020 (in millions): {36}------------------------------------------------ | | | | | Maximum Payout on Protection sold
or Receivable on Protection Purchased
(Notionals) | | | | | | | | |----------------------|-------|--------------|----|-------------------------------------------------------------------------------------------|----|-------------------|----|-----------|-------|-------------|--| | | | | | | | Years to Maturity | | | | | | | | | Carrying | | | | | | | | More than 5 | | | | Value | | | | | 0-3 years | | 3-5 years | years | | | | Protection sold | \$ | (1)
(737) | \$ | 58,239 | \$ | 19,714 | \$ | 35,076 | \$ | 3,449 | | | Protection purchased | \$ | (1)
738 | \$ | 58,802 | \$ | 19,775 | \$ | 35,010 | \$ | 4,017 | | (1) Carrying values are reported on a gross basis, prior to cash collateral and counterparty netting Credit derivatives have a stated notional amount which represents the maximum payment the Company may be required to make under the contract. However, this is generally not a true representation of the amount the Company will actually pay as in addition to purchased credit protection, other risk mitigating factors reduce the likelihood of any payment, including the probability of default and the recovery value of the underlying asset. The Company believes that the maximum potential amount of future payments for credit protection sold does not represent the actual loss exposure based on historical experience. The following table presents information about the Company's written credit derivatives by external credit rating of the underlying asset. Where written credit derivatives have an index as an underlying, the exposure detailed below has been decomposed into the ratings categories below based on ratings of securities or derivatives comprising the index. Where multiple external ratings exist from the major rating services, the rating designated below is determined as the middle rating when ratings are available from all three major rating services, or the lower rating when only two ratings are available, consistent with guidelines specified under the Basel Accords. | | Maximum Payout/Notional on Protection sold
( Dollars in Millions) | | | | | | | | | | | | | | |-----|----------------------------------------------------------------------|----|--------|----|--------|----|--------|----|-------|----|-----------|----|--------|--| | AAA | | | AA | | A | | BBB | | BB | | Other (1) | | Total | | | \$ | 1,949 | \$ | 11,830 | \$ | 13,597 | \$ | 12,814 | \$ | 4,505 | \$ | 13,544 | \$ | 58,239 | | *(1) Other includes credit derivatives where credit rating of the underlying reference asset is below BB, or where no credit rating is available.* ### **Market Risk** The Company is exposed to market risk. Market risk is the risk of loss arising from fluctuations in the value of assets and debts (including off-balance sheet items) due to fluctuations in market risk factors (interest rates, FX rates, prices of securities and others). Market risk primarily impacts the Company's trading activities. {37}------------------------------------------------ Global government-imposed shelter-in-place restrictions and continued uncertainties around the length and severity of the economic and public health impacts of COVID-19 have created a much more volatile operating environment that has, and will likely continue to have, an adverse effect on the Company's business, employees and clients. Effective management of market risk requires the ability to analyze a complex and constantly changing global market environment, identify problematic trends and ensure that appropriate action is taken in a timely manner. The Company is actively monitoring the impact of the COVID-19 pandemic on market risk exposures by leveraging existing measures and controls. Models used to measure market risk are inherently imprecise and may be limited in their ability to measure certain risks or to predict losses. This imprecision may be heightened when sudden or severe shifts in market conditions occur, such as those observed during the COVID-19 pandemic. The Company uses a variety of complementary tools to measure, model and aggregate market risk. The principal statistical measurement tool used to assess and monitor market risk on an ongoing basis is Value at Risk ("VaR"). Limits on VaR are set in line with the Company's risk appetite as expressed through economic capital. In addition to VaR, the Company uses sensitivity analysis and stress testing to measure and analyze its market risk. Sensitivities are measures used to show the potential changes to a portfolio due to standard moves in market risk factors. They are specific to each asset class and cannot usually be aggregated across risk factors. Stress testing explores portfolio risks or tail risks, including non-linear behaviors and can be aggregated across risk factors at any level of the group hierarchy. Market risk is monitored against a set of approved limits, with daily reports and other management information provided to the business units and senior management. VaR is a measure of the potential loss in the value of the Company's trading positions due to adverse movements in markets over a defined time horizon with a specified confidence level. Market risks that are incorporated in the VaR model include equity prices, interest rates, credit, FX rates, and commodities with associated volatilities and correlations. ### **11. Contingent Liabilities and Guarantees** ### **Contingencies** In