FORM 6-K
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
Report of Foreign Private Issuer
Pursuant to Rule 13a-16 or 15d-16
of the Securities Exchange Act of 1934
For
February 24, 2017
Commission
File Number: 001-10306
The
Royal Bank of Scotland Group plc
RBS,
Gogarburn, PO Box 1000
Edinburgh
EH12 1HQ
(Address
of principal executive offices)
Indicate
by check mark whether the registrant files or will file annual
reports under cover of Form 20-F or Form 40-F.
Form
20-F X Form 40-F
___
Indicate
by check mark if the registrant is submitting the Form 6-K in paper
as permitted by Regulation S-T Rule 101(b)(1):_________
Indicate by check
mark if the registrant is submitting the Form 6-K in paper as
permitted by Regulation S-T Rule 101(b)(7):_________
Indicate by check
mark whether the registrant by furnishing the information contained
in this Form is also thereby furnishing the information to the
Commission pursuant to Rule 12g3-2(b) under the Securities Exchange
Act of 1934.
Yes ___
No X
If
"Yes" is marked, indicate below the file number assigned to the
registrant in connection with Rule 12g3-2(b): 82-
________
The
following information was issued as Company announcements in
London, England and is furnished pursuant to General Instruction B
to the General Instructions to Form 6-K:
Royal
Bank of Scotland Group PLC
Annual
Financial Report
The
Royal Bank of Scotland Group plc
24
February 2017
Annual
Report and Accounts 2016
Strategic
Report 2016
Pillar
3 Report 2016
Copies of the Annual Report and Accounts 2016 and
Strategic Report 2016 for The Royal Bank of Scotland Group plc
(RBS) have been submitted to the National Storage Mechanism and
will shortly be available for inspection at:
http://www.morningstar.co.uk/uk/NSM
These documents are available on our website
at www.rbs.com/results.
Printed versions will be mailed to shareholders who have
opted for a hard copy of these documents ahead of the Annual
General Meeting for which formal Notice will be given in due
course.
We
have also published the 2016 Pillar 3 report, available on our
website.
For
further information, please contact:-
RBS
Media Relations
+44
(0) 131 523 4205
Investors
Alexander
Holcroft
Investor
Relations
+44
(0) 207 672 1758
Information
on risk factors and related party transactions
For
the purpose of compliance with the Disclosure Guidance and
Transparency Rules, this announcement also contains risk factors
and details of related party transactions extracted from the Annual
Report and Accounts 2016 in full unedited text. Page
references in the text refer to page numbers in the Annual Report
and Accounts 2016.
Set out
below are certain risk factors that could adversely affect the
Group's future results, its financial condition and prospects and
cause them to be materially different from what is expected. The
factors discussed below and elsewhere in this report should not be
regarded as a complete and comprehensive statement of all potential
risks and uncertainties facing the Group.
The Group is subject to a number of legal, regulatory and
governmental actions and investigations. Unfavourable outcomes in
such actions and investigations could have a material adverse
effect on the Group’s operations, operating results,
reputation, financial position and future prospects.
The
Group’s operations remain diverse and complex and it operates
in legal and regulatory environments that expose it to potentially
significant legal and regulatory actions, including litigation
claims and proceedings and civil and criminal regulatory and
governmental investigations, and other regulatory risk. The Group
has settled a number of legal and regulatory actions over the past
several years but continues to be, and may in the future be,
involved in a number of legal and regulatory actions in the US, the
UK, Europe and other jurisdictions.
The
legal and regulatory actions specifically referred to below are, in
the Group’s view, the most significant legal and regulatory
actions to which the Group is currently exposed. However, the Group
is also subject to a number of additional claims, proceedings and
investigations, the adverse resolution of which may also have a
material adverse impact on the Group and which include ongoing
reviews, investigations and proceedings (both formal and informal)
by governmental law enforcement and other agencies and litigation
proceedings (including class action litigation), relating to, among
other matters, the offering of securities, including residential
mortgage-backed securities (RMBS), conduct in the foreign exchange
market, the setting of benchmark rates such as LIBOR and related
derivatives trading, the issuance, underwriting, and sales and
trading of fixed-income securities (including structured products
and government securities), product mis-selling, customer
mistreatment, anti-money laundering, sanctions, and various other
compliance issues. See pages 370 to 386 for details for these
matters. The Group continues to cooperate with governmental and
regulatory authorities in relation to ongoing regulatory actions.
Legal and regulatory actions are subject to many uncertainties, and
their outcomes, including the timing, amount of fines or
settlements or the form of any settlements, which may be material,
are often difficult to predict, particularly in the early stages of
a case or investigation. It is expected that the Group will
continue to have a material exposure to legal and regulatory
actions relating to legacy issues in the medium term.
In the
US, ongoing matters include various civil claims relating to legacy
RMBS activities, the most material of which are those of the
Federal Housing Finance Agency (FHFA), and investigations by the
civil and criminal divisions of the U.S. Department of Justice
(DOJ) and various other members of the RMBS Working Group of the
Financial Fraud Enforcement Task Force (including several state
attorneys general). On 26 January 2017, the Group announced that it
was taking a further £3.1bn ($3.8bn) provision in relation to
these litigation and investigation matters including in relation to
the Group’s issuance and underwriting of RMBS as well as
other RMBS litigation matters.
The
duration and outcome of the DOJ’s civil and criminal
investigations remain uncertain. No settlement may be reached with
the DoJ and further substantial additional provisions and costs may
be recognised. Any finding of criminal liability by US authorities
(including as a result of guilty pleas) could have material
collateral consequences for the Group’s operations. These may
include consequences resulting from the need to reapply for various
important licences or obtain waivers to conduct certain existing
activities of the Group, particularly but not solely in the US,
which may take a significant period of the time and the results of
which are uncertain. Failure to obtain such licenses or waivers
could adversely impact the Group’s business, in particular
the NatWest Markets business in the US, including if it results in
the Group being precluded from carrying out certain activities. A
further provision of £3.1 billion ($3.8 billion) was recorded
by the Group in Q4 2016 in relation to RBS’s various RMBS
investigations and litigation matters, taking the total of such
provisions to £6.8 billion ($8.3 billion) at 31 December
2016.
The
Group is also facing litigation in the UK in connection with its
2008 shareholder rights issue. In December 2016, the Group
concluded full and final settlements with four of the five
shareholder groups representing 78% of the claims by value. As
announced in December, although the Group has determined a
settlement figure of up to £800 million for the resolution of
these matters (including the settlement referred to above), which
amount is covered by existing provisions. This figure assumes that
agreement is also reached with the remaining claimant group, is
split proportionally and is subject to validation of claims.
Following the settlements described above, a number of claims
remain outstanding with the final shareholder group and the Group
may not manage to reach a settlement agreement with the remaining
claimants, and as a result remains exposed to continuing
litigation. Trial is scheduled to commence in March
2017.
In
addition, the Group is undertaking various remediation programmes
in response to past conduct issues. As announced on 8 November
2016, the Group is also taking steps, including automatic refunds
of certain complex fees and a new complaints process, overseen by
an independent third party for small and medium entity (SME)
customers in the UK and the Republic of Ireland that were in its
Global Restructuring Group (GRG) between 2008 and 2013. This new
complaints review process and the automatic refund of complex fees
was developed with the involvement of the Financial Conduct
Authority (FCA). The FCA’s review into these activities is
continuing and fines or additional redress commitments may be
accepted by or imposed upon the Group, notwithstanding the steps
the Group has already taken. The Group booked a provision of
£400 million in Q4 2016, based on its estimates of the costs
associated with the new complaints review process and the automatic
refund of complex fees for SME customers in GRG.
In
2016, the Group booked additional provisions of £601 million
with respect to payment protection insurance (PPI), resulting in
total provisions made for such matters of £4.9 billion, of
which £3.7 billion had been utilised by 31 December 2016 and
additional future provisions and costs are possible until such time
as the FCA’s consultation on the deadline for PPI is
concluded.
Settlements,
resolutions and outcomes in relation to ongoing legal or regulatory
actions may result in material financial fines or penalties,
non-monetary penalties, restrictions upon or revocation of
regulatory permissions and licences and other collateral
consequences and may prejudice both contractual and legal rights
otherwise available to the Group. The costs of resolving these
legal and regulatory actions could individually or in aggregate
prove to be substantial and monetary penalties and other outcomes
could be materially in excess of provisions, if any, made by the
Group. New provisions or increases in existing provisions relating
to existing or future legal or regulatory actions may be
substantial and may have a material adverse effect on the
Group’s financial condition and results of operations as well
as its reputation. The outcome of on-going claims against the Group
may give rise to additional legal claims being asserted against the
Group. Adverse outcomes or resolution of current or future legal or
regulatory actions could result in restrictions or limitations on
the Group’s operations, adversely impact the implementation
of Group’s current transformation programme as well as its
capital position and its ability to meet regulatory capital
adequacy requirements. The remediation programmes or commitments
which the Group has agreed to in connection with past settlements
or investigations, could require significant financial costs and
personnel investment for the Group and may result in changes in its
operations or product offerings, and failure to comply with
undertakings made by the Group to its regulators may result in
additional measures or penalties being taken against the
Group.
The Group is subject to political risks, including economic,
regulatory and political uncertainty arising from the outcome of
the referendum on the UK’s membership of the European Union
(EU Referendum) which could adversely impact the Group’s
business, results of operations, financial condition and
prospects.
In a
referendum held on 23 June 2016, a majority voted for the UK to
leave the European Union (EU). There is now prevailing uncertainty
relating to the timing of the UK’s exit from the EU, as well
as the negotiation and form of the UK’s relationships with
the EU, with other multilateral organisations and with individual
countries at the time of exit and beyond. Once the exit process is
triggered by the UK government, Article 50 of the Treaty on the EU
stipulates that a maximum two year period of negotiation will begin
to determine the new terms of the UK’s exit from the EU ad
set the framework for the UK’s new relationship with the EU,
after which period its EU membership and all associated treaties
will cease to apply, unless some form of transitional arrangement
encompassing those associated treaties is agreed or there is
unanimous agreement amongst EU member states and the European
Commission to extend the negotiation period. The direct and
indirect effects of the UK’s decision to leave the EU are
expected to affect many aspects of the Group’s business,
including as described elsewhere in these risk factors, and may be
material. During the period in which the UK is negotiating its exit
from the EU, the Group may face an increasingly uncertain operating
environment.
The
longer term effects of the EU Referendum on the Group’s
operating environment are difficult to predict, and subject to
wider global macro-economic trends and events, but are likely to
significantly impact the Group and its customers and counterparties
who are themselves dependent on trading with the EU or personnel
from the EU and may result in periodic financial volatility and
slower economic growth, in the UK in particular, but also in
Republic of Ireland (ROI), Europe and potentially the global
economy. These longer-term effects may endure until the bilateral
and multilateral trading and economic relationships between the UK,
the EU, members of the World Trade Organisation and other key
trading partners are agreed, implemented and settled.
There
is related uncertainty as to the respective legal and regulatory
arrangements under which the Group and its subsidiaries will
operate when the UK is no longer a member of the EU. In addition,
the Group and its counterparties may no longer be able to rely on
the EU passporting framework for financial services and could be
required to apply for authorisation in multiple jurisdictions in
the EU, the costs, timing and viability of which is uncertain. This
uncertainty and any actions taken as a result of this uncertainty,
as well as new or amended rules, could have a significant impact on
the Group’s operations or legal entity structure, including
attendant restructuring costs, capital requirements and tax
implications and as a result adversely impact the Group’s
profitability, business model and product offering. See also
“Changes to the prudential regulatory framework for banks and
investment banks within the EU may require additional structural
changes to the Group’s operations which may affect current
restructuring plans and have a material adverse effect on the
Group.”
The
outcome of the EU Referendum has created constitutional and
political uncertainty as to how the Scottish parliamentary process
may impact the negotiations relating to the UK’s exit from
the EU. As RBSG and RBS plc, its principal operating subsidiary,
are both headquartered and incorporated in Scotland, any changes to
Scotland’s relationship with the UK or the EU may further
impact the environment in which the Group and its subsidiaries
operate, including as it may require changes to be made to the
Group’s structure, independently or in conjunction with other
mandatory or strategic structural and organisational changes and as
a result could adversely impact the Group.
Changes to the prudential regulatory framework for banks and
investment banks within the EU may require additional structural
changes to the Group’s operations which may affect current
restructuring plans and have a material adverse effect on the
Group.
The
exit from the European Union by the UK following the EU Referendum
may result in one or more structural and reorganisation changes
being implemented within the Group, in addition to those currently
planned for. Current proposed changes to the European prudential
regulatory framework for banks and investment banks may result in
additional prudential or structural requirements being imposed on
financial institutions based outside the EU wishing to provide
financial services within the EU which may apply to the Group once
the UK has formally exited the EU. One of the proposals would
impose a requirement for any third country banks with two or more
institutions within the EU to establish a single intermediate
parent undertaking in the European Union. These are currently draft
proposals which, if adopted, are not expected to come into force
until after the implementation deadline for the UK ring fencing
regime (1 January 2019). The Group is currently assessing how these
proposals, if adopted, may impact the Group and its current
restructuring plans to implement the UK ring-fencing regime. If
implemented, the impact of these proposals could be material given
the expectation that both the ring-fenced banking entities
organised as a sub-group (the “RFB”) and the non-ring
fenced group would continue to carry out operations in the EU. If
adopted, these proposals would require further additional
restructuring of the Group’s operations and legal structure,
in addition to the changes already planned to be implemented for
the purposes of compliance with the UK ring-fencing regime and any
other changes required to be implemented as a result of other
regulatory, political or strategic developments and could result in
material additional capital requirements and have adverse tax
implications. Planning and implementation of any additional
restructuring of the Group’s activities may also divert
management and personnel resources from the effective conduct of
the Group’s operations, result in further material
restructuring costs, jeopardise the delivery and implementation of
a number of other significant change projects resulting from
mandatory regulatory developments or as part of its transformation
programme, impact the Group’s product offering or business
model or adversely impact the Group’s ability to deliver its
strategy and meet its targets and guidance, each of which could
have a material adverse impact on the Group’s results of
operations, financial condition and prospects.
The Group is in the process of seeking to satisfy its commitments
arising as a result of the receipt of State Aid in December 2008.
The process to amend the Group’s State Aid obligations in
respect of Williams & Glyn may not ultimately amend such
obligations or the revised obligations may be more onerous than
those currently being discussed. The diversion of Group resources
required to meeting the Group’s obligations in respect of
Williams & Glyn, associated costs or delays in meeting, or a
failure to meet, the deadline for compliance, could have a material
adverse effect on the Group’s operations, operating results,
financial position and reputation.
State
Aid approval was received from the European Commission in
connection with the financial assistance provided to the Group by
the UK Government in 2008. In connection with the receipt of such
financial assistance, and as a condition for State Aid approval,
the Group entered into a state aid commitment deed with HM Treasury
(as amended from time to time, the “State Aid Commitment
Deed”) which set out conditions upon which such State Aid
approval was granted including the requirement for the Group to
divest its RBS branches in England and Wales, NatWest branches in
Scotland, Direct SME banking and certain mid-corporate customers
(Williams & Glyn) by the end of 2017. In light of its
obligations under the State Aid Commitment Deed, the Group actively
sought to fully divest Williams & Glyn and engaged in
discussions with a number of interested parties concerning a
transaction related to substantially all of the Williams & Glyn
business. However, as none of these proposals could deliver full
divestment by 31 December 2017, the Group announced on 28 April
2016 that there was a significant risk that the previously planned
separation and divestment of Williams & Glyn would not be
achieved by the 31 December 2017 deadline. On 5 August 2016, the
Group announced that the Board had determined that it would not be
prudent to continue with the plan for separating and divesting
Williams & Glyn and announced that various alternative
divestment structures were being actively explored.
The
Group subsequently announced on 17 February 2017 that the
Commissioner responsible for EU competition policy planned to
propose to the European Commission to open proceedings to develop
an alternative plan for the Group to meet its remaining State Aid
obligations in regards to Williams & Glyn. If adopted, it is
intended that this alternative plan would replace the existing
requirement to achieve separation and divestment of Williams &
Glyn by 31 December 2017 and the current conditions set out in the
State Aid Commitment Deed would be amended
accordingly.
Under
the current form of the alternative plan, the Group will deliver a
package of measures to promote competition in the market for
banking services to small and medium enterprises (SMEs) in the UK.
This package will include: (i) an SME banking capability fund,
administered by an independent body, which eligible challenger
banks could access to increase their SME business banking
capabilities; (ii) funding for eligible challenger banks to help
them incentivise UK SME customers to switch their accounts from RBS
to eligible challenger banks by paying in the form of
“dowries”; (iii) the Group granting business customers
of eligible challenger banks access to its branch network for cash
and cheque handling, to support the incentivised switching
programme; and (iv) the funding of an independent financial
services innovation fund to invest in and help support the growth
of existing businesses providing or developing innovative financial
services or products for UK SMEs. In connection with this package
of alternative measures, the Group has taken a £750 million
provision in 2016. However, actual costs associated with the
implementation of such measures may be materially higher as a
result of unforeseen complexities and factors outside of the
Group’s control.
Discussions
will continue between the Group, HM Treasury and the European
Commission to further develop the design of this package of
alternative measures and the duration of them. The timing of the
approval for this or any package of alternative measures is
uncertain and there is no guarantee that the European Commission
will ultimately agree to this or any package of alternative
measures in replacement of the original terms of the State Aid
Commitment Deed in relation to Williams & Glyn. In addition,
the final scope and content of the package of alternative measures
will be subject to further market testing by HM Treasury and a
consultation exercise by the European Commission, either of which
may result in amendments to the scope of and costs associated with
this package as a result of which the final terms of a package of
alternative measures may be more onerous than the scope of the plan
set out above.
Implementation
of the package, or if required as a result of the above process a
more onerous package, and any associated business restructuring
could divert resources from the Group’s operations and
jeopardise the delivery and implementation of other significant
plans and initiatives. The incentivised transfer of SME customers
to third parties places reliance on those third parties to achieve
satisfactory customer outcomes which could give rise to
reputational damage if these are not forthcoming.
