Goldman Sachs 2007 Annual Report Download - page 64

Management’s Discussion and Analysis
Subsidiary Capital Requirements
Many of our principal subsidiaries are subject to separate
regulation and capital requirements in the United States and/or
elsewhere. Goldman, Sachs & Co. and Goldman Sachs
Execution & Clearing, L.P. are registered U.S. broker-dealers and
futures commissions merchants, and are subject to regulatory
capital requirements, including those imposed by the SEC, the
Commodity Futures Trading Commission, the Chicago Board
of Trade, The Financial Industry Regulatory Authority
(FINRA) and the National Futures Association. Goldman
Sachs International, our regulated U.K. broker-dealer, is subject
to minimum capital requirements imposed by the U.K.’s
Financial Services Authority. Goldman Sachs Japan Co., Ltd.,
our regulated Japanese broker-dealer, is subject to minimum
capital requirements imposed by Japan’s Financial Services
Agency. Several other subsidiaries of Goldman Sachs are
regulated by securities, investment advisory, banking, insurance,
and other regulators and authorities around the world. As of
November 2007 and November 2006, these subsidiaries were
in compliance with their local capital requirements.
As discussed above, many of our subsidiaries are subject to
regulatory capital requirements in jurisdictions throughout the
world. Subsidiaries not subject to separate regulation may hold
capital to satisfy local tax guidelines, rating agency requirements
(for entities with assigned credit ratings) or internal policies,
including policies concerning the minimum amount of capital
a subsidiary should hold based on its underlying level of risk.
See “ — Liquidity and Funding Risk — Conservative Liability
Structure” below for a discussion of our potential inability to
access funds from our subsidiaries.
Equity investments in subsidiaries are generally funded with
parent company equity capital. As of November 2007, Group Inc.’s
equity investment in subsidiaries was $40.00 billion compared
with its total shareholders’ equity of $42.80 billion.
Our capital invested in non-U.S. subsidiaries is generally exposed
to foreign exchange risk, substantially all of which is managed
through a combination of derivative contracts and non-U.S.
denominated debt. In addition, we generally manage the non-
trading exposure to foreign exchange risk that arises from
transactions denominated in currencies other than the transacting
entity’s functional currency.
See Note 15 to the consolidated financial statements for further
information regarding our regulated subsidiaries.
Equity Capital
The level and composition of our equity capital are principally
determined by our consolidated regulatory capital requirements
but may also be influenced by rating agency guidelines, subsidiary
capital requirements, the business environment, conditions in
the financial markets and assessments of potential future losses
due to extreme and adverse changes in our business and market
environments. As of November 2007, our total shareholders’
equity was $42.80 billion (consisting of common shareholders’
equity of $39.70 billion and preferred stock of $3.10 billion)
compared with total shareholders’ equity of $35.79 billion as of
November 2006 (consisting of common shareholders’ equity of
$32.69 billion and preferred stock of $3.10 billion). In addition
to total shareholders’ equity, we consider the $5.00 billion of
junior subordinated debt issued to trusts (see discussion below)
to be part of our equity capital, as it qualifies as capital for
regulatory and certain rating agency purposes.
Consolidated Regulatory Capital Requirements
Goldman Sachs is regulated by the Securities and Exchange
Commission (SEC) as a CSE and, as such, is subject to group-
wide supervision and examination by the SEC and to minimum
capital adequacy standards on a consolidated basis. Minimum
capital adequacy standards are principally driven by the
amount of our market risk, credit risk and operational risk as
calculated by methodologies approved by the SEC. Eligible
sources of regulatory capital include common equity and certain
types of preferred stock, debt and hybrid capital instruments,
including our junior subordinated debt issued to trusts. The
recognition of preferred stock, debt and hybrid capital instruments
as regulatory capital is subject to limitations. Goldman Sachs
was in compliance with the CSE capital adequacy standards as
of November 2007 and November 2006.
Rating Agency Guidelines
The credit rating agencies assign credit ratings to the obligations
of The Goldman Sachs Group, Inc., which directly issues or
guarantees substantially all of Goldman Sachs’ senior unsecured
obligations. The level and composition of our equity capital
are among the many factors considered in determining our
credit ratings. Each agency has its own definition of eligible
capital and methodology for evaluating capital adequacy, and
assessments are generally based on a combination of factors
rather than a single calculation. See “ — Liquidity and Funding
Risk — Credit Ratings” below for further information regarding
our credit ratings.
62 Goldman Sachs 2007 Annual Report