the normal course of business the Company is involved in investigations, lawsuits and other legal proceedings and, as a result, may suffer loss from any fines, penalties or damages awarded against the Company, any settlements the Company chooses to make to resolve a matter, and legal and other advisory costs incurred to support and formulate a defense. {38}------------------------------------------------ The ability to predict the outcome of these actions and proceedings is inherently difficult, particularly where claimants are seeking substantial or indeterminate damages, where investigations and legal proceedings are at an early stage or where the matters present novel legal theories or involve a large number of parties. The Company regularly evaluates each legal proceeding and claim on a case-by-case basis in consultation with legal counsel to assess whether an estimate of possible loss or range of loss can be made, if recognition of a liability is not appropriate. In accordance with ASC 450 "Contingencies" ("ASC 450"), the Company recognizes a liability for this risk of loss arising on each individual matter when a loss is probable and the amount of such loss or range of loss can be reasonably estimated. The amount recognized as a liability is reviewed at least quarterly and is revised when further information becomes available. If these criteria are not met for an individual matter, such as if an estimated loss is only reasonably possible rather than probable, no liability is recognized. However, where a material loss is reasonably possible, the Company will disclose details of the legal proceeding or claim below. Under ASC 450 an event is defined as reasonably possible if the chance of the loss to the Company is more than remote but less than probable. At March 31, 2020, there were no matters for which a legal reserve was required. ### **Guarantees** The Company applies the provisions of ASC 460, *Guarantees* ("ASC 460"), which provides accounting and disclosure requirements for certain guarantees. ASC 460 defines guarantees as contracts and indemnification agreements that contingently require a guarantor to make payments to the guaranteed party based on changes in an underlying (such as an interest or FX rate, security or commodity price, an index, or the occurrence or nonoccurrence of a specified event) related to an asset, liability or equity security of a guaranteed party. ASC 460 also defines guarantees as contracts that contingently require the guarantor to make payments to the guaranteed party based on another entity's failure to perform under an agreement as well as indirect guarantees of the indebtedness of others. The Company has provided a guarantee to a derivatives clearinghouse of which it is a clearing member. This guarantee is required under the standard membership agreement of the clearinghouse such that members are required to guarantee the performance of other members. To mitigate these performance risks, the clearinghouse requires its members to post collateral in the form of a default fund contribution. The Company's liability under this arrangement is not quantifiable and could exceed the cash it has posted as a default fund contribution. However, the potential for the Company to be required to make payments under such guarantees is deemed remote. Accordingly, no contingent liability is recorded on the Statement of Financial Condition. The Company enters into certain derivative contracts that meet the ASC 460 definition of guarantees. Because the Company does not track whether its clients enter into these derivative contracts for speculative or hedging purposes, the Company has disclosed information about derivative contracts that could meet the ASC 460 definition of guarantees. For information about the maximum potential amount of future payments that the Company could be required to make under certain derivatives, such as written put options, the notional amount of contracts has been disclosed. However, the maximum potential payout for certain derivative contracts, such as written {39}------------------------------------------------ interest rate caps and written currency options, cannot be estimated, as increases in interest or FX rates in the future could be theoretically unlimited. The Company records all derivative contracts at fair value on its Statement of Financial Condition. The Company believes the notional amounts generally overstate its risk exposure. Because the derivative contracts are accounted for at fair value, carrying value is considered to be the best indication of payment/performance risks for individual contracts. The following table sets forth information about the Company's derivative contracts that could meet the definition of a guarantee (other than credit derivatives disclosed as protection sold in Note 10) as of March 31, 2020 (in millions): | | | Maximum Payout/Notional By Period of Expiration | | | | | | | | | |----------------|--------------|-------------------------------------------------|-------------------|---------------|---------------|---------------|---------------|---------------|--|--| | | | | Years to Maturity | | | | | | | | | Carrying Value | | Maximum | Less than 1 | | | | | After 5 | | | | | of Liability | Payout | year | 1-2 years | 2-3 years | 3-4 years | 4-5 years | years | | | | \$ | 60,870 | \$
2,399,385 | \$
209,162 | \$
450,723 | \$
345,565 | \$
287,138 | \$
153,904 | \$