Execution
of the alternative measures package plan entails significant costs,
including the funding commitments and financial incentives
envisaged to be provided under the plan. In addition, the final
terms of the agreement entered into among the Group, HM Treasury
and the European Commission may include sanctions or additional
financial incentives designed to ensure that the Group delivers its
commitments. The Group will also need to assess the timing and
manner in which to reintegrate the remaining Williams & Glyn
business into the Group which is expected to result in additional
restructuring charges and may adversely impact the Group’s
existing restructuring plans, including in respect of the
implementation of the UK ring-fencing regime.
As a
direct consequence of the incentivised switching component of the
package of alternative measures described above, the Group will
lose existing customers and deposits and associated revenues and
margins. Furthermore, the SME banking capability fund and financial
services innovation fund envisaged by the alternative plan is
intended to benefit challenger banks and negatively impact the
Group’s competitive position. To support this incentivised
switching initiative, the Group will also have to agree to grant
business customers of eligible challenger banks access to its
branch network for cash and cheque handling, which may result in
reputational and financial exposure for the Group and impact
customer service quality for RBS’s own customers with
consequent competitive, financial and reputational
implications.
If the
Group fails to come to an agreement with HM Treasury and the
European Commission in respect of the proposed package of
alternative measures, and a determination is made that the Group
remains required to divest Williams & Glyn, there is no
guarantee that the Group will be able to identify or recommence
discussions with interested buyers for Williams & Glyn at that
time or that it will be able to agree a divestment on commercially
beneficial terms, and there is no certainty that any such
discussions would lead to a viable transaction. In addition, the
Group would be required to conduct further restructuring in order
to divest the Williams & Glyn business, at the same time that
it is implementing significant restructuring changes in connection
with the implementation of the UK ring-fencing regime and other
restructuring changes which may be required as a result of the UK
terminating its membership of the European Union, which entails
material execution risks and costs, as well as diverting Group and
management resources. In addition, if no alternative to the
Group’s current State Aid Commitment Deed obligations becomes
effective, the Group would be unable to meet the principal
obligation in the State Aid Commitment Deed to divest Williams
& Glyn by 31 December 2017, which could entail material
sanctions (including the appointment of a divestiture trustee, with
the mandate to complete the divestment at no minimum
price).
A
failure to comply with the terms of the revised State Aid
Commitment Deed, once agreed, could result in the imposition of
additional measures or limitations on the Group’s operations,
additional supervision by the Group’s regulators, and loss of
investor confidence, any of which could have a material adverse
impact on the Group. Delays in execution may also impact the
Group’s ability to carry out its transformation programme,
including the implementation of cost saving initiatives and
implement mandatory regulatory requirements, including the UK
ring-fencing regime. Such risks will increase in line with any
additional delays.
Implementation of the ring-fencing regime in the UK which began in
2015 and must be completed before 1 January 2019 will result in
material structural changes to the Group’s business. These
changes could have a material adverse effect on the
Group.
The
requirement to “ring-fence” retail banking operations
was introduced under the UK Financial Services (Banking Reform) Act
2013 (the “Banking Reform Act 2013”) and adopted
through secondary legislation (the “UK ring-fencing
regime”). These reforms form part of a broader range of
structural reforms of the banking industry seeking to improve the
resilience and resolvability of banks and which range from
structural reforms (including ring-fencing) to the implementation
of a new recovery and resolution framework (which in the UK will
incorporate elements of the ring-fencing regime). See “The
Group and its subsidiaries are subject to a new and evolving
framework on recovery and resolution, the impact of which remains
uncertain, and which may result in additional compliance challenges
and costs.”
On 30
September 2016, the Group announced plans for its future
ring-fencing compliant structure. By the end of 2018, the Group
intends to place the majority of its UK and Western European
banking business in ring-fenced banking entities organised as a
sub-group under an intermediate holding company named NatWest
Holdings Limited which will be a direct subsidiary of RBSG and will
ultimately assume ownership of National Westminster Bank Plc, Adam
& Company PLC (to be renamed The Royal Bank of Scotland plc)
and Ulster Bank Ireland DAC (Ulster Bank). As a result, National
Westminster Bank Plc will no longer be a subsidiary of RBS plc. The
NatWest Markets franchise (formerly known as the Corporate and
Institutional Banking business) and the RBS International business
will be outside the ring-fence in other banking subsidiaries of
RBSG.
As part
of this restructuring, in mid-2018, the majority of existing
personal, private, business and commercial customers of RBS plc
will be transferred to the RFB, specifically to National
Westminster Bank Plc and Adam & Company PLC which (on the same
day) will be renamed The Royal Bank of Scotland plc. At the same
time, RBS plc (which will sit outside the RFB) will be renamed
NatWest Markets Plc to bring its legal name in line with the
rebranding of the NatWest Markets franchise which was initiated in
December 2016, and will continue to operate the NatWest Markets
franchise as a direct subsidiary of RBSG.
As a
result of the changes described above, the establishment of the RFB
sub-group will have a material impact on how the Group conducts its
business and requires a significant legal and organisational
restructuring of the Group and the transfer of large numbers of
assets, liabilities and customers between legal entities and the
realignment of employees which started in early 2017. The Group is
still considering whether a number of its current activities will
be conducted within or outside of the RFB.
The
Group’s final ring-fenced legal structure and the actions
taken to achieve it, remain subject to, amongst other factors,
additional regulatory, board and other approvals as well as
employee representative information and consultation procedures. In
particular, transfers of assets and liabilities through a
ring-fencing transfer scheme are now subject to review by an
Independent Skilled Person designated by the PRA in advance of
commencing the formal court process in late 2017 prior to such
transfers and migrations taking place in 2018, which may result in
amendments being required to be made to the Group’s current
plan and in delays in the implementation of the UK ring-fencing
regime, additional costs and/or changes to the Group’s
business.
The
implementation of these changes involves a number of risks related
to both the revised Group structure and also the process of
transition to that new structure. Those risks include the
following:
●
The Group is unable
to predict how some customers may react to the required changes,
including for some customers a requirement to deal with both the
RFB and other Group entities outside the RFB to obtain the full
range of products and services or to take any affirmative steps in
connection with the reorganisation.
●
As part of the
establishment of the RFB, the RFB will need to operate
independently from the rest of the Group and material changes to
the existing corporate governance structure will need to be put in
place by the Group to ensure the RFB’s independence. This new
structure may result in divergences between the various governance
bodies within the Group and create operational challenges. In
addition, the Group may experience difficulties in attracting
qualified candidates to occupy these new positions and the new
governance structure may result in an increase in overhead and
compliance costs.
●
In order to comply
with the requirements of the UK ring-fencing regime, the Group will
need to revise its operations infrastructure so as to comply with
the shared services, independence and resolvability requirements
set out in the UK ring-fencing rules, including in areas such as
information technology (IT) infrastructure, human resources and
critical service providers which may involve associated execution
risk and may result in increased costs. Arrangements between RFB
and other Group entities will also need to be reviewed in light of
these requirements and the requirement that all such transactions
take place on an arm’s-length basis.
●
The implementation
of the UK ring-fencing regime will significantly impact the
management of the Group’s treasury operations, including
internal and external funding arrangements. The changes required
may adversely impact the assessment made by credit rating agencies,
creditors and other stakeholders of the credit strength of the
different entities on a standalone basis and may heighten the cost
of capital and funding for the Group and its subsidiaries. The
ability of bank entities outside the RFB to meet funding and
capital prudential requirements will be dependent on obtaining an
adequate credit rating. Reliance on intragroup exemptions in
relation to the calculation of risk-weighted assets and large
exposures may not be possible between the RFB and other Group
entities and may result in risk-weighted assets inflation.
Intragroup distributions (including payments of dividends) between
RFB and other Group entities (with the exception of distributions
to the Group parent company) will also be prohibited.
●
From 2026 it will
not be possible for the RFB and other Group entities that are not
RFB entities or wholly owned subsidiaries of the RFB to participate
in the same defined benefit pension plan. As a result, it will be
necessary to restructure the Group’s defined benefit pension
plans (including The Royal Bank of Scotland Group Pension Fund, the
Group’s main defined benefit pension scheme (the “Main
Scheme”)), such that either the RFB or other Group entities
that are not wholly owned subsidiaries of the RFB leave the current
scheme. The costs of separation may be material and may trigger
certain legal and regulatory obligations including possibly
increased contributions. Such restructuring may also result in
additional or increased cash contributions in the event the pension
trustees determine that the employer covenant has been weakened as
a result of such separation.
●
The restructuring
and planned transfers may also result in accounting consequences
for the Group. Although a number of transfers will be made at book
value between fully owned Group entities and will therefore not
have an accounting impact, certain transfers will be made at fair
value which may result in a profit or loss being recognised by
Group entities. In addition, transfers of assets that have related
hedging arrangements may result in adverse operational, financial
or accounting consequences if the transfer is not consistent with
the unaffected continuation of such hedging
arrangements.
●
In addition, the
proposed transfers may have tax costs, or may impact the tax
attributes of the RFB or other Group entities and the ability to
transfer tax losses between RFB and other Group
entities.
The
steps required to implement the UK ring-fencing regime within the
Group to comply with the relevant rules and regulations are
extraordinarily complex and require an extended period of time to
plan, execute and implement and entail significant costs and
operational, legal and execution risks, which risks may be
exacerbated by the Group’s other ongoing restructuring
efforts. External or internal factors including new and developing
legal requirements relating to the regulatory framework for the
banking industry and the evolving regulatory and economic landscape
resulting from the UK’s planned exit from the EU, as well as
further political developments or changes to the Group’s
current strategy or means of compliance with its EU State Aid
Commitment, may require the Group to further restructure its
operations (including its operations in Western Europe) and may in
turn require further changes to be made to the Group’s
ring-fencing plans (including the planned structure of the Group
post implementation). See “Changes to the prudential
regulatory framework for banks and investment banks within the EU
may require additional structural changes to the Group’s
operations which may affect current restructuring plans and have a
material adverse effect on the Group”. There is no certainty
that the Group will be able to complete the legal restructuring and
migration of customers by the 1 January 2019 deadline or in
accordance with future rules and the consequences of non-compliance
are currently uncertain. Conducting the Group’s operations in
accordance with the new rules may result in additional costs
(transitional and recurring) following implementation and impact
the Group’s profitability. As a result, the implementation of
the UK ring-fencing regime could have a material adverse effect on
the Group’s reputation, results of operations, financial
condition and prospects.
The Group has been, and will remain, in a period of major
restructuring through to 2019, which carries significant execution
and operational risks, and the Group may not be a viable,
competitive, customer-focused and profitable bank as a
result.
Since
early 2015, the Group has been implementing a major restructuring
and transformation programme, articulated around a strategy focused
on the growth of its strategic operations in Personal &
Business Banking (PBB) and Commercial & Private Banking (CPB)
and the further restructuring of the NatWest Markets franchise, to
focus mainly on UK and Western European corporate and financial
institutions. As part of this programme, the Group also continues
to run-down certain of its operations, businesses and portfolios in
order to reduce risk-weighted assets as well as the scope and
complexity of its activities, including through the run-down of the
higher risk and capital intensive assets in Capital Resolution.
Throughout 2016, the Group stepped up the run-down of the higher
risk and capital intensive assets in Capital Resolution, reducing
risk-weighted assets by £14.5 billion.
Part of
the focus of this transformation programme is to downsize and
simplify the Group, reduce underlying costs, strengthen its overall
capital position, improve customer experience and employee
engagement, update its operational and technological capabilities,
strengthen governance and control frameworks and better position
the Group for the implementation of the UK ring-fencing regime by 1
January 2019. Together, these initiatives are referred to as the
Group’s “transformation programme”.
As part
of its transformation programme, a number of financial, capital,
operational and diversity targets, expectations and trends have
been set by management for the Group, both for the short term and
throughout the restructuring period. These include (but are not
limited to) expectations relating to the Group’s return to
profitability and the timing thereof, one-off costs incurred in
connection with material litigation and conduct matters and the
timing thereof, expected growth rates in income, customer loans and
advances and volumes and underlying drivers and trends, cost:income
ratio targets, expectations with respect to reductions in operating
costs, including remediation costs, expectations relating to
restructuring costs and charges as well as impairment charges,
disposal losses relating to Capital Resolution, CET1 ratio targets
and expectations regarding funding plans and requirements,
expectations with respect to reductions in risk-weighted assets and
the timing thereof, expectations with respect to employees
engagement and diversity targets.
The
successful implementation of the Group’s transformation
programme and the Group’s ability to meet associated targets
and expectations, are subject to various internal and external
factors and risks, including those described in this risk factor,
the other risk factors included in this section and the disclosure
included in the rest of this document. These include, but are not
limited to, market, regulatory, economic and political
uncertainties, developments relating to litigation and regulatory
matters, operational risks, risks relating to the Group’s
business model and strategy and delays or difficulties in
implementing its transformation programme, including the
restructuring of its NatWest Markets franchise, the implementation
of the UK ring-fencing regime and compliance with the Group’s
State Aid obligations. A number of factors may impact the
Group’s ability to maintain its CET1 ratio target at or over
13% throughout the restructuring period, including conduct related
costs, pension or legacy charges, accounting impairments or limited
organic capital generation through profits. In addition, the
run-down of risk-weighted assets may be accompanied by the
recognition of disposal losses which may be higher than
anticipated, including due to a degraded economic environment.
Further regulatory changes may also result in risk-weighted assets
inflation in the medium term. For a further discussion of the risks
associated with meeting the Group’s capital targets, see" The
Group’s business performance and financial position could be
adversely affected if its capital is not managed effectively or if
it is unable to meet its capital targets.”. The Group’s
ability to meet its cost:income ratio target and the planned
reductions in its annual underlying costs (excluding restructuring
and conduct-related charges) may also be impacted, and the focus on
meeting cost reduction targets may result in limited investment in
other areas which could affect the Group’s long-term product
offering or competitive position.
Due to
the changed nature of the Group’s business model, the
Group’s expectations with respect to its return to
profitability and the timing thereof may not be achieved in the
timescale envisaged or at any time. An adverse macroeconomic
environment, including sustained low interest rates, political and
regulatory uncertainty, increased market competition and/or
heightened litigation costs may also pose significant headwinds to
the profitability of the Group. In addition there can be no
certainty that the new business model defined for the NatWest
Markets franchise will result in a sustainable or profitable
business.
More
generally, the targets, expectations and trends which accompany the
Group’s transformation programme are based on management
plans, projections and models and are subject to a number of key
assumptions and judgments any of which may prove to be inaccurate.
Among others, the targets, expectations and trends set as part of
the Group’s transformation programme assume that the Group
will be successful in implementing its business model and strategy,
in executing its transformation programme and reducing the
complexity of its business and infrastructure at the same time that
it will be implementing significant structural changes to comply
with the regulatory environment and that it will implement and
maintain a robust control environment and effective culture,
including with respect to risk management.
The
Group may not be able to successfully implement any part of its
transformation programme or reach any of its related targets or
expectations in the time frames contemplated or at all. The
Group’s transformation programme comprises a large number of
concurrent actions and initiatives, any of which could fail to be
implemented due to operational or execution issues. Implementation
of the Group’s transformation programme is expected to result
in significant costs, which could be materially higher than
currently contemplated, including due to material uncertainties and
factors outside of the Group’s control.
Implementing
the Group’s current transformation programme, including the
restructuring of its NatWest Markets franchise, requires further
material changes to be implemented within the Group over the medium
term concurrent with the implementation of significant structural
changes to comply with the UK ring-fencing regime and resulting
from the Group’s seeking to comply with its State Aid
obligations. This restructuring period will be disruptive, will
increase operational and people risks for the Group and will
continue to divert management resources from the conduct of the
Group’s operations and development of its
business.
The
scale of changes being concurrently implemented has and will
continue to require the implementation and application of robust
governance and controls frameworks and there is no guarantee that
the Group will be successful in doing so.
Due to
changes in the micro and macro-economic and political and
regulatory environment in which it operates, in particular as a
result of the consequences of the EU Referendum, the Group may also
be required to reconsider certain aspects of its current
restructuring programme, or the timeframe for its implementation.
In particular, there may be a need to further restructure the
Group’s Western European operations, including for example,
as a result of potential changes in the prudential regulatory
framework for banks and investment banks within the EU or if the
Group is no longer able to rely on the passporting framework for
financial services applicable in the EU. Any such additional
restructuring will be likely to increase operational and people
risks for the Group.
As a
result, there can be no certainty that the implementation of the
Group’s transformation programme will prove to be a
successful strategy, that the Group will meet its targets and
expectations during the restructuring period or that the
restructured Group will be a viable, competitive, customer-focused
or profitable bank.
Operational risks are inherent in the
Group’s businesses and these risks are heightened as the
Group implements its transformation programme, including
significant cost reductions, the UK ring-fencing regime and
compliance with its State Aid obligations against
the backdrop of legal and regulatory changes.
Operational
risk is the risk of loss resulting from inadequate or failed
internal processes, people or systems, or from external events,
including legal risks. The Group has complex and diverse operations
and operational risk and losses can result from a number of
internal or external factors, including:
●
internal and
external fraud and theft from the Group;
●
compromise of the
confidentiality, integrity, or availability of the Group’s
data, systems and services;
●
failure to identify
or maintain the Group’s key data within the limits of the
Group’s agreed risk appetite;
●
failure of the
Group’s technology services due to loss of data, systems or
data centre failure or failure by third parties to restore
services;
●
failure to
appropriately or accurately manage the Group’s operations,
transactions or security;
●
incorrect
specification of models used by the Group, implementing or using
such models incorrectly;
●
failure to
effectively design, execute or deliver the Group’s
transformation programme;
●
failure to attract
retain or engage staff;
●
insufficient
resources to deliver change and business-as-usual
activity;
●
decreasing employee
engagement or failure by the Group to embed new ways of working and
values; or
●
incomplete,
inaccurate or untimely statutory, regulatory or management
reporting.
Operational
risks are and will continue to be heightened as a result of the
number of initiatives being concurrently implemented by the Group,
including the implementation of its transformation programme,
including its cost-reduction programme, the implementation of the
UK ring-fencing regime compliance with its State Aid obligations.
