Item 7A. Quantitative and Qualitative Disclosures About Market Risk
ITEM 7A. QUANTITATIVE AND QUALITATIVE DISCLOSURES ABOUT MARKET RISK
Our primary exposure to market risk is related to our role as general partner or investment advisor to our investment funds and the sensitivities to movements in the fair value of their investments, including the effect on management fees, incentive fees, performance allocations and principal investment income.
Although our investment funds share many common themes, each of our asset management asset classes runs its own investment and risk management processes, subject to our overall risk tolerance and philosophy. The investment process of our investment funds involves a comprehensive due diligence approach, including review of reputation of shareholders and management, company size and sensitivity of cash flow generation, business sector and competitive risks, portfolio fit, exit risks and other key factors highlighted by the deal team. Key investment decisions are subject to approval by both the fund-level managing directors, as well as the investment committee, which is generally comprised of one or more of the three founding partners, one “sector” head, one or more advisors and senior investment professionals associated with that particular fund. Once an investment in a portfolio company has been made, our fund teams closely monitor the performance of the portfolio company, generally through frequent contact with management and the receipt of financial and management reports.
Effect on Fund Management Fees
Management fees will only be directly affected by short-term changes in market conditions to the extent they are based on NAV or represent permanent impairments of value. These management fees will be increased (or reduced) in direct proportion to the effect of changes in the market value of our investments in the related funds. In addition, the terms of the governing agreements with respect to certain of our carry funds provide that the management fee base will be reduced when the aggregate fair market value of a fund’s investments is below its cost. The proportion of our management fees that are based on NAV is dependent on the number and types of investment funds in existence and the current stage of each fund’s life cycle.
Effect on Performance Allocations
Performance allocations reflect revenue primarily from carried interest on our carry funds. In our discussion of “Key Financial Measures” and “Critical Accounting Policies”, we disclose that performance allocations are recognized upon appreciation of the valuation of our funds’ investments above certain return hurdles and are based upon the amount that would be due to Carlyle at each reporting date as if the funds were liquidated at their then-current fair values. Changes in the fair value of the funds’ investments may materially impact performance allocations depending upon the respective funds’ performance to date as compared to its hurdle rate and the related carry waterfall.
The following table summarizes the incremental impact, including our Consolidated Funds, of a 10% change in total remaining fair value by segment as of December 31, 2021 on our performance allocations revenue:
10% Increase
in Total
Remaining
Fair Value 10% Decrease
in Total
Remaining
Fair Value
(Dollars in millions)
Global Private Equity $ 1,675.9 $ (1,918.3)
Global Credit 170.3 (146.8)
Global Investment Solutions 219.1 (204.7)
Total $ 2,065.3 $ (2,269.8)
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The following table summarizes the incremental impact of a 10% change in Level III remaining fair value by segment as of December 31, 2021 on our performance allocations revenue:
10% Increase
in Level III
Remaining
Fair Value 10% Decrease
in Level III
Remaining
Fair Value
(Dollars in millions)
Global Private Equity $ 1,490.7 $ (1,732.0)
Global Credit 159.2 (142.2)
Global Investment Solutions 207.1 (192.8)
Total $ 1,857.0 $ (2,067.0)
The effect of the variability in performance allocations revenue would be in part offset by performance allocation related compensation.
Effect on Assets Under Management
Generally, our Fee-earning assets under management are not affected by changes in valuation. However, total assets under management is impacted by valuation changes to net asset value. The table below shows the remaining fair value and the percentage amount classified as Level III investments as defined within the fair value standards of U.S. GAAP:
Remaining Fair Value Percentage Amount
Classified as Level
III Investments
(Dollars in millions)
Global Private Equity $ 113,853 89 %
Global Credit (1)
$ 59,694 97 %
Global Investment Solutions $ 43,012 95 %
(1) Comprised of approximately $33.0 billion (100% Level III Investments) in our structured credit products, $10.5 billion (96% Level III Investments) in our carry funds, $10.3 billion (89% Level III Investments) in our managed accounts/other products, and $5.9 billion (94% Level III Investments) in our direct lending products.
Exchange Rate Risk
Our investment funds hold investments that are denominated in non-U.S. dollar currencies that may be affected by movements in the rate of exchange between the U.S. dollar and non-U.S. dollar currencies. Non-U.S. dollar denominated assets and liabilities are translated at year-end rates of exchange, and the consolidated statements of operations accounts are translated at rates of exchange in effect throughout the year. Additionally, a portion of our management fees are denominated in non-U.S. dollar currencies. We estimate that as of December 31, 2021, if there was a 10% decline in the rate of exchange of all foreign currencies against the U.S. dollar, the impact on our consolidated results of operations for the year then ended would be as follows: (a) fund management fees would decrease by $42.8 million, (b) performance allocations would decrease by $173.6 million and (c) principal investment income would decrease by $6.2 million.
Interest Rate Risk
We have obligations under our CLO term loans that accrue interest at variable rates. Interest rate changes may therefore affect the amount of interest payments, future earnings and cash flows. The CLO term loans incur interest at EURIBOR plus an applicable rate. We do not have any interest rate swaps in place for these borrowings.
Based on our debt obligations payable as of December 31, 2021, we estimate that interest expense relating to variable rates would increase by approximately $2.2 million on an annual basis in the event interest rates were to increase by one percentage point.
Credit Risk
Certain of our investment funds hold derivative instruments that contain an element of risk in the event that the counterparties are unable to meet the terms of such agreements. We minimize our risk exposure by limiting the counterparties with which we enter into contracts to banks and investment banks who meet established credit and capital guidelines. We do
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not expect any counterparty to default on its obligations and therefore do not expect to incur any loss due to counterparty default.
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