Notes on the Group financial statements

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E: Asset management (including US broker-dealer) and other operations

The Group’s asset management operations are based in the UK, Asia and the US where they operate different models and under different brands tailored to their markets.

Asset management in the UK is undertaken through M&G which is made up of three distinct businesses, being Retail, Wholesale and Finance, and whose operations include retail asset management, institutional fixed income, pooled life and pension funds, property and private finance. M&G also manage the Group’s balance sheet.

Asset management in Asia serves both the life companies in Asia by managing the life funds and funds underlying the investment linked products and third party customers through mutual fund business. Asia offers mutual fund investment products in a number of countries within the region, allowing customers to participate in debt, equity and money market investments.

Asset management in the US is undertaken through PPM America which manages assets for the Group’s US, UK and Asian affiliates plus also provides investment services to other affiliated and unaffiliated institutional clients including CDOs, private investment funds, institutional accounts and mutual funds. In addition, broker-dealer activities are undertaken in the US where trades in securities are carried out for both third party customers and for its own account.

Other operations covers unallocated corporate activities and includes the head office functions.

E1: Income statement for asset management operations

The profit included in the income statement in respect of asset management operations for the year is as follows:

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Asset management operations
2007 £m 2006 £m
M&G US Asia Total Total
Revenue 810 386 201 1,397 1,080
Charges (547) (377) (129) (1,053) (797)
Profit before tax 263 9 72 344 283
Profit before tax for asset management operations comprise:
Operating profit based on longer-term investment returns* 254 8 72 334 262
Short-term fluctuations in investment returns 4 1 – 5 –
Shareholders’ share of actuarial gains and
losses on defined benefit schemes 5 – – 5 21
Profit before tax 263 9 72 344 283

*Operating profit based on longer-term investment returns includes £nil (2006: £2 million) of UK restructuring costs.

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E2: Balance sheet for asset management operations

Assets, liabilities and shareholders’ funds included in the Group consolidated balance sheet in respect of asset management operations are as follows:

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Asset management operations
2007 £m 2006 £m
M&G US Asia Total Total
Assets
Intangible assets:
Goodwill 1,153 16 61 1,230 1,230
Deferred acquisition costs 6 – – 6 6
Total 1,159 16 61 1,236 1,236
Other non-investment and non-cash assets 304 132 85 521 415
Investment properties – – – – 1
Financial investments:
Loans note i 2,334 – – 2,334 2,181
Equity securities and portfolio holdings in unit trusts 11 – 6 17 13
Debt securities note ii 857 – 25 882 678
Other investments 132 19 4 155 80
Deposits – 15 11 26 10
Total investments 3,334 34 46 3,414 2,963
Cash and cash equivalents note iii 1,751 33 56 1,840 951
Total assets 6,548 215 248 7,011 5,565
Equity and liabilities
Equity
Shareholders’ equity 1,424 81 172 1,677 1,590
Minority interests 52 – – 52 52
Total equity 1,476 81 172 1,729 1,642
Liabilities
Intra Group debt represented by operational
borrowings at Group level note iv 2,477 – – 2,477 2,032
Net asset value attributable to external holders
of consolidated funds note iii 1,234 – – 1,234 513
Other liabilities 1,361 134 76 1,571 1,378
Total liabilities 5,072 134 76 5,282 3,923
Total equity and liabilities 6,548 215 248 7,011 5,565

Notes

i Loans

The M&G loans of £2,334 million comprise £1,383 million of bridging loan finance assets and £951 million in respect of a structured finance arrangement, both managed by Prudential Capital. The bridging loan finance assets generally have no external credit ratings available, with internal ratings prepared by the Group’s asset management operations as part of the risk management process rating £738 million BBB+ to BBB- and £645 million BB+ to BB-. Of the loans receivable under the structured finance arrangement, £826 million of the receivable was with counterparties rated AA by Standard and Poor’s and £125 million AA-. In addition a AAA rated credit default swap was held covering £400 million of the AA rated element of the loans.

ii Debt securities

Of the debt securities of £857 million for M&G at 31 December 2007, £278 million were rated AAA by Standard and Poor’s, £6 million AA+, £42 million AA, £271 million AA-, £162 million A+, £7 million A and £ 29 million A-. Of the £62 million which was not rated by Standard and Poor’s £46 million was rated Aaa by Moody’s.

iii Consolidated investment funds

The M&G balance sheet shown above includes investment funds which are managed on behalf of third parties and that are consolidated under IFRS in recognition of the control arrangements for the funds. The balance sheet includes cash and cash equivalents of £1,253 million, £(19) million of other net assets and liabilities and the net asset value attributable to external unit holders of £1,234 million in respect of these funds, which are non-recourse to M&G and the Group.

iv Intra Group debt represented by operational borrowings at Group level

Operational borrowings for M&G are in respect of Prudential Capital’s short-term fixed income security programme and comprise £2,422 million of commercial paper and £55 million of medium-term notes.

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E3: Regulatory capital positions

Asset management operations in the UK, Hong Kong, Singapore, Vietnam and China are subject to regulatory requirements based on fixed operating expenses and other operating considerations. The movement in the year of the surplus regulatory capital position of these operations, combined with the movement in the IFRS basis shareholders’ funds for other asset management operations, is as follows:

Asset management operations
2007 £m 2006 £m
M&G US Asia Total Total
Capital surplus position
Beginning of year 114 57 72 243 311
Exchange movement – (1) – (1) (15)
Movement in capital requirement (6) – (3) (9) (26)
Gains during the year 105 25 59 189 172
Distributions made (114) – (36) (150) (199)
End of year 99 81 92 272 243

The movement in the year reflects changes in regulatory requirements whilst gains are driven by profits generated during the year. Distributions consist of dividends paid up to the parent company.

E4: Sensitivity of profit and equity to market and other financial risk

i Currency translation

Consistent with the Group’s accounting policies, the profits of the Asia and PPM America asset management operations are translated at average exchange rates and shareholders’ equity at the closing rate for the reporting period. For 2007, the rates for the most significant operations are given in note B4.

A 10 per cent increase in these rates and those of other Asian operations would have reduced reported profit before tax attributable to shareholders and shareholders’ equity, excluding goodwill attributable to Asia and PPM America asset management operations, by £7 million (2006: £14 million) and £18 million (2006: £19 million) respectively.

ii Other sensitivities to other financial risks for asset management operations

The principal sensitivities to other financial risk of asset management operations are credit risk on the bridging loan portfolio (as described in note E2) of M&G’s Prudential Capital operation and the indirect effect of changes to market values of funds under management. Due to the nature of the asset management operations there is limited direct sensitivity to movements in interest rates. Total debt securities held at 31 December 2007 by asset management operations were £882 million (2006: £678 million), the majority of which are held by the Prudential Capital operation of M&G. Debt securities held by M&G are in general variable rate bonds and so market value is limited in sensitivity to interest rate movements and consequently any change in interest rates would not have a material impact on profit or shareholder’s equity. Asset management operations do not hold significant investments in property or equities.

E5: Other operations

Other operations consist of unallocated corporate activities including Group Head Office (GHO) and Asia regional head office, with net income and expenditure for the year of £248 million (2006: £248 million) for other operations detailed in note B1. An analysis of assets and liabilities relating to other operations is shown in note B6.


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