Individually, these initiatives carry significant execution and
delivery risk and such risks are heightened as their implementation
is generally highly correlated and dependent on the successful
implementation of interdependent initiatives.
These
initiatives are being delivered against the backdrop of ongoing
cost challenges and increasing legal and regulatory uncertainty and
will put significant pressure on the Group’s ability to
maintain effective internal controls and governance frameworks.
Although the Group has implemented risk controls and loss
mitigation actions and significant resources and planning have been
devoted to mitigate operational risk, it is not possible to be
certain that such actions have been or will be effective in
controlling each of the operational risks faced by the Group.
Ineffective management of operational risks could have a material
adverse effect on the Group’s business, financial condition
and results of operations.
The Group is exposed to cyberattacks and a failure to prevent or
defend against such attacks could have a material adverse effect on
the Group’s operations, results of operations or
reputation.
The
Group is subject to cybersecurity attacks which have regularly
targeted financial institutions and corporates as well as
governments and other institutions and have materially increased in
frequency, sophistication and severity in recent years. The Group
relies on the effectiveness of its internal policies and associated
procedures, IT infrastructure and capabilities to protect the
confidentiality, integrity and availability of information held on
its computer systems, networks and mobile devices, and on the
computer systems, networks and mobile devices of third parties on
whom the Group relies.
The
Group takes measures to protect itself from attacks designed to
prevent the delivery of critical business processes to its
customers. Despite these preventative measures, the Group’s
computer systems, software, networks and mobile devices, and those
of third parties on whom the Group relies, are vulnerable to
cyberattacks, sabotage, unauthorised access, computer viruses,
worms or other malicious code, and other events that have a
security impact. Financial institutions, such as the Group, with
complex legacy infrastructure may be even more susceptible to
attack due to the increased number of potential entry points and
weaknesses.
Failure
to protect the Group’s operations from cyberattacks or to
continuously review and update current processes in response to new
threats could result in the loss of customer data or other
sensitive information as well as instances of denial of service for
the Group’s customers. Although the Group experienced
attempted distributed denial of service (DDoS) attacks in 2016,
none of these attacks were successful. During 2015, the Group
experienced a number of DDoS attacks, one of which had a temporary
impact on some of NatWest’s web services, as well as a
smaller number of malware attacks.
The
Bank of England, the FCA and HM Treasury in the UK and regulators,
in the US and in Europe have identified cybersecurity as a systemic
risk to the financial sector and highlighted the need for financial
institutions to improve resilience to cyberattacks and the Group
expects greater regulatory engagement, supervision and enforcement
on cybersecurity in the future. The Group continues to participate
in initiatives led by the Bank of England and other regulators
designed to test how major firms respond to significant
cyberattacks. The outputs of this exercise and other regulatory and
industry-led initiatives are being incorporated into the
Group’s on-going IT priorities and improvement measures.
However, the Group expects to be the target of continued attacks in
the future and there can be no certainty that the Group will be
able to effectively mitigate the impact of such
attacks.
Any
failure in the Group’s cybersecurity policies, procedures or
capabilities, or cyber-related crime, could lead to the Group
suffering reputational damage and a loss of customers, regulatory
investigations or sanctions being imposed and could have a material
adverse effect on the Group’s results of operations,
financial condition or prospects.
The Group’s business performance and financial position could
be adversely affected if its capital is not managed effectively or
if it is unable to meet its capital targets.
Effective
management of the Group’s capital is critical to its ability
to operate its businesses, comply with its regulatory obligations,
pursue its strategy of returning to stand-alone strength, resume
dividend payments on its ordinary shares and maintain discretionary
payments. The Group is required by regulators in the UK, the EU and
other jurisdictions in which it undertakes regulated activities to
maintain adequate capital resources. Adequate capital also gives
the Group financial flexibility in the face of continuing
turbulence and uncertainty in the global economy and specifically
in its core UK and European markets.
The
Group currently targets a CET1 ratio at or above 13% throughout the
period until completion of its restructuring. On a fully loaded
basis, the Group’s CET1 ratio was 13.4% at 31 December 2016,
compared with 15.5% at 31 December 2015.
The
Group’s target capital ratio is based on its expected
regulatory requirements and internal modelling, including of stress
scenarios. However, the Group’s ability to achieve such
targets depends on a number of factors, including the
implementation of its transformation programme and any of the
factors described below. A shortage of capital, which could in turn
affect the Group’s capital ratio, could arise
from:
●
a depletion of the
Group’s capital resources through increased costs or
liabilities (including pension, conduct and litigation costs),
reduced profits or increased losses (which would in turn impact
retained earnings), sustained periods of low or lower interest
rates, reduced asset values resulting in write-downs or impairments
or accounting charges;
●
an increase in the
amount of capital that is required to meet the Group’s
regulatory requirements, including as a result of changes to the
actual level of risk faced by the Group, factors influencing the
Group’s regulator’s determination of the firm-specific
Pillar 2B buffer applicable to the Group (PRA buffer), changes in
the minimum levels of capital or liquidity required by legislation
or by the regulatory authorities or the calibration of capital or
leverage buffers applicable to the Group, including countercyclical
buffers, increases in risk-weighted assets or in the risk weighting
of existing asset classes, or an increase in the Group’s view
of any management buffer it needs, taking account of, for example,
the capital levels or capital targets of the Group’s peer
banks and criteria set by the credit rating agencies.
The
Group’s current capital strategy is based on the expected
accumulation of additional capital through the accrual of profits
over time and/or through the planned reduction of its risk-weighted
assets through disposals or natural attrition, the execution of
which is subject to operational and market risks.
Further
losses or a failure to meet profitability targets or reduce
risk-weighted assets in accordance with or within the timeline
contemplated by the Group’s capital plan, a depletion of its
capital resources, earnings and capital volatility resulting from
the implementation of IFRS 9 as of 1 January 2018, or an increase
in the amount of capital it needs to hold (including as a result of
the reasons described above), would adversely impact the
Group’s ability to meet its capital targets or requirements
and achieve its capital strategy during the restructuring
period.
If the
Group is determined to have a shortage of capital as a result of
any of the circumstances described above, the Group may suffer a
loss of confidence in the market with the result that access to
liquidity and funding may become constrained or more expensive or
may result in the Group being subject to regulatory interventions
and sanctions. The Group’s regulators may also request that
the Group carry out certain capital management actions or, in an
extreme scenario, this may also trigger the implementation of its
recovery plans. Such actions may, in turn, affect the Group’s
product offering, capacity to continue its business operations, pay
future dividends and make other distributions (including
discretionary coupons on capital instruments) or pursue strategic
opportunities, affecting the underlying profitability of the Group
and future growth potential.
If, in
response to such shortage, certain regulatory capital instruments
are converted into equity or the Group raises additional capital
through the issuance of share capital or regulatory capital
instruments, existing shareholders may experience a dilution of
their holdings. The success of such issuances will also be
dependent on favourable market conditions and the Group may not be
able to raise the amount of capital required or on satisfactory
terms. Separately, the Group may address a shortage of capital by
taking action to reduce leverage and/or risk-weighted assets, by
modifying the Group’s legal entity structure or by asset or
business disposals. Such actions may affect the underlying
profitability of the Group.
Failure by the Group to comply with regulatory capital and leverage
requirements may result in intervention by its regulators and loss
of investor confidence, and may have a material adverse effect on
its results of operations, financial condition and reputation and
may result in distribution restrictions and adversely impact
existing shareholders.
The
Group is subject to extensive regulatory supervision in relation to
the levels and quality of capital it is required to hold in
connection with its business, including as a result of the
transposition of the Basel Committee on Banking Supervision’s
regulatory capital framework (Basel III) in Europe by a Directive
and Regulation (collectively known as “CRD
IV”).
In
addition, the Group is currently identified as a global
systemically important bank (G-SIB) by the Financial Stability
Board (FSB) and is therefore subject to more intensive oversight
and supervision by its regulators as well as additional capital
requirements, although the Group belongs to the last
“bucket” of the FSB G-SIB list and is therefore subject
to the lowest level of additional loss-absorbing capital
requirements. As the Group reduces its global footprint and its
balance sheet, the FSB may, at its discretion, determine that the
Group is no longer a G-SIB.
Under
CRD IV, the Group is required to hold at all times a minimum amount
of regulatory capital calculated as a percentage of risk-weighted
assets (Pillar 1 requirement). CRD IV also introduced a number of
new capital buffers that are in addition to the Pillar 1 and Pillar
2A requirements (as described below) that must be met with CET1
capital. The combination of the capital conservation buffer (which,
subject to transitional provisions, will be set at 2.5% from 2019),
the countercyclical capital buffer (of up to 2.5% which is
currently set at 0% by the FPC for UK banks) and the higher of
(depending on the institution) the systemic risk buffer, the global
systemically important institutions buffer (G-SIB Buffer) and the
other systemically important institutions buffer, is referred to as
the “combined buffer requirement”. These rules entered
into force on 1 May 2014 for the countercyclical capital buffer and
on 1 January 2016 for the capital conservation buffer and the G-SIB
buffer. The G-SIB buffer is currently set at 1.0% for the Group
(from 1 January 2017), and is being phased in over the period to 1
January 2019. The systemic risk buffer will be applicable from 1
January 2019. The Bank of England’s Financial Policy
Committee (the “FPC”) was responsible for setting the
framework for the systemic risk buffer and the PRA adopted in
December 2016 a final statement of policy implementing the
FPC’s framework. In early 2019, the PRA is expected to
determine which institutions the systemic risk buffer should apply
to, and if so, how large the buffer should be up to a maximum of 3%
of a firm’s risk-weighted assets. The systemic risk buffer
will apply to ring-fenced entities only and not all entities within
a banking group. The systemic risk buffer is part of the UK
framework for identifying and setting higher capital buffers for
domestic systemically important banks (D-SIBs), which are groups
that, upon distress or failure, could have an important impact on
their domestic financial systems. This follows on the 2012
framework recommendations by the FSB that national authorities
should identify D-SIBs and take measures to reduce the probability
and impact of the distress or failure of D-SIBs.
In
addition, national supervisory authorities may add extra capital
requirements (the “Pillar 2A requirements”) to cover
risks that they believe are not covered or insufficiently covered
by Pillar 1 requirements. The Group’s current Pillar 2A
requirement set by the PRA at an equivalent of 3.8% of
risk-weighted assets. The PRA has also introduced the PRA buffer
which is a forward-looking requirement set annually and based on
various factors including firm-specific stress test results and
credible recovery and resolution planning and is to be met with
CET1 capital (in addition to any CET1 Capital used to meet any
Pillar 1 or Pillar 2A requirements).
Where
appropriate, the PRA may require an increase in an institution's
PRA buffer to reflect additional capital required to be held to
mitigate the risk of additional losses that could be incurred as a
result of risk management and governance weaknesses, including with
respect to the effectiveness of the internal stress testing
framework and control environment. UK banks are required to meet
the higher of the combined buffer requirement or PRA buffer
requirement.
In
addition to capital requirements and buffers, the regulatory
framework adopted under CRD IV, as transposed in the UK, sets out
minimum leverage ratio requirements for financial institutions,
namely: (i) a minimum leverage requirement of 3% which applies to
major UK banks, (ii) an additional leverage ratio to be met by
G-SIBs and ring-fenced institutions to be calibrated at 35% of the
relevant firm’s capital G-SIB Buffer or systemic risk buffer
and which is being phased in from 2016 (currently set at 0.175%
from 1 January 2017) and (iii) a countercyclical leverage ratio
buffer for all firms subject to the minimum leverage ratio
requirements which is calibrated at 35% of a firm’s
countercyclical capital buffer. Further changes may be made to the
current leverage ratio framework as a result of future regulatory
reforms, including FSB proposals and proposed amendments to the CRD
IV proposed by the European Commission in November
2016.
Most of
the capital requirements which apply or will apply to the Group
will need to be met in whole or in part with CET1 capital. CET1
capital broadly comprises retained earnings and equity instruments,
including ordinary shares. As a result, the Group’s ability
meet applicable CET1 capital requirements is dependent on organic
generation of CET1 through sustained profitability and/or the
Group’s ability to issue ordinary shares, and there is no
guarantee that the Group may be able to generate CET1 capital
through either of these alternatives.
The
amount of regulatory capital required to meet the Group’s
regulatory capital requirements (and any additional management
buffer), is determined by reference to the amount of risk-weighted
assets held by the Group. The models and methodologies used to
calculate applicable risk-weightings are a combination of
individual models, subject to regulatory permissions, and more
standardised approaches. The rules are applicable to the
calculation of the Group’s risk-weighted assets are subject
to regulatory changes which may impact the levels of regulatory
capital required to be met by the Group.
The
Basel Committee and other agencies remain focused on changes that
will increase, or recalibrate, measures of risk-weighted assets as
the key measure of the different categories of risk in the
denominator of the risk-based capital ratio. While they are at
different stages of maturity, a number of initiatives across risk
types and business lines are in progress that are expected to
impact the calculation of risk-weighted assets.
The
Basel Committee is currently consulting on new rules relating to
the risk weighting of real estate exposures and other changes to
risk-weighting calculations, including proposals to introduce
floors for the calculation of risk-weighted assets, which could
directly affect the calculation of capital ratios. However, given
recent delays, the timing and outcome of this consultation is
increasingly uncertain. In the UK, the PRA is also considering ways
of reducing the sensitivity of UK mortgage risk weights to economic
conditions. The Basel Committee is also consulting on a revised
standardised measurement approach for operational risk. Certain EU
officials have raised concerns in relation to the new proposed
rules and there is therefore uncertainty as to the way in which the
FSB’s proposals would be implemented in the EU. The new
approach for operational risk would replace the three existing
standardised approaches for calculating operational risk, as well
as the internal model-based approach. The proposed new methodology
combines a financial statement-based measure of operational risk,
with an individual firm’s past operational losses. While the
quantum of impact of these reforms remains uncertain owing to lack
of clarity of the proposed changes and the timing of their
introduction, the implementation of such initiatives may result in
higher levels of risk-weighted assets and therefore higher levels
of capital, and in particular CET1 capital, required to be held by
the Group, under Pillar 1 requirements. Such requirements would be
separate from any further capital overlays required to be held as
part of the PRA’s determination of the Group’s Pillar
2A or PRA buffer requirements with respect to such
exposures.
Although
the above provides an overview of the capital and leverage
requirements currently applicable to the Group, such requirements
are subject to ongoing amendments and revisions, including as a
result of final rules and recommendations adopted by the FSB or by
European or UK regulators. In particular, on 23 November 2016, the
European Commission published a comprehensive package of reforms
including proposed amendments to CRD IV and the EU Bank Recovery
and Resolution Directive “BRRD”. Although such
proposals are currently being considered and discussed among the
European Commission, the European Parliament and the European
Council and their final form and the timetable for their
implementation are not known, such amendments may result in
increased or more stringent requirements applying to the Group or
its subsidiaries. This uncertainty is compounded by the UK’s
decision to leave the EU following the outcome of the EU Referendum
which may result in further changes to the prudential and
regulatory framework applicable to the Group.
If the
Group is unable to raise the requisite amount of regulatory capital
(including loss absorbing capital), or to otherwise meet regulatory
capital and leverage requirements, it may be exposed to increased
regulatory supervision or sanctions, loss of investor confidence,
restrictions on distributions and it may be required to reduce
further the amount of its risk-weighted assets or total assets and
engage in the disposal of core and other non-core businesses, which
may not occur on a timely basis or achieve prices which would
otherwise be attractive to the Group.
This
may also result in write-down or the conversion into equity of
certain regulatory capital instruments issued by the Group or the
issue of additional equity by the Group, each of which could result
in the dilution of the Group’s existing shareholders. A
breach of the Group’s applicable capital or leverage
requirements may also trigger the application of the Group’s
recovery plan to remediate a deficient capital
position.
Failure by the Group to comply with its capital requirements or to
maintain sufficient distributable reserves may result in the
application of restrictions on its ability to make discretionary
distributions, including the payment of dividends to its ordinary
shareholders and coupons on certain capital
instruments.
In
accordance with the provisions of CRD IV, a minimum level of
capital adequacy is required to be met by the Group in order for it
to be entitled to make certain discretionary payments.
Pursuant
to Article 141 (Restrictions on distribution) of the CRD IV
Directive, as transposed in the UK, institutions that fail to meet
the “combined buffer requirement” will be subject to
restricted “discretionary payments” (which are defined
broadly by CRD IV as payments relating to CET1 instruments
(dividends), variable remuneration and coupon payments on
additional tier 1 instruments). The resulting restrictions are
scaled according to the extent of the breach of the “combined
buffer requirement” and calculated as a percentage of the
profits of the institution since the last distribution of profits
or “discretionary payment” which gives rise to a
maximum distributable amount (MDA) (if any) that the financial
institution can distribute through discretionary payments. The EBA
has clarified that the CET1 capital to be taken into account for
the MDA calculation should be limited to the amount not used to
meet the Pillar 1 and Pillar 2 own funds requirements of the
institution. In the event of a breach of the combined buffer
requirement, the Group will be required to calculate its MDA, and
as a consequence it may be necessary for the Group to reduce or
cease discretionary payments to the extent of the
breach.
The
ability of the Group to meet the combined buffer requirement will
be subject to the Group holding sufficient CET1 capital in excess
of its minimum Pillar 1 and Pillar 2 capital requirements. In
addition, the interaction of such restrictions on distributions
with the capital requirements and buffers applicable to the Group
remains uncertain in many respects while the relevant authorities
in the EU and the UK consult on and develop their proposals and
guidance on the application of the rules. In particular, the
proposals published by the European Commission in November 2016
contain certain proposed amendments to Article 141, including to
introduce a “stacking order” in the calculation of the
maximum distributable amount and establish certain priorities in
the payments which could be made in the event the restrictions
apply (with payments relating to additional tier 1 instruments
being required to be made before payments on CET1 instruments
(dividends) or other discretionary payments). The treatment of MDA
breaches under the European Commission proposals differ from the
proposed consequences set out in the final PRA rules and may result
in uncertainty in the application of these rules.