952,893 | | | ### **12. Income Taxes** The Company is included in the consolidated federal and certain combined state and local tax returns filed by NHA and Subsidiaries (the "Group"). The Company and the Group have a practice whereby federal and state and local income and capital taxes for the Company are determined, for financial reporting purposes, on a separate company basis. The accrual for unrecognized tax benefits, on the other hand, is accrued on a weighted basis of the Company's share of the Group's unrecognized tax benefits. Federal and certain state and local income and capital taxes are paid to NHA in accordance with this practice. As such, capital taxes payable of \$857 thousand, primarily payable to NHA for state and local income and capital taxes are included in *Other payables to affiliates* on the Statement of Financial Condition as of March 31, 2020. The Company did not have any deferred income tax expense/(benefit) for the year. The effective tax rate differs from the statutory federal tax rate of 21% primarily due to the accrued unrecognized tax benefits and the maintenance of a full valuation allowance ("VA") used to offset the Company's deferred tax assets ("DTA"), which fail to meet the ASC 740 recognition test. The components of the Company's net DTA at March 31, 2020 are as follows (in thousands): {40}------------------------------------------------ | Deferred tax asset | \$
219,466 | |--------------------------|---------------| | Less valuation allowance | (219,466) | | | - | | Deferred tax liabilities | - | | Net deferred tax asset | \$
- | ASC 740 prescribes an asset and liability approach to accounting for taxes that requires the recognition of DTAs and deferred tax liabilities ("DTLs") for the expected future tax consequences of events that have been recognized in the financial statements or tax returns. In estimating future tax consequences, ASC 740 generally considers all expected future events other than future enactments of changes in the tax law or rates. The gross DTAs relate primarily to temporary differences relating to the Company's net operating loss ("NOL") carryforward and interest expense deferral carryforwards. A VA of \$219 million has been maintained against the Company's net DTAs in accordance with the realization criteria set forth in ASC 740. The net decrease during the fiscal year ending March 31, 2020 in the total VA is \$11 million, which was primarily attributable to the Company's pre-tax book income that reduced the DTA and VA balances as a result of NOL utilization. At March 31, 2020, the Company had federal NOL carryforward of approximately \$549 million. \$541 million will begin to expire on March 31, 2028, while \$8 million can be carried forward indefinitely. In addition, the Company had New York State ("NYS") NOL carryforwards of approximately \$735 million and New York City ("NYC") NOL carryforwards of approximately \$670 million. Both will begin to expire on March 31, 2035. Roll-forward of unrecognized tax benefits (in thousands): | Balance at April 1, 2019 | \$
383 | |---------------------------------------------------------|-------------| | Addition based on tax positions related to current year | 1,590 | | Balance at March 31, 2020 | \$
1,973 | | Net unrecognized tax benefits | \$
1,973 | The balance of the net unrecognized tax benefits, due to uncertainties in the tax law/acceptance of application of new rules, is included in *Other liabilities* on the Statement of Financial Condition as of March 31, 2020. If recognized, these benefits would favorably impact the effective tax rate in future periods. The Company did not accrue any interest expense or tax penalty on the unrecognized tax benefits during the year. The Company does not expect any significant changes in the balance of unrecognized tax benefits could occur within the next twelve months. {41}------------------------------------------------ As of March 31, 2020, the Company is subject to tax examination for tax years ending March 31, 2017 through 2019 at the federal level and for tax years ending March 31, 2016 through 2018 at the NYS and NYC level. ## **13. Net Capital** The Company computes its net capital under Appendix F of SEC Rule 15c3-1 which allows for market risk charges to be calculated using internal VaR models. As of March 31, 2020 the Company's net capital, as defined, of \$1,011 million was in excess of the minimum net capital requirement by \$991 million. As an SEC registered OTC Derivatives Dealer, the Company does not carry securities accounts for customers and therefore is exempt from the provisions of SEC Rule 15c3-3. Advances to affiliates, dividend payments, and other equity withdrawals are subject to certain notification and other provisions of the SEC Uniform Net Capital Rule. ## **14. Subsequent Events** The Company has evaluated subsequent events through May 29, 2020, the date as of which this Statement of Financial Condition is available to be issued. The recent global outbreak of COVID–19 has caused significant volatility within the economic markets, for which the duration and spread of the outbreak is uncertain and cannot be predicted. Given the uncertainty of the COVID-19 pandemic and resulting economic impact on the Company, estimates may need to be revised in the future, which could materially impact the Company's future results of operations and/or financial condition. Source: SEC EDGAR via Adviser Search (https://search.stillhousedata.com). Agents: see https://search.stillhousedata.com/llms.txt.