In
addition to these rules, in order to make distributions (including
dividend payments) in the first place, RBSG is required to have
sufficient distributable reserves available. Furthermore, coupon
payments due on the additional tier 1 instruments issued by RBSG
must be cancelled in the event that RBSG has insufficient
“distributable items” as defined under CRD IV. Both
distributable reserves and distributable items are largely impacted
by the Group’s ability to generate and accumulate profits or
conversely by material losses (including losses resulting from
conduct related-costs, restructuring costs or
impairments).
RBSG’s
distributable reserves and distributable items are sensitive to the
accounting impact of factors including the redemption of preference
shares, restructuring costs and impairment charges and the carrying
value of its investments in subsidiaries which are carried at the
lower of cost and their prevailing recoverable amount. Recoverable
amounts depend on discounted future cash flows which can be
affected by restructurings, including the restructuring required to
implement the UK ring-fencing regime, or unforeseen events. The
distributable reserves of RBSG also depend on the receipt of income
from subsidiaries, principally as dividends. The ability of
subsidiaries to pay dividends is subject to their performance and
applicable local laws and other restrictions, including their
respective regulatory requirements and distributable reserves. Any
of these factors, including restructuring costs, impairment charges
and a reduction in the carrying value of RBSG subsidiaries or a
shortage of dividends from them could limit RBSG’s ability to
maintain sufficient distributable reserves to be able to pay
coupons on certain capital instruments and dividends to its
ordinary shareholders. In Q3 2016, the Group reviewed the value of
the investments in subsidiaries held in the parent company, RBSG,
and in light of the deterioration in the economic outlook, impaired
the carrying value of the investments by £6.0 billion to
£44.7 billion.
This
had the effect of reducing distributable profits of RBSG by
£6.0 billion and the Group may be required to recognise
further impairments in the future if the outlook for its
subsidiaries were to worsen. Whilst this level of distributable
profits does not impact upon RBSG’s ability to pay coupons on
existing securities, the Group intends to implement a capital
reorganisation in 2017 (subject to shareholder and court approval)
in order to increase RBSG’s distributable reserves, providing
greater flexibility for potential future distributions and
preference share redemptions (if any).
Failure
by the Group to meet the combined buffer requirement or retain
sufficient distributable reserves or distributable items as a
result of reduced profitability or losses, or changes in regulation
or taxes adversely impacting distributable reserves or
distributable items, may therefore result in limitations on the
Group’s ability to make discretionary distributions which may
negatively impact the Group’s shareholders, holders of
additional tier 1 instruments, staff receiving variable
compensation (such as bonuses) and other stakeholders and impact
its market valuation and investors’ and analysts’
perception of its financial soundness.
The Group is subject to stress tests mandated by its regulators in
the UK and in Europe which may result in additional capital
requirements or management actions which, in turn, may impact the
Group’s financial condition, results of operations and
investor confidence or result in restrictions on
distributions.
The
Group is subject to annual stress tests by its regulator in the UK
and also subject to stress tests by the European regulators with
respect to RBSG, RBS NV and Ulster Bank. Stress tests provide an
estimate of the amount of capital banks might deplete in a
hypothetical stress scenario. In addition, if the stress tests
reveal that a bank’s existing regulatory capital buffers are
not sufficient to absorb the impact of the stress, it is possible
that it will need to take action to strengthen its capital
position. There is a strong expectation that the PRA would require
a bank to take action if, at any point during the stress, a bank
were projected to breach any of its minimum CET1 capital or
leverage ratio requirements. However, if a bank is projected to
fail to meet its systemic buffers, it will still be expected to
strengthen its capital position over time but the supervisory
response is expected to be less intensive than if it were projected
to breach its minimum capital requirements. The PRA will also use
the annual stress test results to inform its determination of
whether individual banks’ current capital positions are
adequate or need strengthening. For some banks, their individual
stress-test results might imply that the capital conservation
buffer and countercyclical rates set for all banks is not
consistent with the impact of the stress on them. In that case, the
PRA can increase regulatory capital buffers for individual banks by
adjusting their PRA buffers.
Under
the 2016 Bank of England stress tests, which were based on the
balance sheet of the Group for the year ended 31 December 2015, the
Group did not meet its CET1 capital or Tier 1 leverage hurdle rates
before additional tier 1 conversion. After additional tier 1
conversion, it did not meet its CET1 systemic reference point or
Tier 1 leverage ratio hurdle rate. In light of the stress test
results the Group agreed a revised capital plan with the PRA to
improve its stress resilience in light of the various challenges
and uncertainties facing both the Group and the wider economy
highlighted by the concurrent stress testing process. As part of
this revised capital plan, the Group intends to execute an array of
capital management actions to supplement organic capital generation
from its core franchises and further improve its stress resilience,
including: further decreasing the cost base of the Group; further
reductions in risk-weighted assets across the Group; further
run-down and sale of other non-core loan portfolios in relation to
the personal and commercial franchises and the management of
undrawn facilities in 2017. Additional management actions may be
required by the PRA until the Group’s balance sheet is
sufficiently resilient to meet the regulator’s stressed
scenarios.
Consistent
with the approach set out in the 2015, the 2017 Bank of England
stress test will, for the first time, test the resilience of the
system, and individual banks within it, against two stress
scenarios. In addition to the annual cyclical scenario, there will
be an additional ‘exploratory’ scenario that will be
tested for the first time in 2017. This will allow the Bank of
England to assess the resilience of the system, and the individual
banks within it, to a wider range of potential threats, including
weak global supply growth, persistently low interest rates, and a
continuation of declines in both world trade relative to GDP and
cross-border banking activity. If the Group were to fail under
either of these scenarios, it may be required to take further
action to strengthen its capital position. In addition, the
introduction of IFRS 9, effective for annual periods beginning on
or after 1 January 2018, is expected to result in capital
volatility for the Group, which in turn could have an impact on the
Group’s ability to meet its required CET1 ratio in a stress
test scenario.
Failure
by the Group to meet the thresholds set as part of the stress tests
carried out by its regulators in the UK and elsewhere may result in
the Group’s regulators requiring the Group to generate
additional capital, increased supervision and/or regulatory
sanctions, restrictions on capital distributions and loss of
investor confidence, which may impact the Group’s financial
condition, results of operations and prospects.
As a result of extensive reforms being implemented relating to the
resolution of financial institutions within the UK, the EU and
globally, material additional requirements will arise to ensure
that financial institutions maintain sufficient loss-absorbing
capacity. Such changes to the funding and regulatory capital
framework may require the Group to meet higher capital levels than
the Group anticipated within its strategic plans and affect the
Group’s funding costs.
In
addition to the prudential requirements applicable under CRD IV,
the BRRD introduces, among other things, a requirement for banks to
maintain at all times a sufficient aggregate amount of own funds
and “eligible liabilities” (that is, liabilities that
can absorb loss and assist in recapitalising a firm in accordance
with a predetermined resolution strategy), known as the minimum
requirements for own funds and eligible liabilities (MREL),
designed to ensure that the resolution of a financial institution
may be carried out, without public funds being exposed to the risk
of loss and in a way which ensures the continuity of critical
economic functions, maintains financial stability and protects
depositors.
In
November 2015, the FSB published a final term sheet setting out its
total loss-absorbing capacity (TLAC) standards for G-SIBs. The EBA
was mandated to assess the implementation of MREL in the EU and the
consistency of MREL with the final TLAC standards and published an
interim report setting out the conclusions of its review in July
2016 and its final report in December 2016. On the basis of the
EBA’s work and its own assessment of CRD IV and the BRRD, the
European Commission published in November 2016 a comprehensive set
of proposals, seeking to make certain amendments to the existing
MREL framework. In particular, the proposals make a number of
amendments to the MREL requirements under the BRRD, in part in
order to transpose the FSB’s final TLAC term
sheet.
The UK
government is required to transpose the BRRD's provisions relating
to MREL into law through further secondary legislation. In November
2016, the Bank of England published its final rules setting out its
approach to setting MREL for UK banks. These final rules (which
were adopted on the basis of the current MREL framework in force in
the EU) do not take into account the European Commission’s
most recent proposals with respect to MREL and differ in a number
of respects. In addition, rules relating to a number of specific
issues under the framework remain to be implemented, following the
publication of further rules by the FSB, in particular rules on
internal MREL requirements, cross holdings and disclosure
requirements are outstanding.
The
Bank of England is responsible for setting the MREL requirements
for each UK bank, building society and certain investment firms in
consultation with the PRA and the FCA, and such requirement will be
set depending on the resolution strategy of the financial
institution. In its final rules, the Bank of England has set out a
staggered compliance timeline for UK banks, including with respect
to those requirements applicable to G-SIBs (including the Group).
Under the revised timeline, G-SIBs will be expected to (i) meet the
minimum requirements set out in the FSB’s TLAC term sheet
from 1 January 2019 (i.e. the higher of 16% of risk-weighted assets
or 6% of leverage exposures), and (ii) meet the full MREL
requirements to be phased in from 1 January 2020, with the full
requirements applicable from 2 January 2022 (i.e. for G-SIBs two
times Pillar 1 plus Pillar 2A or the higher of two times the
applicable leverage ratio requirement or 6.75% of leverage
exposures). MREL requirements are expected to be set on
consolidated, sub-consolidated and individual bases, and are in
addition to regulatory capital requirements(so that there can be no
double counting of instruments qualifying for capital
requirements).
For
institutions, including the Group, for which bail-in is the
required resolution strategy and which are structured to permit
single point of entry resolution due to their size and systemic
importance, the Bank of England has indicated that in order to
qualify as MREL, eligible liabilities must be issued by the
resolution entity (i.e. the holding company for the Group) and be
structurally subordinated to operating and excluded liabilities
(which include insured deposits, short-term debt, derivatives,
structured notes and tax liabilities).
The
final PRA rules set out a number of liabilities which cannot
qualify as MREL and are therefore “excluded
liabilities”. As a result, senior unsecured issuances by RBSG
will need to be subordinated to the excluded liabilities described
above. The proceeds from such issuances will be transferred
downstream to material operating subsidiaries in the form of
capital or another form of subordinated claim. In this way, MREL
resources will be “structurally subordinated” to senior
liabilities of operating companies, allowing losses from operating
companies to be transferred to the holding company and - if
necessary - for resolution to occur at the holding company level,
without placing the operating companies into a resolution process.
The TLAC standard includes an exemption from this requirement if
the total amount of excluded liabilities on RBSG’s balance
sheet does not exceed 5% of its external TLAC (i.e. the eligible
liabilities RBSG has issued to investors which meet the TLAC
requirements) and the Bank of England has adopted this criterion in
its final rules. If the Group were to fail to comply with this
“clean balance sheet” requirement, it could disqualify
otherwise eligible liabilities from counting towards MREL and
result in the Group breaching its MREL requirements.
Compliance
with these and other future changes to capital adequacy and
loss-absorbency requirements in the EU and the UK by the relevant
deadline will require the Group to restructure its balance sheet
and issue additional capital compliant with the rules which may be
costly whilst certain existing Tier 1 and Tier 2 securities and
other senior instruments issued by the Group will cease to count
towards the Group’s loss-absorbing capital for the purposes
of meeting MREL/TLAC requirements. The Group’s resolution
authority can impose an MREL requirement over and above the
regulatory minima and potentially higher than the Group’s
peers, if it has concerns regarding the resolvability of the Group.
As a result, RBSG may be required to issue additional
loss-absorbing instruments in the form of CET1 capital or
subordinated or senior unsecured debt instruments or may result in
an increased risk of a breach of the Group’s combined buffer
requirement, triggering the restrictions relating to the MDA
described above.
There
remain some areas of uncertainty as to how these rules will be
implemented within the UK, the EU and globally and the final
requirements to which the Group will be subject, and the Group may
therefore need to revise its capital plan accordingly. The European
Commission’s recent proposals also include a proposal seeking
to harmonise the priority ranking of unsecured debt instruments
under national insolvency proceedings to facilitate the
implementation of MREL across Europe. This rule is currently
subject to consideration and negotiation by the European
institutions but, to the extent it were to apply to the Group, it
could impact the ranking of current or future senior unsecured
creditors of the Group.
The Group’s borrowing costs, its access to the debt capital
markets and its liquidity depend significantly on its credit
ratings and, to a lesser extent, on the rating of the UK
Government.
The
credit ratings of RBSG, RBS plc and other Group members directly
affect the cost of funding and capital instruments issued by the
Group, as well as secondary market liquidity in those instruments.
A number of UK and other European financial institutions, including
RBSG, RBS plc and other Group companies, have been downgraded
multiple times in recent years in connection with rating
methodology changes and credit rating agencies’ revised
outlook relating to regulatory developments, macroeconomic trends
and a financial institution’s capital position and financial
prospects.
The
senior unsecured long-term and short-term credit ratings of RBSG
are below investment grade by Moody’s, and investment grade
by S&P and Fitch. The senior unsecured long-term and short-term
credit ratings of RBS plc are investment grade by Moody’s,
S&P and Fitch. The outlook for RBSG and RBS plc by
Moody’s is currently positive and is stable for S&P and
Fitch.
Rating
agencies regularly review the RBSG and Group entity credit ratings
and their ratings of long-term debt are based on a number of
factors, including the Group’s financial strength as well as
factors not within the Group’s control, including political
developments and conditions affecting the financial services
industry generally. In particular, the rating agencies may further
review the RBSG and Group entity ratings as a result of the
implementation of the UK ring-fencing regime, pension and
litigation/regulatory investigation risk, including potential fines
relating to investigations relating to legacy conduct issues, and
other macroeconomic and political developments, including in light
of the outcome of the negotiations relating to the shape and timing
of the UK’s exit from the EU. A challenging macroeconomic
environment, reduced profitability and greater market uncertainty
could negatively impact the Group’s performance and
potentially lead to credit ratings downgrades which could adversely
impact the Group’s ability and cost of funding. The
Group’s ability to access capital markets on acceptable terms
and hence its ability to raise the amount of capital and funding
required to meet its regulatory requirements and targets, including
those relating to loss-absorbing instruments to be issued by the
Group, could be affected.
Any
further reductions in the long-term or short-term credit ratings of
RBSG or of certain of its subsidiaries (particularly RBS plc),
including further downgrades below investment grade, could
adversely affect the Group’s issuance capacity in the
financial markets, increase its funding and borrowing costs,
require the Group to replace funding lost due to the downgrade,
which may include the loss of customer deposits and may limit the
Group’s access to capital and money markets and trigger
additional collateral or other requirements in derivatives
contracts and other secured funding arrangements or the need to
amend such arrangements, limit the range of counterparties willing
to enter into transactions with the Group and its subsidiaries and
adversely affect its competitive position, all of which could have
a material adverse impact on the Group’s earnings, cash flow
and financial condition.
As
discussed above, the success of the implementation of the UK
ring-fencing regime and the restructuring of the Group’s
NatWest Markets franchise, is in part dependent upon the relevant
banking entities obtaining a sustainable credit rating. A failure
to obtain such a rating, or any subsequent downgrades to current
ratings may threaten the ability of the NatWest Markets franchise
or other entities outside of the RFB, in particular with respect to
their ability to meet prudential capital requirements. At 31
December 2016, a simultaneous one-notch long-term and associated
short-term downgrade in the credit ratings of RBSG and RBS plc by
the three main ratings agencies would have required the Group to
post estimated additional collateral of £3.3 billion, without
taking account of mitigating action by management. Individual
credit ratings of RBSG, RBS plc, RBS N.V, RBS International and
Ulster Bank are also important to the Group when competing in
certain markets such as corporate deposits and over-the-counter
derivatives.
The
major credit rating agencies downgraded and changed their outlook
to negative on the UK’s sovereign credit rating following the
results of the EU Referendum in June 2016. Any further downgrade in
the UK Government’s credit ratings could adversely affect the
credit ratings of Group companies and may result in the effects
noted above. Further political developments, including in relation
to the UK’s exit from the EU or the outcome of any further
Scottish referendum could negatively impact the credit ratings of
the UK Government and result in a downgrade of the credit ratings
of RBSG and Group entities.
The Group’s ability to meet its obligations including its
funding commitments depends on the Group’s ability to access
sources of liquidity and funding.
Liquidity
risk is the risk that a bank will be unable to meet its
obligations, including funding commitments, as they fall due. This
risk is inherent in banking operations and can be heightened by a
number of factors, including an over-reliance on a particular
source of wholesale funding (including, for example, short-term and
overnight funding), changes in credit ratings or market-wide
phenomena such as market dislocation and major disasters. Credit
markets worldwide, including interbank markets, have experienced
severe reductions in liquidity and term funding during prolonged
periods in recent years. In 2016, although the Group’s
overall liquidity position remained strong, credit markets
experienced elevated volatility and certain European banks, in
particular in the peripheral countries of Spain, Portugal, Greece
and Italy, remained reliant on the ECB as one of their principal
sources of liquidity.
The
Group relies on retail and wholesale deposits to meet a
considerable portion of its funding. The level of deposits may
fluctuate due to factors outside the Group’s control, such as
a loss of confidence, increasing competitive pressures for retail
customer deposits or the repatriation of deposits by foreign
wholesale depositors, which could result in a significant outflow
of deposits within a short period of time.
An
inability to grow, or any material decrease in, the Group’s
deposits could, particularly if accompanied by one of the other
factors described above, have a material adverse impact on the
Group’s ability to satisfy its liquidity needs. Increases in
the cost of retail deposit funding may impact the Group’s
margins and profitability.
The
Group is using the Bank of England’s term funding scheme
which was introduced in August 2016, in order to reduce the funding
costs for the Group. Such funding has a short maturity profile and
hence the Group will diversify its sources of funding.
The
market view of bank credit risk has changed radically as a result
of the financial crisis and banks perceived by the market to be
riskier have had to issue debt at significantly higher costs.
Although conditions have improved, there have been recent periods
where corporate and financial institution counterparties have
reduced their credit exposures to banks and other financial
institutions, limiting the availability of these sources of
funding. Rules currently proposed by the FSB and in the EU in
relation to the implementation of TLAC and MREL may also limit the
ability of certain large financial institutions to hold debt
instruments issued by other large financial institutions. The
ability of the Bank of England to resolve the Group in an orderly
manner may also increase investors’ perception of risk and
hence affect the availability and cost of funding for the Group.
Any uncertainty relating to the credit risk of financial
institutions may lead to reductions in levels of interbank lending
or may restrict the Group’s access to traditional sources of
funding or increase the costs or collateral requirements for
accessing such funding.
The
Group has, at times, been required to rely on shorter-term and
overnight funding with a consequent reduction in overall liquidity,
and to increase its recourse to liquidity schemes provided by
central banks. Such schemes require assets to be pledged as
collateral. Changes in asset values or eligibility criteria can
reduce available assets and consequently available liquidity,
particularly during periods of stress when access to the schemes
may be needed most. The implementation of the UK ring-fencing
regime may also impact the Group’s funding strategy and the
cost of funding may increase for certain Group entities which will
be required to manage their own funding and liquidity strategy, in
particular those entities outside the ring-fence which will no
longer be able to rely on retail deposit funding.
In
addition, the Group is subject to certain regulatory requirements
with respect to liquidity coverage, including a liquidity coverage
ratio set by the PRA in the UK. This requirement is currently being
phased in and is set at 90% from 1 January 2017 to increase 100% in
January 2018 (as required by the CRR). The PRA may also impose
additional liquidity requirements to reflect risks not captured in
the leverage coverage ratio by way of Pillar 2 add-ons, which may
increase from time to time and require the Group to obtain
additional funding or diversify its sources of funding. Current
proposals by the FSB and the European Commission also seek to
introduce certain liquidity requirements for financial
institutions, including the introduction of a net stable funding
ratio (NSFR). Under the European Commission November 2016
proposals, the NSFR would be calculated as the ratio of an
institution's available stable funding relative to the required
stable funding it needs over a one-year horizon.
The
NSFR would be expressed as a percentage and set at a minimum level
of 100%, which indicates that an institution holds sufficient
stable funding to meet its funding needs during a one-year period
under both normal and stressed conditions. If an
institution’s NSFR were to fall below the 100% level, the
institution would be required to take the measures laid down in the
CRD IV Regulation for a timely restoration to the minimum level.
Competent authorities would assess the reasons for non-compliance
with the NSFR requirement before deciding on any potential
supervisory measures. These proposals are currently being
considered and negotiated among the European Commission, the
European Parliament and the Council and, in light of the UK’s
decision to leave the EU, there is considerable uncertainty as to
the extent to which such rules will apply to the
Group.
If the
Group is unable to raise funds through deposits and/or in the
capital markets, its liquidity position could be adversely affected
and it might be unable to meet deposit withdrawals on demand or at
their contractual maturity, to repay borrowings as they mature, to
meet its obligations under committed financing facilities, to
comply with regulatory funding requirements or to fund new loans,
investments and businesses. The Group may need to liquidate
unencumbered assets to meet its liabilities, including disposals of
assets not previously identified for disposal to reduce its funding
commitments. In a time of reduced liquidity, the Group may be
unable to sell some of its assets, or may need to sell assets at
depressed prices, which in either case could have a material
adverse effect on the Group’s financial condition and results
of operations.
The Group’s businesses and performance can be negatively
affected by actual or perceived economic conditions in the UK and
globally and other global risks and the Group will be increasingly
impacted by developments in the UK as its operations become
increasingly concentrated in the UK.
Actual
or perceived difficult global economic conditions create
challenging economic and market conditions and a difficult
operating environment for the Group’s businesses and its
customers and counterparties. As part of its revised strategy, the
Group has been refocusing its business in the UK, the ROI and
Western Europe and, accordingly is more exposed to the economic
conditions of the British economy as well as the Eurozone. In
particular, the longer term effects of the EU Referendum are
difficult to predict, and subject to wider global macro-economic
trends, but may include periods of financial market volatility and
slower economic growth, in the UK in particular, but also in the
ROI, Europe and the global economy, at least in the short to medium
term.
The
outlook for the global economy over the medium-term remains
uncertain due to a number of factors including: political
instability, continued slowdown of global growth, an extended
period of low inflation and low interest rates and delays in
normalising monetary policy. Such conditions could be worsened by a
number of factors including political uncertainty or macro-economic
deterioration in the Eurozone or the US, increased instability in
the global financial system and concerns relating to further
financial shocks or contagion, a further weakening of the pound
sterling, new or extended economic sanctions, volatility in
commodity prices or concerns regarding sovereign debt. In
particular, concerns relating to emerging markets, including lower
economic growth or recession, concerns relating to the Chinese
economy and financial markets, reduced global trade in emerging
market economies to which the Group is exposed (including those
economies to which the Group remains exposed pending the exit of
certain of its businesses and which include China, India and Saudi
Arabia) or increased financing needs as existing debt matures, may
give rise to further instability and financial market volatility.
Any of the above developments could impact the Group directly by
resulting in credit losses and indirectly by further impacting
global economic growth and financial markets.
Developments
relating to current economic conditions, including those discussed
above, could have a material adverse effect on the Group’s
business, financial condition, results of operations and prospects.
Any such developments may also adversely impact the financial
position of the Group’s pension schemes, which may result in
the Group being required to make additional contributions. See
“The Group is subject to pension risks and may be required to
make additional contributions to cover pension funding deficits as
a result of degraded economic conditions or as a result of the
restructuring of its pension schemes in relation to the
implementation of the UK ring-fencing regime”.
In
addition, the Group is exposed to risks arising out of geopolitical
events or political developments, such as trade barriers, exchange
controls, sanctions and other measures taken by sovereign
governments that can hinder economic or financial activity levels.
Furthermore, unfavourable political, military or diplomatic events,
armed conflict, pandemics and terrorist acts and threats, and the
responses to them by governments, could also adversely affect
economic activity and have an adverse effect upon the Group’s
business, financial condition and results of
operations.
Changes in interest rates or foreign exchange rates have
significantly affected and will continue to affect the
Group’s business and results of operations.
Some of
the most significant market risks that the Group faces are interest
rate and foreign exchange risks. Monetary policy has been highly
accommodative in recent years, including as a result of certain
policies implemented by the Bank of England and HM Treasury such as
the ‘Funding for Lending’ scheme, which have helped to
support demand at a time of very pronounced fiscal tightening and
balance sheet repair. In the UK, the Bank of England lowered
interest rates to 0.25% in August 2016 and there remains
considerable uncertainty as to whether or when the Bank of England
and other central banks will increase interest rates. While the ECB
has been conducting a quantitative easing programme since January
2015 designed to improve confidence in the Eurozone and encourage
more private bank lending, there remains considerable uncertainty
as to whether such measures have been or will be sufficient or
successful and the extension of this programme during 2017 may put
additional pressure on margins. Further decreases in interest rates
by the Bank of England or other central banks, continued sustained
low or negative interest rates or any divergences in monetary
policy approach between the Bank of England and other major central
banks could put further pressure on the Group’s interest
margins and adversely affect the Group’s profitability and
prospects. A continued period of low interest rates and yield
curves and spreads may affect the interest rate margin realised
between lending and borrowing costs, the effect of which may be
heightened during periods of liquidity stress.
Conversely
while increases in interest rates may support Group income, sharp
increases in interest rates could lead to generally weaker than
expected growth, or even contracting GDP, reduced business
confidence, higher levels of unemployment or underemployment,
adverse changes to levels of inflation, potentially higher interest
rates and falling property prices in the markets in which the Group
operates. In turn, this could cause stress in the loan portfolio of
the Group, particularly in relation to non-investment grade lending
or real estate loans and consequently to an increase in delinquency
rates and default rates among customers, leading to the possibility
of the Group incurring higher impairment charges. Similar risks
result from the exceptionally low level of inflation in developed
economies, which in Europe particularly could deteriorate into
sustained deflation if policy measures prove ineffective. Reduced
monetary stimulus and the actions and commercial soundness of other
financial institutions have the potential to impact market
liquidity.
Changes
in currency rates, particularly in the sterling-US dollar and
sterling-euro exchange rates, affect the value of assets,
liabilities, income and expenses denominated in foreign currencies
and the reported earnings of the Group’s non-UK subsidiaries
and may affect the Group’s reported consolidated financial
condition or its income from foreign exchange dealing. Such changes
may result from the decisions of the Bank of England, ECB or of the
US Federal Reserve or from political events and lead to sharp and
sudden variations in foreign exchange rates, such as those seen in
the GBP/USD exchange rates during the second half of 2016 following
the EU Referendum.
The Group’s earnings and financial condition have been, and
its future earnings and financial condition may continue to be,
materially affected by depressed asset valuations resulting from
poor market conditions.
The
Group’s businesses and performance are affected by financial
market conditions. The performance and volatility of financial
markets affect bond and equity prices and have caused, and may in
the future cause, changes in the value of the Group’s
investment and trading portfolios. Financial markets have recently
experienced and may in the near term experience significant
volatility, including as a result of concerns about the outcome of
the EU Referendum, political and financial developments in the US
and in Europe, including as a result of general elections,
geopolitical developments and developments relating to trade
agreements volatility and instability in the Chinese and global
stock markets, expectations relating to or actions taken by central
banks with respect to monetary policy, and weakening fundamentals
of the Chinese economy, resulting in further short-term changes in
the valuation of certain of the Group’s assets. Uncertainty
about potential fines for past misconduct and concerns about the
longer-term viability of business models have also weighed heavily
on the valuations of some financial institutions in Europe and in
the UK, including the Group.
Any
further deterioration in economic and financial market conditions
or weak economic growth could require the Group to recognise
further significant write-downs and realise increased impairment
charges or goodwill impairments, all of which may have a material
adverse effect on its financial condition, results of operations
and capital ratios. As part of its transformation programme, the
Group is executing the run-down or disposal of a number of
businesses, assets and portfolios. In addition, the Group’s
interest in the remainder of the businesses and portfolios within
the exiting business may be difficult to sell due to unfavourable
market conditions for such assets or businesses.
Moreover,
market volatility and illiquidity (and the assumptions, judgements
and estimates in relation to such matters that may change over time
and may ultimately not turn out to be accurate) make it difficult
to value certain of the Group’s exposures. Valuations in
future periods reflecting, among other things, the then-prevailing
market conditions and changes in the credit ratings of certain of
the Group’s assets may result in significant changes in the
fair values of the Group’s exposures, such as credit market
exposures, and the value ultimately realised by the Group may be
materially different from the current or estimated fair value. As
part of its ongoing derivatives operations, the Group also faces
significant basis, volatility and correlation risks, the occurrence
of which are also impacted by the factors noted above.
In
addition, for accounting purposes, the Group carries some of its
issued debt, such as debt securities, at the current market price
on its balance sheet. Factors affecting the current market price
for such debt, such as the credit spreads of the Group, may result
in a change to the fair value of such debt, which is recognised in
the income statement as a profit or loss.
The financial performance of the Group has been, and may continue
to be, materially affected by customer and counterparty credit
quality and deterioration in credit quality could arise due to
prevailing economic and market conditions and legal and regulatory
developments.
The
Group has exposure to many different industries, customers and
counterparties, and risks arising from actual or perceived changes
in credit quality and the recoverability of monies due from
borrowers and other counterparties are inherent in a wide range of
the Group’s businesses.
In
particular, the Group has significant exposure to certain
individual customers and other counterparties in weaker business
sectors and geographic markets and also has concentrated country
exposure in the UK, the US and across the rest of Europe
principally Germany, the Netherlands, Ireland and
France.
At 31
December 2016, current exposure in the UK was £338.9 billion,
in the US was £22.4 billion and in Western Europe (excluding
the UK) was £79.7 billion); and within certain business
sectors, namely personal, financial institutions, property,
shipping and the oil and gas sector (at 31 December 2016, personal
lending amounted to £166.2 billion, lending to banks and other
financial institutions was £47.7 billion, property lending was
£42.4 billion, lending to the oil and gas sector was £2.9
billion and shipping was £4.6 billion).
Provisions
held on loans in default have decreased in recent years due to
asset sales and the portfolio run-down in Ulster Bank ROI and
Capital Resolution. If the risk profile of these loans were to
increase, including as a result of a degradation of economic or
market conditions, this could result in an increase in the cost of
risk and the Group may be required to make additional provisions,
which in turn would reduce earnings and impact the Group’s
profitability. The Group’s lending strategy or processes may
also fail to identify or anticipate weaknesses or risks in a
particular sector, market or borrower category, which may result in
an increase in default rates, which may, in turn, impact the
Group’s profitability. Any adverse impact on the credit
quality of the Group’s customers and other counterparties,
coupled with a decline in collateral values, could lead to a
reduction in recoverability and value of the Group’s assets
and higher levels of impairment allowances, which could have an
adverse effect on the Group’s operations, financial position
or prospects.
The
credit quality of the Group’s borrowers and its other
counterparties is impacted by prevailing economic and market
conditions and by the legal and regulatory landscape in their
respective markets. Credit quality has improved in certain of the
Group’s core markets, in particular the UK and Ireland, as
these economies have improved. However, a further deterioration in
economic and market conditions or changes to legal or regulatory
landscapes could worsen borrower and counterparty credit quality
and also impact the Group’s ability to enforce contractual
security rights. In particular, the UK’s decision to leave
the EU may adversely impact credit quality in the UK.
In
addition, as the Group implements its new strategy and withdraws
from many geographic markets and continues to materially scale down
its international activities, the Group’s relative exposure
to the UK and certain sectors and asset classes in the UK will
increase significantly as its business becomes more concentrated in
the UK. The level of UK household indebtedness remains high and the
ability of some households to service their debts could be
challenged by a period of higher unemployment. Highly indebted
households are particularly vulnerable to shocks, such as falls in
incomes or increases in interest rates, which threaten their
ability to service their debts.
In
particular, in the UK the Group is at risk from volatility in
property prices in both the residential and commercial sectors.
With UK home loans representing the most significant portion of the
Group’s total loans and advances to the retail sector, the
Group has a large exposure to adverse developments in the UK
residential property sector. In the UK commercial real estate
market, activity slowed during the second half of 2016 following
the EU Referendum. There is a risk of further adjustment given the
reliance of the UK commercial real estate market in recent years on
inflows of foreign capital and, in some segments, stretched
property valuations. As a result, a fall in house prices,
particularly in London and the South East of the UK, would be
likely to lead to higher impairment and negative capital impact as
loss given default rate increases. In addition, reduced
affordability of residential and commercial property in the UK, for
example, as a result of higher interest rates or increased
unemployment, could also lead to higher impairments on loans held
by the Group being recognised.
The
Group also remains exposed to certain counterparties operating in
certain industries which have been under pressure in recent years,
including the oil and gas and shipping industries, and any further
deterioration in the outlook the credit quality of these
counterparties may require the Group to make additional provisions,
which in turn would reduce earnings and impact the Group’s
profitability.
In
addition, the Group’s credit risk is exacerbated when the
collateral it holds cannot be realised as a result of market
conditions or regulatory intervention or is liquidated at prices
not sufficient to recover the full amount of the loan or derivative
exposure that is due to the Group, which is most likely to occur
during periods of illiquidity and depressed asset valuations, such
as those experienced in recent years. This has particularly been
the case with respect to large parts of the Group’s
commercial real estate portfolio. Any such deteriorations in the
Group’s recoveries on defaulting loans could have an adverse
effect on the Group’s results of operations and financial
condition.
Concerns
about, or a default by, one financial institution could lead to
significant liquidity problems and losses or defaults by other
financial institutions, as the commercial and financial soundness
of many financial institutions may be closely related as a result
of credit, trading, clearing and other relationships. Even the
perceived lack of creditworthiness of, or questions about, a
counterparty may lead to market-wide liquidity problems and losses
for, or defaults by, the Group. This systemic risk may also
adversely affect financial intermediaries, such as clearing
agencies, clearing houses, banks, securities firms and exchanges
with which the Group interacts on a daily basis.
The
effectiveness of recent prudential reforms designed to contain
systemic risk in the EU and the UK is yet to be tested.
Counterparty risk within the financial system or failures of the
Group’s financial counterparties could have a material
adverse effect on the Group’s access to liquidity or could
result in losses which could have a material adverse effect on the
Group’s financial condition, results of operations and
prospects.
The
trends and risks affecting borrower and counterparty credit quality
have caused, and in the future may cause, the Group to experience
further and accelerated impairment charges, increased repurchase
demands, higher costs, additional write-downs and losses for the
Group and an inability to engage in routine funding
transactions.
The Group’s operations are highly dependent on its IT
systems. A failure of the Group’s IT systems, including as a
result of the lack of or untimely investments, could adversely
affect its operations, competitive position and investor and
customer confidence and expose the Group to regulatory
sanctions.
The
Group’s operations are dependent on the ability to process a
very large number of transactions efficiently and accurately while
complying with applicable laws and regulations where it does
business. The proper functioning of the Group’s payment
systems, financial and sanctions controls, risk management, credit
analysis and reporting, accounting, customer service and other IT
systems, as well as the communication networks between its branches
and main data processing centres, are critical to the Group’s
operations.
The
vulnerabilities of the Group’s IT systems are due to their
complexity, attributable in part to overlapping multiple dated
systems that result from the Group’s historical acquisitions
and insufficient investment prior to 2013 to keep the IT
applications and infrastructure up-to-date. A complex IT estate
containing end-of-life hardware and software creates challenges in
recovering from system breakdowns. IT failures adversely affect the
Group’s relationship with its customers and reputation and
have led, and may in the future, lead to regulatory investigations
and redress.
The
Group experienced a limited number of IT failures in 2016 affecting
customers, although improvements introduced since 2012 allowed the
Group to contain the impact of such failures. The Group’s
regulators in the UK are actively surveying progress made by banks
in the UK to modernise, manage and secure their IT infrastructures,
in order to prevent future failures affecting customers. Any
critical system failure, any prolonged loss of service availability
or any material breach of data security could cause serious damage
to the Group’s ability to service its customers, could result
in significant compensation costs or fines resulting from
regulatory investigations and could breach regulations under which
the Group operates.
In
particular, failures or breaches resulting in the loss or
publication of confidential customer data could cause long-term
damage to the Group’s reputation, business and brands, which
could undermine its ability to attract and keep
customers.
The
Group is currently implementing a number of complex initiatives,
including its transformation programme, the UK ring-fencing regime
and the restructuring of the NatWest Markets franchise, all which
put additional strains on the Group’s existing IT systems. A
failure to safely and timely implement one or several of these
initiatives could lead to disruptions of the Group’s IT
infrastructure and in turn cause long-term damage to the
Group’s reputation, brands, results of operations and
financial position.
The
Group has made, and will continue to make, considerable investments
in its IT systems to further simplify and upgrade the systems and
capabilities to make them more cost-effective and improve controls
and procedures, strengthen cyber security defences, enhance the
digital services provided to its bank customers and improve its
competitive position and address system failures which adversely
affect its relationship with its customers and reputation and may
lead to regulatory investigations and redress. However, the
Group’s current focus on cost-saving measures as part of its
transformation programme may impact the resources available to
implement further improvements to the Group IT infrastructure or
limit the resources available for investments in technological
developments and innovations. Should such investment and
rationalisation initiatives fail to achieve the expected results,
or prove to be insufficient, it could have a material adverse
impact on the Group’s operations, its ability to retain or
grow its customer business or its competitive position and could
negatively impact the Group’s financial
position.
The Group’s businesses are subject to substantial regulation
and oversight. Significant regulatory developments and increased
scrutiny by the Group’s key regulators has had and is likely
to continue to increase compliance and conduct risks and could have
a material adverse effect on how the Group conducts its business
and on its results of operations and financial
condition.
The
Group is subject to extensive laws, regulations, corporate
governance requirements, administrative actions and policies in
each jurisdiction in which it operates. Many of these have been
introduced or amended recently and are subject to further material
changes. Among others, the implementation and strengthening of the
prudential and resolution framework applicable to financial
institutions in the UK, the EU and the US, and future amendments to
such rules, are considerably affecting the regulatory landscape in
which the Group operates and will operate in the future, including
as a result of the adoption of rules relating to the UK
ring-fencing regime, prohibitions on proprietary trading, CRD IV
and the BRRD and certain other measures. Increased regulatory focus
in certain areas, including conduct, consumer protection regimes,
anti-money laundering, payment systems, and antiterrorism laws and
regulations, have resulted in the Group facing greater regulation
and scrutiny in the UK, the US and other countries in which it
operates.
Recent
regulatory changes, proposed or future developments and heightened
levels of public and regulatory scrutiny in the UK, Europe and the
US have resulted in increased capital, funding and liquidity
requirements, changes in the competitive landscape, changes in
other regulatory requirements and increased operating costs, and
have impacted, and will continue to impact, product offerings and
business models.
Such
changes may also result in an increased number of regulatory
investigations and proceedings and have increased the risks
relating to the Group’s ability to comply with the applicable
body of rules and regulations in the manner and within the time
frames required.
Such
risks are currently exacerbated by the outcome of the EU Referendum
and the UK’s decision to leave the EU and the unprecedented
degree of uncertainty as to the respective legal and regulatory
frameworks in which the Group and its subsidiaries will operate
when the UK is no longer a member of the EU. For example, current
proposed changes to the European prudential regulatory framework
for banks and investment banks may result in additional prudential
or structural requirements being imposed on financial institutions
based outside the EU wishing to provide financial services within
the EU (which may apply to the Group once the UK has formally
exited the EU). See also “Changes to the prudential
regulatory framework for banks and investment banks within the EU
may require additional structural changes to the Group’s
operations which may affect current restructuring plans and have a
material adverse effect Group”. In addition, the Group and
its counterparties may no longer be able to rely on the European
passporting framework for financial services and could be required
to apply for authorisation in multiple European jurisdictions, the
costs, timing and viability of which is uncertain.
Any of
these developments (including failures to comply with new rules and
regulations) could have a significant impact on how the Group
conducts its business, its authorisations and licences, the
products and services it offers, its reputation and the value of
its assets, the Group’s operations or legal entity structure,
including attendant restructuring costs and consequently have a
material adverse effect on its business, funding costs, results of
operations, financial condition and future prospects.
Areas
in which, and examples of where, governmental policies, regulatory
and accounting changes and increased public and regulatory scrutiny
could have an adverse impact (some of which could be material) on
the Group include, but are not limited to, those set out above as
well as the following:
●
amendments to the
framework or requirements relating to the quality and quantity of
regulatory capital to be held by the Group as well as liquidity and
leverage requirements, either on a solo, consolidated or subgroup
level (and taking into account the Group’s new legal
structure following the implementation of the UK ring-fencing
regime), including amendments to the rules relating to the
calculation of risk-weighted assets and reliance on internal models
and credit ratings as well as rules affecting the eligibility of
deferred tax assets;
●
the design and
implementation of national or supranational mandated recovery,
resolution or insolvency regimes or the implementation of
additional or conflicting loss-absorption requirements, including
those mandated under MREL or by the FSB’s recommendations on
TLAC;
●
new or amended
regulations or taxes that reduce profits attributable to
shareholders which may diminish, or restrict, the accumulation of
the distributable reserves or distributable items necessary to make
distributions or coupon payments or limit the circumstances in
which such distributions may be made or the extent
thereof;
●
the monetary,
fiscal, interest rate and other policies of central banks and other
governmental or regulatory bodies;
●
further
investigations, proceedings or fines either against the Group in
isolation or together with other large financial institutions with
respect to market conduct wrongdoing;
●
the imposition of
government-imposed requirements and/or related fines and sanctions
with respect to lending to the UK SME market and larger commercial
and corporate entities;
●
increased
regulatory scrutiny with respect to mortgage lending, including
through the implementation of the UK mortgage market review and
other initiatives led by the Bank of England or European
regulators;
●
additional rules
and regulatory initiatives and review relating to customer
protection, including the FCA’s Treating Customers Fairly
regime and increased focus by regulators on how institutions
conduct business, particularly with regard to the delivery of fair
outcomes for customers and orderly/transparent
markets.
●
the imposition of
additional restrictions on the Group’s ability to compensate
its senior management and other employees and increased
responsibility and liability rules applicable to senior and key
employees;
●
regulations
relating to, and enforcement of, anti-bribery, anti-money
laundering, anti-terrorism or other similar sanctions
regimes;
●
rules relating to
foreign ownership, expropriation, nationalisation and confiscation
of assets;
●
changes to
financial reporting standards (including accounting standards or
guidance) and guidance or the timing of their
implementation;
●
changes to risk
aggregation and reporting standards;
●
changes to
corporate governance requirements, senior manager responsibility,
corporate structures and conduct of business rules;
●
competition reviews
and investigations relating to the retail banking sector in the UK,
including with respect to SME banking and PCAs;
●
financial market
infrastructure reforms establishing new rules applying to
investment services, short selling, market abuse, derivatives
markets and investment funds, including the European Market
Infrastructure Regulation and the Markets in Financial Instruments
Directive and Regulation in the EU and the Dodd Frank Wall Street
Reform Consumer Protection Act of 2010 in the US;
●
increased attention
to competition and innovation in UK payment systems following the
establishment of the new Payments Systems Regulator and
developments relating to the UK initiative on Open Banking and the
European directive on payment services;
●
new or increased
regulations relating to customer data and privacy protection,
including the EU General Data Protection Regulation;
●
restrictions on
proprietary trading and similar activities within a commercial bank
and/or a group;
●
the introduction
of, and changes to, taxes, levies or fees applicable to the
Group’s operations, such as the imposition of a financial
transaction tax, changes in tax rates, increases in the bank
corporation tax surcharge in the UK, restrictions on the tax
deductibility of interest payments or further restrictions imposed
on the treatment of carry-forward tax losses that reduce the value
of deferred tax assets and require increased payments of
tax;
●
investigations into
facilitation of tax evasion or avoidance or the creation of new
civil or criminal offences relating thereto;
●
the regulation or
endorsement of credit ratings used in the EU (whether issued by
agencies in European member states or in other countries, such as
the US); and
●
other requirements
or policies affecting the Group’s profitability or product
offering, including through the imposition of increased compliance
obligations or obligations which may lead to restrictions on
business growth, product offerings, or pricing.
Changes
in laws, rules or regulations, or in their interpretation or
enforcement, or the implementation of new laws, rules or
regulations, including contradictory laws, rules or regulations by
key regulators in different jurisdictions, or failure by the Group
to comply with such laws, rules and regulations, may have a
material adverse effect on the Group’s business, financial
condition and results of operations. In addition, uncertainty and
lack of international regulatory coordination as enhanced
supervisory standards are developed and implemented may adversely
affect the Group’s ability to engage in effective business,
capital and risk management planning.
The Group is subject to pension risks and may be required to make
additional contributions to cover pension funding deficits as a
result of degraded economic conditions or as a result of the
restructuring of its pension schemes in relation to the
implementation of the UK ring-fencing regime.
The
Group maintains a number of defined benefit pension schemes for
certain former and current employees. Pension risk includes the
risk that the assets of the Group’s various defined benefit
pension schemes do not fully match the timing and amount of the
schemes’ liabilities, as a result of which the Group is
required or chooses to make additional contributions to address
deficits that may emerge. Risk arises from the schemes because the
value of the asset portfolios may be less than expected and because
there may be greater than expected increases in the estimated value
of the schemes’ liabilities and additional future
contributions to the schemes may be required.
The
value of pension scheme liabilities varies with changes to
long-term interest rates (including prolonged periods of low
interest rates as is currently the case), inflation, monetary
policy, pensionable salaries and the longevity of scheme members,
as well as changes in applicable legislation. In particular, as
life expectancies increase, so too will the pension scheme
liabilities; the impact on the pension scheme liabilities due to a
one year increase in longevity would have been expected to be
£1.5 billion as at 31 December 2016.
In
addition, as the Group expects to continue to materially reduce the
scope of its operations as part of the implementation of its
transformation programme and of the UK ring-fencing regime, pension
liabilities will therefore increase relative to the size of the
Group, which may impact the Group’s results of operations and
capital position.
Given
economic and financial market difficulties and volatility, the low
interest rate environment and the risk that such conditions may
occur again over the near and medium term, some of the
Group’s pension schemes have experienced increased pension
deficits.
The
last triennial valuation of the Main Scheme, had an effective date
of 31 December 2015. This valuation was concluded with the
acceleration of the nominal value of all committed contributions in
respect of past service (£4.2 billion), which was paid in Q1
2016.
The
next triennial period valuation will take place in Q4 2018 and the
Main Scheme pension trustee has agreed that it would not seek a new
valuation prior to that date, except where a material change
arises. The 2018 triennial valuation is expected to result in a
significant increase in the regular annual contributions in respect
of the ongoing accrual of benefits. Notwithstanding the 2016
accelerated payment and any additional contributions that may be
required beforehand as a result of a material change, the Group
expects to have to agree to additional contributions, over and
above the existing committed past service contributions, as a
result of the next triennial valuation. Under current legislation,
such agreement would need to be reached no later than Q1 2020. The
cost of such additional contributions could be material and any
additional contributions that are committed to the Main Scheme
following new actuarial valuations would trigger the recognition of
a significant additional liability on the Group’s balance
sheet and/or an increase in any pension surplus derecognised, which
in turn could have a material adverse effect on the Group’s
results of operations, financial position and
prospects.
In
addition, the UK ring-fencing regime will require significant
changes to the structure of the Group’s existing defined
benefit pension schemes as RFB entities may not be liable for debts
to pension schemes that might arise as a result of the failure of
an entity that is not an RFB or wholly owned subsidiary thereof
after 1 January 2026. The restructuring of the Group and its
defined benefit pension plans to implement the UK ring-fencing
regime could affect assessments of the Group’s pension scheme
deficits or result in the pension scheme trustees considering that
the employer covenant has been weakened and result in additional
contributions being required.
The
Group is developing a strategy to meet these requirements, which
has been discussed with the PRA and is likely to require the
agreement of the pension scheme trustee. Discussions with the
pension scheme trustee are ongoing and will be influenced by the
Group’s overall ring-fence strategy and its pension funding
and investment strategies.
If
agreement is not reached with the pension trustee, alternative
options less favourable to the Group may need to be developed to
meet the requirements of the pension regulations. The costs
associated with the restructuring of the Group’s existing
defined benefit pension schemes could be material and could result
in higher levels of additional contributions than those described
above and currently agreed with the pension trustee which could
have a material adverse effect on the Group’s results of
operations, financial position and prospects.
Pension risk and changes to the Group’s funding of its
pension schemes may have a significant impact on the Group’s
capital position.
The
Group’s capital position is influenced by pension risk in
several respects: Pillar 1 capital is impacted by the requirement
that net pension assets are to be deduced from capital and that
actuarial gains/losses impact reserves and, by extension, CET1
capital; Pillar 2A requirements result in the Group being required
to carry a capital add-on to absorb stress on the pension fund and
finally the risk of additional contributions to the Group’s
pension fund is taken into account in the Group’s capital
framework plan.
The
Group believes that the accelerated payment to the Group’s
Main Scheme pension fund made in Q1 2016 improved the Group’s
capital planning and resilience through the period to 2019 and
provided the Main Scheme pension trustee with more flexibility over
its investment strategy. This payment has resulted in a reduction
in prevailing Pillar 2A add-on. However, subsequent contributions
required in connection with the 2018 triennial valuation may
adversely impact the Group’s capital position. The
Group’s expectations as to the impact on its capital position
of this payment in the near and medium term and of the accounting
impact under its revised accounting policy are based on a number of
assumptions and estimates, including with respect to the beneficial
impact on its Pillar 2A requirements and confirmation of such
impact by the PRA and the timing thereof, any of which may prove to
be inaccurate (including with respect to the calculation of the
CET1 ratio impact on future periods), including as a result of
factors outside of the Group’s control (which include the
PRA’s approval).
As a
result, if any of these assumptions proves inaccurate, the
Group’s capital position may significantly deteriorate and
fall below the minimum capital requirements applicable to the Group
or Group entities, and in turn result in increased regulatory
supervision or sanctions, restrictions on discretionary
distributions or loss of investor confidence, which could
individually or in aggregate have a material adverse effect on the
Group’s results of operations, financial prospects or
reputation.
The
impact of the Group’s pension obligations on its results and
operations are also dependent on the regulatory environment in
which it operates. There is a risk that changes in prudential
regulation, pension regulation and accounting standards, or a lack
of coordination between such sets of rules, may make it more
challenging for the Group to manage its pension obligations
resulting in an adverse impact on the Group’s CET1
capital.
The Group relies on valuation, capital and stress test models to
conduct its business, assess its risk exposure and anticipate
capital and funding requirements. Failure of these models to
provide accurate results or accurately reflect changes in the
micro-and macroeconomic environment in which the Group operates or
findings of deficiencies by the Group’s regulators resulting
in increased regulatory capital requirements could have a material
adverse effect on the Group’s business, capital and
results.
Given
the complexity of the Group’s business, strategy and capital
requirements, the Group relies on analytical models to manage its
business, assess the value of its assets and its risk exposure and
anticipate capital and funding requirements, including with stress
testing. The Group’s valuation, capital and stress test
models and the parameters and assumptions on which they are based,
need to be periodically reviewed and updated to maximise their
accuracy.
Failure
of these models to accurately reflect changes in the environment in
which the Group operates or to be updated in line with the
Group’s business model or operations, or the failure to
properly input any such changes could have an adverse impact on the
modelled results or could fail to accurately capture the
Group’s risk exposure or the risk profile of the
Group’s financial instruments or result in the Group being
required to hold additional capital as a function of the PRA
buffer. The Group also uses valuation models that rely on market
data inputs. If incorrect market data is input into a valuation
model, it may result in incorrect valuations or valuations
different to those which were predicted and used by the Group in
its forecasts or decision making. Internal stress test models may
also rely on different, less severe, assumptions or take into
account different data points than those defined by the
Group’s regulators.
Some of
the analytical models used by the Group are predictive in nature.
In addition, a number of internal models used by Group subsidiaries
are designed, managed and analysed by the Group and may not
appropriately capture risks and exposures at subsidiary level. Some
of the Group's internal models are subject to periodic review by
its regulators and, if found deficient, the Group may be required
to make changes to such models or may be precluded from using any
such models, which could result in an additional capital
requirement which could have a material impact on the Group’s
capital position.
The
Group could face adverse consequences as a result of decisions
which may lead to actions by management based on models that are
poorly developed, implemented or used, or as a result of the
modelled outcome being misunderstood or such information being used
for purposes for which it was not designed. Risks arising from the
use of models could have a material adverse effect on the
Group’s business, financial condition and/or results of
operations, minimum capital requirements and
reputation.
The reported results of the Group are sensitive to the accounting
policies, assumptions and estimates that underlie the preparation
of its financial statements. Its results in future periods may be
affected by changes to applicable accounting rules and
standards.
The
preparation of financial statements requires management to make
judgements, estimates and assumptions that affect the reported
amounts of assets, liabilities, income and expenses. Due to the
inherent uncertainty in making estimates, results reported in
future periods may reflect amounts which differ from those
estimates. Estimates, judgements and assumptions take into account
historical experience and other factors, including market practice
and expectations of future events that are believed to be
reasonable under the circumstances.
The
accounting policies deemed critical to the Group’s results
and financial position, based upon materiality and significant
judgements and estimates, include goodwill, provisions for
liabilities, deferred tax, loan impairment provisions, fair value
of financial instruments, which are discussed in detail in
“Critical accounting policies and key sources of estimation
uncertainty” on pages 190, 308 and 310 . IFRS Standards and
Interpretations that have been issued by the International
Accounting Standards Board (the IASB) but which have not yet been
adopted by the Group are discussed in “Accounting
developments” on pages 310 to 315. Changes in accounting
standards or guidance by internal accounting bodies or in the
timing of their implementation, whether mandatory or as a result of
recommended disclosure relating to the future implementation of
such standards could result in the Group having to recognise
additional liabilities on its balance sheet, or in further
write-downs or impairments and could also significantly impact the
financial results, condition and prospects of the
Group.
In July
2014, the IASB published a new accounting standard for financial
instruments (IFRS 9) effective for annual periods beginning on or
after 1 January 2018. It introduces a new framework for the
recognition and measurement of credit impairment, based on expected
credit losses, rather than the incurred loss model currently
applied under IAS 39. The inclusion of loss allowances with respect
to all financial assets that are not recorded at fair value will
tend to result in an increase in overall impairment balances when
compared with the existing basis of measurement under IAS 39. As a
result of ongoing regulatory consultation, there is currently
uncertainty as to the impact of the implementation of this standard
on the Group’s CET1 capital (and therefore CET1 ratio),
although it is expected that this will result in increased earnings
and capital volatility for the Group.
The
valuation of financial instruments, including derivatives, measured
at fair value can be subjective, in particular where models are
used which include unobservable inputs. Generally, to establish the
fair value of these instruments, the Group relies on quoted market
prices or, where the market for a financial instrument is not
sufficiently active, internal valuation models that utilise
observable market data. In certain circumstances, the data for
individual financial instruments or classes of financial
instruments utilised by such valuation models may not be available
or may become unavailable due to prevailing market conditions. In
such circumstances, the Group’s internal valuation models
require the Group to make assumptions, judgements and estimates to
establish fair value, which are complex and often relate to matters
that are inherently uncertain. Resulting changes in the fair values
of the financial instruments has had and could continue to have a
material adverse effect on the Group’s earnings, financial
condition and capital position.
The Group’s operations entail inherent reputational
risk.
Reputational risk, meaning the risk of brand damage and/or
financial loss due to a failure to meet stakeholders’
expectations of the Group’s conduct, performance and business
profile, is inherent in the Group’s business. Stakeholders
include customers, investors, rating agencies, employees,
suppliers, governments, politicians, regulators, special interest
groups, consumer groups, media and the general public.
Brand
damage can be detrimental to the business of the Group in a number
of ways, including its ability to build or sustain business
relationships with customers, low staff morale, regulatory censure
or reduced access to, or an increase in the cost of, funding. In
particular, negative public opinion resulting from the actual or
perceived manner in which the Group conducts its business
activities and operations, including as a result of speculative or
inaccurate media coverage, the Group’s financial performance,
ongoing investigations and proceedings and the settlement of any
such investigations and proceedings, IT failures or cyber-attacks
resulting in the loss or publication of confidential customer data
or other sensitive information, the level of direct and indirect
government support, or the actual or perceived strength or
practices in the banking and financial industry may adversely
affect the Group’s ability to keep and attract customers and,
in particular, corporate and retail depositors.
Modern
technologies, in particular online social networks and other
broadcast tools which facilitate communication with large audiences
in short time frames and with minimal costs, may also significantly
enhance and accelerate the impact of damaging information and
allegations.
Reputational
risks may also be increased as a result of the restructuring of the
Group to implement its transformation programme and the UK
ring-fencing regime. Although the Group has implemented a
Reputational Risk Policy across customer-facing businesses to
improve the identification, assessment and management of customers,
transactions, products and issues which represent a reputational
risk, the Group cannot ensure that it will be successful in
avoiding damage to its business from reputational risk, which could
result in a material adverse effect on the Group’s business,
financial condition, results of operations and
prospects.
The Group is exposed to conduct risk which may adversely impact the
Group or its employees and may result in conduct having a
detrimental impact on the Group’s customers or
counterparties.
In
recent years, the Group has sought to refocus its culture on
serving the needs of its customers and continues to redesign many
of its systems and processes to promote this focus and strategy.
However, the Group is exposed to various forms of conduct risk in
its operations. These include business and strategic planning that
does not consider customers’ needs, ineffective management
and monitoring of products and their distribution, a culture that
is not customer-centric, outsourcing of customer service and
product delivery via third parties that do not have appropriate
levels of control, oversight and culture, the possibility of
alleged mis-selling of financial products or the mishandling of
complaints related to the sale of such product, or poor governance
of incentives and rewards. Some of these risks have materialised in
the past and ineffective management and oversight of conduct issues
may result in customers being poorly or unfairly treated and may in
the future lead to further remediation and regulatory
intervention/enforcement.
The
Group’s businesses are also exposed to risk from employee
misconduct including non-compliance with policies and regulatory
rules, negligence or fraud, any of which could result in regulatory
sanctions and serious reputational or financial harm to the Group.
In recent years, a number of multinational financial institutions,
including the Group, have suffered material losses due to the
actions of employees, including, for example, in connection with
the foreign exchange and LIBOR investigations and the Group may not
succeed in protecting itself from such conduct in the future. It is
not always possible to deter employee misconduct and the
precautions the Group takes to prevent and detect this activity may
not always be effective.
The
Group has implemented a number of policies and allocated new
resources in order to help mitigate against these risks. The Group
has also prioritised initiatives to reinforce good conduct in its
engagement with the markets in which it operates, together with the
development of preventative and detective controls in order to
positively influence behaviour.
The
Group’s transformation programme is also intended to improve
the Group’s control environment. Nonetheless, no assurance
can be given that the Group’s strategy and control framework
will be effective and that conduct issues will not have an adverse
effect on the Group’s results of operations, financial
condition or prospects.
The Group may be adversely impacted if its risk management is not
effective and there may be significant challenges in maintaining
the effectiveness of the Group’s risk management framework as
a result of the number of strategic and restructuring initiatives
being carried out by the RBS Group simultaneously.
The
management of risk is an integral part of all of the Group’s
activities. Risk management includes the definition and monitoring
of the Group’s risk appetite and reporting of the
Group’s exposure to uncertainty and the consequent adverse
effect on profitability or financial condition arising from
different sources of uncertainty and risks as described throughout
these risk factors.
Ineffective
risk management may arise from a wide variety of events and
behaviours, including lack of transparency or incomplete risk
reporting, unidentified conflicts or misaligned incentives, lack of
accountability control and governance, lack of consistency in risk
monitoring and management or insufficient challenges or assurance
processes.
Failure
to manage risks effectively could adversely impact the
Group’s reputation or its relationship with its customers,
shareholders or other stakeholders, which in turn could have a
significant effect on the Group’s business prospects,
financial condition and/or results of operations.
Risk
management is also strongly related to the use and effectiveness of
internal stress tests and models. See “The Group relies on
valuation, capital and stress test models to conduct its business,
assess its risk exposure and anticipate capital and funding
requirements. Failure of these models to provide accurate results
or accurately reflect changes in the micro-and macroeconomic
environment in which the Group operates or findings of deficiencies
by the Group’s regulators resulting in increased regulatory
capital requirements could have a material adverse effect on the
Group’s business, capital and results.”
A failure by the Group to embed a strong risk culture across the
organisation could adversely affect the Group’s ability to
achieve its strategic objective.
In
response to weaknesses identified in previous years, the Group is
currently seeking to embed a strong risk culture within the
organisation based on a robust risk appetite and governance
framework. A key component of this approach is the three lines of
defence model designed to identify, manage and mitigate risk across
all levels of the organisation. This framework has been implemented
and improvements continue and will continue to be made to clarify
and improve the three lines of defence and internal risk
responsibilities and resources, including in response to feedback
from regulators. Notwithstanding the Group’s efforts,
changing an organisation’s risk culture requires significant
time, investment and leadership, and such efforts may not insulate
the Group from future instances of misconduct. A failure by any of
these three lines to carry out their responsibilities or to
effectively embed this culture could have a material adverse effect
on the Group through an inability to achieve its strategic
objectives for its customers, employees and wider
stakeholders.
The Group’s business and results of operations may be
adversely affected by increasing competitive pressures and
technology disruption in the markets in which it
operates.
The
markets for UK financial services, and the other markets within
which the Group operates, are very competitive, and management
expects such competition to continue or intensify in response to
customer behaviour, technological changes (including the growth of
digital banking), competitor behaviour, new entrants to the market
(including non-traditional financial services providers such as
large retail or technology conglomerates), new lending models (such
as peer-to-peer lending), industry trends resulting in increased
disaggregation or unbundling of financial services or conversely
the re-intermediation of traditional banking services, and the
impact of regulatory actions and other factors. In particular,
developments in the financial sector resulting from new banking,
lending and payment solutions offered by rapidly evolving
incumbents, challengers and new entrants, in particular with
respect to payment services and products, and the introduction of
disruptive technology may impede the Group’s ability to grow
or retain its market share and impact its revenues and
profitability, particularly in its key UK retail banking segment.
These trends may be catalysed by regulatory and competition policy
implemented by the UK government, particularly as a result of the
Open Banking initiative and remedies imposed by the Competition and
Markets Authority (CMA) designed to support the objectives of this
initiative.
Increasingly
many of the products and services offered by the Group are, and
will become, technology intensive and the Group’s ability to
develop such services has become increasingly important to
retaining and growing the Group’s customer business in the
UK.
There
can be no certainty that the Group’s investment in its IT
capability intended to address the material increase in customer
use of online and mobile technology for banking will be successful
or that it will allow the Group to continue to grow such services
in the future. Certain of the Group’s current or future
competitors may have more efficient operations, including better IT
systems allowing them to implement innovative technologies for
delivering services to their customers. Furthermore, the
Group’s competitors may be better able to attract and retain
customers and key employees and may have access to lower cost
funding and/or be able to attract deposits on more favourable terms
than the Group. Although the Group invests in new technologies and
participates in industry and research led initiatives aimed at
developing new technologies, such investments may be insufficient,
especially against a backdrop of cost savings targets for the
Group, or the Group may fail to identify future opportunities or
derive benefits from disruptive technologies. If the Group is
unable to offer competitive, attractive and innovative products
that are also profitable, it will lose market share, incur losses
on some or all of its activities and lose opportunities for
growth.
In
addition, recent and future disposals and restructurings by the
Group relating to the implementation of non-customer facing
elements of its transformation programme and the UK ring-fencing
regime, or required by the Group’s regulators, as well as
constraints imposed on the Group’s ability to compensate its
employees at the same level as its competitors, may also have an
impact on its ability to compete effectively. Intensified
competition from incumbents, challengers and new entrants in the
Group’s core markets could lead to greater pressure on the
Group to maintain returns and may lead to unsustainable growth
decisions. These and other changes in the Group’s competitive
environment could have a material adverse effect on the
Group’s business, margins, profitability, financial condition
and prospects.
The Group operates in markets that are subject to intense scrutiny
by the competition authorities and its business and results of
operations could be materially affected by competition rulings and
other government measures.
The
competitive landscape for banks and other financial institutions in
the UK, the rest of Europe and the US is changing rapidly. Recent
regulatory and legal changes have and may continue to result in new
market participants and changed competitive dynamics in certain key
areas, such as in retail and SME banking in the UK where the
introduction of new entrants is being actively encouraged by the UK
Government. The competitive landscape in the UK is also likely to
be affected by the UK Government’s implementation of the UK
ring-fencing regime and other customer protection measures
introduced by the Banking Reform Act 2013. The implementation of
these reforms may result in the consolidation of newly separated
businesses or assets of certain financial institutions with those
of other parties to realise new synergies or protect their
competitive position and is likely to increase competitive
pressures on the Group.
The UK
retail banking sector has been subjected to intense scrutiny by the
UK competition authorities and by other bodies, including the FCA,
in recent years, including with a number of reviews/inquiries being
carried out, including market reviews conducted by the CMA and its
predecessor the Office of Fair Trading regarding SME banking and
Personal Current Accounts (PCAs), the Independent Commission on
Banking and the Parliamentary Commission on Banking Standards.
These reviews raised significant concerns about the effectiveness
of competition in the banking sector. The CMA’s Retail
Banking Market Investigation report sets out measures primarily
intended to make it easier for consumers and businesses to compare
PCA and SME bank products, increase the transparency of price
comparison between banks and amend PCA overdraft charging. The CMA
is working with HM Treasury and other regulators to implement these
remedies which are likely to impose additional compliance
requirements on the Group and could, in aggregate, adversely impact
the Group’s competitive position, product offering and
revenues.
Adverse
findings resulting from current or future competition
investigations may result in the imposition of reforms or remedies
which may impact the competitive landscape in which the Group
operates or result in restrictions on mergers and consolidations
within the UK financial sector.
The
impact of any such developments in the UK will become more
significant as the Group’s business becomes increasingly
concentrated in the UK retail sector. These and other changes to
the competitive framework in which the Group operates could have a
material adverse effect on the Group’s business, margins,
profitability, financial condition and prospects.
As a result of the commercial and regulatory environment in which
it operates, the Group may be unable to attract or retain senior
management (including members of the board) and other skilled
personnel of the appropriate qualification and competence. The
Group may also suffer if it does not maintain good employee
relations.
Implementation
of the Group’s transformation programme and its future
success depend on its ability to attract, retain and remunerate
highly skilled and qualified personnel, including senior management
(which includes directors and other key employees), in a highly
competitive labour market. This cannot be guaranteed, particularly
in light of heightened regulatory oversight of banks and the
increasing scrutiny of, and (in some cases) restrictions placed
upon, employee compensation arrangements, in particular those of
banks in receipt of Government support (such as the Group), which
may place the Group at a competitive disadvantage. In addition, the
market for skilled personnel is increasingly competitive, thereby
raising the cost of hiring, training and retaining skilled
personnel.
Certain
of the Group’s directors as well as members of its executive
committee and certain other senior managers and employees are also
subject to the new responsibility regime introduced under the
Banking Reform Act 2013 which introduces clearer accountability
rules for those within the new regime. The senior managers’
regime and certification regime took effect on 7 March 2016, whilst
the conduct rules will apply to the wider employee population from
7 March 2017 onwards, with the exception of some transitional
provisions. The new regulatory regime may contribute to reduce the
pool of candidates for key management and non-executive roles,
including non-executive directors with the right skills, knowledge
and experience, or increase the number of departures of existing
employees, given concerns over the allocation of responsibilities
and personal liability introduced by the new rules.
In
addition, in order to ensure the independence of the RFB, the Group
will be required to recruit new independent directors and senior
members of management to sit on the boards of directors and board
committees of the RFB and other Group entities, and there may be a
limited pool of competent candidates from which such appointments
can be made.
The
Group’s evolving strategy has led to the departure of a large
number of experienced and capable employees. The restructuring
relating to the ongoing implementation of the Group’s
transformation programme and related cost-reduction targets may
cause experienced staff members to leave and prospective staff
members not to join the Group. The lack of continuity of senior
management and the loss of important personnel coordinating certain
or several aspects of the Group’s restructuring could have an
adverse impact on its implementation.
The
failure to attract or retain a sufficient number of appropriately
skilled personnel to manage the complex restructuring required to
implement the Group’s strategy could prevent the Group from
successfully implementing its strategy and meeting regulatory
commitments. This could have a material adverse effect on the
Group’s business, financial condition and results of
operations.
In
addition, many of the Group’s employees in the UK,
continental Europe and other jurisdictions in which the Group
operates are represented by employee representative bodies,
including trade unions. Engagement with its employees and such
bodies is important to the Group and a breakdown of these
relationships could adversely affect the Group’s business,
reputation and results.
HM Treasury (or UKFI on its behalf) may be able to exercise a
significant degree of influence over the Group and any further
offer or sale of its interests may affect the price of securities
issued by the Group.
On 6
August 2015, the UK Government made its first sale of RBSG ordinary
shares since its original investment in 2009 and sold approximately
5.4% of its stake in RBSG. Following this initial sale, the UK
Government exercised its conversion rights under the B Shares on 14
October 2015 which resulted in HM Treasury holding 72.88% of the
ordinary share capital of RBSG. The UK Government, through HM
Treasury, currently holds 71.3% of the issued ordinary share
capital of the Group. The UK Government has indicated its intention
to continue to sell down its shareholding in the
Group.
Any
offers or sale, or expectations relating to the timing thereof, of
a substantial number of ordinary shares by HM Treasury, could
negatively affect prevailing market prices for the outstanding
ordinary shares of RBSG and other securities issued by the Group
and lead to a period of increased price volatility for the
Group’s securities.
In
addition, UKFI manages HM Treasury’s shareholder relationship
with the Group and, although HM Treasury has indicated that it
intends to respect the commercial decisions of the Group and that
the Group will continue to have its own independent board of
directors and management team determining its own strategy, its
position as a majority shareholder (and UKFI’s position as
manager of this shareholding) means that HM Treasury or UKFI might
be able to exercise a significant degree of influence over, among
other things, the election of directors and appointment of senior
management, the Group’s capital strategy, dividend policy,
remuneration policy or the conduct of the Group’s operations.
The manner in which HM Treasury or UKFI exercises HM
Treasury’s rights as majority shareholder could give rise to
conflicts between the interests of HM Treasury and the interests of
other shareholders. The Board has a duty to promote the success of
the Group for the benefit of its members as a whole.
The Group is committed to executing the run-down and sale of
certain businesses, portfolios and assets forming part of the
businesses and activities being exited by the Group. Failure by the
Group to do so on commercially favourable terms could have a
material adverse effect on the Group’s operations, operating
results, financial position and reputation.
The
Group’s ability to dispose of the remaining businesses,
portfolios and assets forming part of the businesses and activities
being exited by the Group and the price achieved for such disposals
will be dependent on prevailing economic and market conditions,
which remain volatile.
As a
result, there is no assurance that the Group will be able to sell,
exit or run down these businesses, portfolios or assets either on
favourable economic terms to the Group or at all or that it may do
so within the intended timetable. Material tax or other contingent
liabilities could arise on the disposal or run-down of assets or
businesses and there is no assurance that any conditions precedent
agreed will be satisfied, or consents and approvals required will
be obtained in a timely manner or at all. The Group may be exposed
to deteriorations in the businesses, portfolios or assets being
sold between the announcement of the disposal and its completion,
which period may span many months.
In
addition, the Group may be exposed to certain risks, including
risks arising out of ongoing liabilities and obligations, breaches
of covenants, representations and warranties, indemnity claims,
transitional services arrangements and redundancy or other
transaction-related costs, and counterparty risk in respect of
buyers of assets being sold.
The
occurrence of any of the risks described above could have a
material adverse effect on the Group’s business, results of
operations, financial condition and capital position and
consequently may have the potential to impact the competitive
position of part or all of the Group’s business.
The value or effectiveness of any credit protection that the Group
has purchased depends on the value of the underlying assets and the
financial condition of the insurers and
counterparties.
The
Group has some remaining credit exposure arising from
over-the-counter derivative contracts, mainly credit default swaps
(CDSs), and other credit derivatives, each of which are carried at
fair value.
The
fair value of these CDSs, as well as the Group’s exposure to
the risk of default by the underlying counterparties, depends on
the valuation and the perceived credit risk of the instrument
against which protection has been bought. Many market
counterparties have been adversely affected by their exposure to
residential mortgage-linked and corporate credit products, whether
synthetic or otherwise, and their actual and perceived
creditworthiness may deteriorate rapidly. If the financial
condition of these counterparties or their actual or perceived
creditworthiness deteriorates, the Group may record further credit
valuation adjustments on the credit protection bought from these
counterparties under the CDSs. The Group also recognises any
fluctuations in the fair value of other credit
derivatives.
Any
such adjustments or fair value changes may have a material adverse
impact on the Group’s financial condition and results of
operations.
The Group and its subsidiaries are subject to a new and evolving
framework on recovery and resolution, the impact of which remains
uncertain, and which may result in additional compliance challenges
and costs.
In the
EU, the UK and the US, regulators have implemented or are in the
process of implementing recovery and resolution regimes designed to
prevent the failure of financial institutions and resolution tools
to ensure the timely and orderly resolution of financial
institutions. These initiatives have been complemented by a broader
set of initiatives to improve the resilience of financial
institutions and reduce systemic risk, including the UK
ring-fencing regime, the introduction of certain prudential
requirements and powers under CRD IV, and certain other measures
introduced under the BRRD, including the requirements relating to
loss absorbing capital.
The
BRRD which was implemented in the UK from January 2015, provides a
framework for the recovery and resolution of credit institutions
and investment firms, their subsidiaries and certain holding
companies in the EU, and the tools and powers introduced under the
BRRD include preparatory and preventive measures, early supervisory
intervention powers and resolution tools.
Implementation
of certain provisions of the BRRD remains subject to secondary
rulemaking as well as a review by the European Parliament and the
European Commission of certain topics mandated by the BRRD. In
November 2016, as a result of this review, the European Commission
published a package of proposals seeking to introduce certain
amendments to CRD IV and the BRRD as well as a new proposal seeking
to harmonize creditor hierarchy. These proposals are now subject to
further discussions and negotiations among the European
institutions and it is not possible to anticipate their final
content. Further amendments to the BRRD or the implementing rules
in the EU may also be necessary to ensure continued consistency
with the FSB recommendations on resolution regimes and resolution
planning for G-SIBs, including with respect to TLAC
requirements.
In
light of these potential developments as well as the impact of the
UK’s decision to leave the EU following the result of the EU
Referendum, there remains uncertainty as to the rules which may
apply to the Group going forward. In addition, banks headquartered
in countries which are members of the Eurozone are now subject to
the European banking union framework. In November 2014, the ECB
assumed direct supervisory responsibility for RBS NV and Ulster
Bank Ireland under the Single Supervisory Mechanism (SSM). As a
result of the above, there remains uncertainty as to how the
relevant resolution regimes in force in the UK, the Eurozone and
other jurisdictions, would interact in the event of a resolution of
the Group.
The
BRRD requires national resolution funds to raise “ex
ante” contributions on banks and investment firms in
proportion to their liabilities and risk profiles and allow them to
raise additional “ex post” funding contributions in the
event the ex-ante contributions do not cover the losses, costs or
other expenses incurred by use of the resolution fund. Although
receipts from the UK bank levy are currently being used to meet the
ex-ante and ex post funding requirements, the Group may be required
to make additional contributions in the future. In addition, Group
entities in countries subject to the European banking union are
required to pay supervisory fees towards the funding of the SSM as
well as contributions to the single resolution fund.
The new
recovery and resolution regime implementing the BRRD in the UK
replaces the previous regime and has imposed and is expected to
impose in the near-to medium-term future, additional compliance and
reporting obligations on the Group which may result in increased
costs, including as a result of the Group’s mandatory
participation in resolution funds, and heightened compliance risks
and the Group may not be in a position to comply with all such
requirements within the prescribed deadlines or at
all.
In
addition, the PRA has adopted a new framework requiring financial
institutions to ensure the continuity of critical shared services
(provided by entities within the group or external providers) to
facilitate recovery action, orderly resolution and post-resolution
restructuring, which will apply from 1 January 2019.
The
application of such rules to the Group may require the Group to
restructure certain of its activities or reorganise the legal
structure of its operations, may limit the Group’s ability to
outsource certain functions and/or may result in increased costs
resulting from the requirement to ensure the financial and
operational resilience and independent governance of such critical
services.
In
addition, compliance by the Group with this new recovery and
resolution framework has required and is expected to continue to
require significant work and engagement with the Group’s
regulators, including in order for the Group to submit to the PRA
credible recovery and resolution plans, the outcome of which may
impact the Group’s operations or structure. Such rules will
need to be implemented consistently with the UK ring-fencing
regime.
The Group may become subject to the application of stabilisation or
resolution powers in certain significant stress situations, which
may result in various actions being taken in relation to the Group
and any securities of the Group, including the write-off,
write-down or conversion of the Group’s
securities.
The
Banking Act 2009, as amended to implement the BRRD (“Banking
Act”) confers substantial powers on relevant UK authorities
designed to enable them to take a range of actions in relation to
UK banks or investment firms and certain of their affiliates in the
event a bank or investment firm in the same group is considered to
be failing or likely to fail. Under the Banking Act, wide powers
are granted to the relevant resolution authorities, as appropriate
as part of a special resolution regime (the “SRR”).
These powers enable the relevant UK resolution authority to
implement resolution measures with respect to a UK bank or
investment firm and certain of its affiliates (including, for
example, RBSG) (each a “relevant entity”) in
circumstances in which the relevant UK resolution authority is
satisfied that the resolution conditions are met. Under the
applicable regulatory framework and pursuant to guidance issued by
the Bank of England, governmental capital support, if any is
provided, would only be used as a last resort measure where a
serious threat to financial stability cannot be avoided by other
measures (such as the stabilisation options described below,
including the UK bail-in power) and subject to the limitations set
out in the Banking Act.
Several
stabilisation options and tools are available to the relevant UK
resolution authority under the SRR, where a resolution has been
triggered. In addition, the UK resolution authority may commence
special administration or liquidation procedures specifically
applicable to banks. Where stabilisation options are used which
rely on the use of public funds, the option can only be used once
there has been a contribution to loss absorption and
recapitalisation of at least 8% of the total liabilities of the
institution under resolution. The Bank of England has indicated
that among these options, the UK bail-in tool (as described further
below) would apply in the event a resolution of the Group were
triggered.
Further,
the Banking Act grants broad powers to the UK resolution authority,
the application of which may adversely affect contractual
arrangements and which include the ability to (i) modify or cancel
contractual arrangements to which an entity in resolution is party,
in certain circumstances; (ii) suspend or override the enforcement
provisions or termination rights that might be invoked by
counterparties facing an entity in resolution, as a result of the
exercise of the resolution powers; and (iii) disapply or modify
laws in the UK (with possible retrospective effect) to enable the
powers under the Banking Act to be used effectively.
The
stabilisation options are intended to be applied prior to the point
at which any insolvency proceedings with respect to the relevant
entity would otherwise have been initiated. Accordingly, the
stabilisation options may be exercised if the relevant UK
resolution authority: (i) is satisfied that a UK bank or investment
firm is failing, or is likely to fail; (ii) determines that it is
not reasonably likely that (ignoring the stabilisation powers)
action will be taken by or in respect of a UK bank or investment
firm that will result in condition (i) above ceasing to be met;
(iii) considers the exercise of the stabilisation powers to be
necessary, having regard to certain public interest considerations
(such as the stability of the UK financial system, public
confidence in the UK banking system and the protection of
depositors, being some of the special resolution objectives) and
(iv) considers that the special resolution objectives would not be
met to the same extent by the winding-up of the UK bank or
investment firm.
In the
event that the relevant UK resolution authority seeks to exercise
its powers in relation to a UK banking group company (such as
RBSG), the relevant UK resolution authority has to be satisfied
that (A) the conditions set out in (i) to (iv) above are met in
respect of a UK bank or investment firm in the same banking group
(or, in respect of an EEA or third country credit institution or
investment firm in the same banking group, the relevant EEA or
third country resolution authority is satisfied that the conditions
for resolution applicable in its jurisdiction are met) and (B)
certain criteria are met, such as the exercise of the powers in
relation to such UK banking group company being necessary having
regard to public interest considerations. The use of different
stabilisation powers is also subject to further “specific
conditions” that vary according to the relevant stabilisation
power being used. Although the SRR sets out the pre-conditions for
determining whether an institution is failing or likely to fail, it
is uncertain how the Bank of England would assess such conditions
in any particular pre-insolvency scenario affecting RBSG and/or
other members of the Group and in deciding whether to exercise a
resolution power. Further regulatory developments, including
proposals by the FSB on cross-border recognition of resolution
actions, could also influence the conditions for the exercise of
the stabilisation powers. There has been no application of the SRR
powers in the UK to a large financial institution, such as RBSG, to
date, which could provide an indication of the relevant UK
resolution authority’s approach to the exercise of the
resolution powers, and even if such examples existed, they may not
be indicative of how such powers would be applied to RBSG.
Therefore, holders of shares and other securities issued by the
Group may not be able to anticipate a potential exercise of any
such powers.
The UK
bail-in tool is one of the powers available to the UK resolution
authority under the SRR and was introduced under the Banking Reform
Act 2013. The UK government amended the provisions of the Banking
Act to ensure the consistency of these provisions with the bail-in
provisions under the BRRD, which amendments came into effect on 1
January 2015. The UK bail-in tool includes both a power to
write-down or convert capital instruments and triggered at the
point of non-viability of a financial institution and a bail-in
tool applicable to eligible liabilities (including senior unsecured
debt securities issued by the Group) and available in
resolution.
The
capital instruments write-down and conversion power may be
exercised independently of, or in combination with, the exercise of
a resolution tool, and it allows resolution authorities to cancel
all or a portion of the principal amount of capital instruments
and/or convert such capital instruments into common equity Tier 1
instruments when an institution is no longer viable. The point of
non-viability for such purposes is the point at which the Bank of
England or the PRA determines that the institution meets the
conditions for entry into the Special Resolution Regime as defined
under the Banking Act or will no longer be viable unless the
relevant capital instruments are written down or extraordinary
public support is provided, and without such support the
appropriate authority determines that the institution would no
longer be viable.
Where
the conditions for resolution exist and it is determined that a
stabilisation power may be exercised, the Bank of England may use
the bail-in tool (in combination with other resolution tools under
the Banking Act ) to, among other things, cancel or reduce all or a
portion of the principal amount of, or interest on, certain
unsecured liabilities of a failing financial institution and/or
convert certain debt claims into another security, including
ordinary shares of the surviving entity.
In
addition, the Bank of England may use the bail-in tool to, among
other things, replace or substitute the issuer as obligor in
respect of debt instruments, modify the terms of debt instruments
(including altering the maturity (if any) and/or the amount of
interest payable and/or imposing a temporary suspension on
payments) and discontinue the listing and admission to trading of
financial instruments. The exercise of the bail-in tool will be
determined by the Bank of England which will have discretion to
determine whether the institution has reached a point of
non-viability or whether the conditions for resolution are met, by
application of the relevant provisions of the Banking Act, and
involves decisions being taken by the PRA and the Bank of England,
in consultation with the FCA and HM Treasury. As a result, it will
be difficult to predict when, if at all, the exercise of the
bail-in power may occur.
The
potential impact of these powers and their prospective use may
include increased volatility in the market price of shares and
other securities issued by the Group, as well as increased
difficulties in issuing securities in the capital markets and
increased costs of raising such funds.
If
these powers were to be exercised (or there is an increased risk of
exercise) in respect of the Group or any entity within the Group
such exercise could result in a material adverse effect on the
rights or interests of shareholders which would likely be
extinguished or very heavily diluted. Holders of debt securities
(which may include holders of senior unsecured debt), would see the
conversion of part (or all) of their claims into equity or written
down in part or written off entirely. In accordance with the rules
of the Special Resolution Regime, the losses imposed on holders of
equity and debt instruments through the exercise of bail-in powers
would be subject to the “no creditor worse off”
safeguard, which requires losses not to exceed those which would be
realised in insolvency.
Although
the above represents the risks associated with the UK bail-in power
currently in force in the UK and applicable to the Group’s
securities, changes to the scope of, or conditions for the exercise
of the UK bail-in power may be introduced as a result of further
political or regulatory developments. In addition, further
political, legal or strategic developments may lead to structural
changes to the Group, including at the holding company level.
Notwithstanding any such changes, the Group expects that its
securities would remain subject to the exercise of a form of
bail-in power, either pursuant to the provisions of the Banking
Act, the BRRD or otherwise.
In the UK and in other jurisdictions, the Group is responsible for
contributing to compensation schemes in respect of banks and other
authorised financial services firms that are unable to meet their
obligations to customers.
In the
UK, the Financial Services Compensation Scheme (FSCS) was
established under the Financial Services and Markets Act 2000 and
is the UK’s statutory fund of last resort for customers of
authorised financial services firms. The FSCS pays compensation if
a firm is unable to meet its obligations. The FSCS funds
compensation for customers by raising levies on the industry,
including the Group. In relation to protected deposits, each
deposit-taking institution contributes towards these levies in
proportion to their share of total protected deposits.
In the
event that the FSCS needs to raise additional and unexpected
funding, is required to raise funds more frequently or
significantly increases the levies to be paid by authorised firms,
the associated costs to the Group may have an adverse impact on its
results of operations and financial condition. For example the
deposit protection limit increased by £10,000 to £85,000
effective from 30 January 2017, which will result in an increase to
the Group’s FSCS levies.
To the
extent that other jurisdictions where the Group operates have
introduced or plan to introduce similar compensation, contributory
or reimbursement schemes, the Group may make further provisions and
may incur additional costs and liabilities, which may have an
adverse impact on its financial condition and results of
operations.
The Group’s results could be adversely affected in the event
of goodwill impairment.
The
Group capitalises goodwill, which is calculated as the excess of
the cost of an acquisition over the net fair value of the
identifiable assets, liabilities and contingent liabilities
acquired. Acquired goodwill is recognised initially at cost and
subsequently at cost less any accumulated impairment losses. As
required by IFRS Standards, the Group tests goodwill for impairment
annually, or more frequently when events or circumstances indicate
that it might be impaired. An impairment test involves comparing
the recoverable amount (the higher of the value in use and fair
value less cost to sell) of an individual cash generating unit with
its carrying value.
At 31
December 2016, the Group carried goodwill of £5.6 billion on
its balance sheet. The value in use and fair value of the
Group’s cash-generating units are affected by market
conditions and the performance of the economies in which the Group
operates.
Where
the Group is required to recognise a goodwill impairment, it is
recorded in the Group’s income statement, but it has no
effect on the Group’s regulatory capital position. Further
impairments of the Group’s goodwill could have an adverse
effect on the Group’s results and financial
condition.
Recent and anticipated changes in the tax legislation in the UK are
likely to result in increased tax payments by the Group and may
impact the recoverability of certain deferred tax assets recognised
by the Group.
In
accordance with IFRS Standards, the Group has recognised deferred
tax assets on losses available to relieve future profits from tax
only to the extent it is probable that they will be recovered. The
deferred tax assets are quantified on the basis of current tax
legislation and accounting standards and are subject to change in
respect of the future rates of tax or the rules for computing
taxable profits and offsetting allowable losses.
In the
UK, legislation has been introduced over the past few years which
seeks to impose restrictions on the use of certain brought forward
tax losses of banking companies.. This has impacted and will
continue to impact the extent to which the Group is able to
recognise deferred tax assets. Failure to generate sufficient
future taxable profits or further changes in tax legislation
(including rates of tax) or accounting standards may reduce the
recoverable amount of the recognised deferred tax assets. Further
changes to the treatment of deferred tax assets may impact the
Group’s capital, for example by reducing further the
Group’s ability to recognise deferred tax assets. The
implementation of the rules relating to the UK ring-fencing regime
and the resulting restructuring of the Group may further restrict
the Group’s ability to recognise tax deferred tax assets in
respect of brought forward losses.
Related parties
UK Government
On 1
December 2008, the UK Government through HM Treasury became the
ultimate controlling party of The Royal Bank of Scotland Group plc.
The UK Government's shareholding is managed by UK Financial
Investments Limited, a company wholly owned by the UK Government.
As a result, the UK Government and UK Government controlled bodies
became related parties of the Group. During 2015, all of the B
shares held by the UK Government were converted into ordinary
shares of £1 each (see Note 24).
The
Group enters into transactions with many of these bodies on an
arm’s length basis. Transactions include the payment of:
taxes principally UK corporation tax (see Note 6) and value added
tax; national insurance contributions; local authority rates; and
regulatory fees and levies (including the bank levy (see Note 3)
and FSCS levies (see Note 30) together with banking transactions
such as loans and deposits undertaken in the normal course of
banker-customer relationships.
Bank of England facilities
The
Group may participate in a number of schemes operated by the Bank
of England in the normal course of business.
Members
of the Group that are UK authorised institutions are required to
maintain non-interest bearing (cash ratio) deposits with the Bank
of England amounting to 0.18% of their average eligible liabilities
in excess of £600 million. They also have access to Bank of
England reserve accounts: sterling current accounts that earn
interest at the Bank of England Rate.
Other related parties
(a)
In their roles as
providers of finance, RBS companies provide development and other
types of capital support to businesses. These investments are made
in the normal course of business and on arm's length terms. In some
instances, the investment may extend to ownership or control over
20% or more of the voting rights of the investee company. However,
these investments are not considered to give rise to transactions
of a materiality requiring disclosure under IAS 24.
(b)
RBS recharges The
Royal Bank of Scotland Group Pension Fund with the cost of
administration services incurred by it. The amounts involved are
not material to the Group.
(c)
In accordance with
IAS 24, transactions or balances between RBS entities that have
been eliminated on consolidation are not reported.
(d)
The captions in the
primary financial statements of the parent company include amounts
attributable to subsidiaries. These amounts have been disclosed in
aggregate in the relevant notes to the financial
statements.
Legal
Entity Identifier: 2138005O9XJIJN4JPN90
Date: 24
February 2017
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THE
ROYAL BANK OF SCOTLAND GROUP plc (Registrant)
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By: /s/
Jan Cargill
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Name:
Jan Cargill
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Title:
Deputy Secretary
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