• Historical simulation VaR may not provide the best estimate of future market movements. It can only provide a forecast of portfolio losses based on events that occurred in the past. The Group model uses the previous two years of data; this period represents a balance between model responsiveness to recent shocks and risk factor data coverage.
• The use of a 99% confidence level VaR statistic does not provide information about losses beyond this level, usually referred to as ‘tail’ risks. These risks are more appropriately assessed using measures such as Stressed VaR and stress testing.
• The Group computes the VaR of trading positions at the close of business. Positions may change substantially during the course of the trading day and so intra-day price volatility and trading may not be captured by the model.
• The data used in the model are collected from global sources. For some sources, local end-of-day, rather than London end-of-day, data may be used. This timing mismatch is more material for 1-day return periods than for 10-day periods (which are used for capitalisation purposes) as the overlaps are inherently smaller across shorter periods. When deciding whether or not to use local end-of-day timing, the internal model review committee balances the principle of aligning the treatment of positions and their associated hedges against the goal of using London end-of-day timing consistently.
• Risk factors relevant to a specific portfolio may be omitted, due to a lack of reliable data, or the use of proxy risk factors, for example. The Group has developed the RNIV framework to address these issues.
Note: (1) The internal 99% 1-day VaR does not distinguish between regulator approved products and therefore includes a broader range of products. Refer to page 330 for discussion of regulatory VaR.
• The Group's Core and CEM period end and average VaR declined, driven by the declines in the interest rate and credit spread VaR.
• The decrease in average and period end Non-Core VaR reflects the
As well as being an important market risk measurement and control tool, the VaR model is also used to determine a significant component of the market risk capital requirement (see page 332 for more information on calculation of capital requirements). Therefore, it is subject to not only ongoing internal review and validation but also regulator-prescribed backtesting.
VaR back-testing* The main approach employed to assess the ongoing model performance is back-testing, which counts the number of days when a loss exceeds the corresponding daily VaR estimate, measured at a 99% confidence level.
The Clean P&L figure for a particular business day is the firm’s actual P&L for that day in respect of the trading activities within the scope of the firm’s regulatory VaR model, adjusted by stripping out: • Fees and commissions; • Brokerage; • Additions to, and releases from, reserves that are not directly related to market risk; and
A portfolio is said to produce a back-testing exception when the Clean or Hypo P&L exceeds the VaR level on a given day. Such an event may be caused by a large market movement or may highlight issues such as missing risk factors or inappropriate time series. Any such issues identified are analysed and addressed through taking appropriate remediation or development action. The Group monitors both Clean and Hypo back-testing exceptions.
Regulatory back-testing is performed and reported on a daily basis for legal entities and major business portfolios. Divisional market risk teams also perform back-testing at the lower levels as part of the internal ongoing VaR model validation.
The back-testing described above primarily applies to Markets and NonCore models, which are approved by the regulators. However, where appropriate, back-testing is also performed for other portfolios that are not subject to regulatory approval.
The graph below presents 1-day 99% regulatory VaR vs. Hypo P&L for RBS plc, the Group's largest legal entity by market risk RWAs and positions.
• The exception at the NatWest level was mainly driven by a large move in inflation following an Office of National Statistics announcement in January that it would not be changing the RPI calculation.
• The exception at the RBS NV level was primarily a result of a significant rise in Indian bond yields as the country’s central bank unexpectedly raised benchmark interest rates by 200 basis points.
Market risk continued Traded market risk continued Stressed VaR (SVaR)* As with VaR, the SVaR technique produces estimates of the potential change in the market value of a portfolio, over a specified time horizon, at a given confidence level. SVaR is a VaR-based measure using historical data from a one-year period of stressed market conditions.
Key point • The Group's period end SVaR declined in 2013 compared with 2012. This is consistent with the observed decrease in VaR during 2013 and is primarily driven by significant de-risking of interest rate exposures and reduction in the asset-backed securities inventory.
Risks not in VaR (RNIVs)* The RNIV approach is used for market risks that fall within the scope of VaR and SVaR but that are insufficiently captured by the model methodology, for example due to a lack of suitable historical data. The RNIV framework has been developed to quantify these market risks and to ensure that the Group holds adequate capital.
The need for an RNIV is typically identified in one of the following two circumstances: (i) as part of the New Product Risk Assessment process, when a risk manager assesses that the associated risk is not adequately captured by the VaR model; or (ii) as a result of a recommendation made by GRA or the model validation team when reviewing the VaR model.
The Group adopts two approaches for the quantification of RNIVs: • A standalone VaR approach. Under this approach, two values are calculated: (i) the VaR RNIV; and (ii) the SVaR RNIV.
• Higher-order sensitivity terms: to account for the fact that the
RNIVs that are related specifically to instruments that have level 3 valuation hierarchy assumptions (see pages 418 to 423) are mainly included in the following categories: proxied sensitivities or risk factors; higher-order sensitivity terms; and static pricing parameters.
Risks not in VaR (RNIVs)* The table below analyses capital requirements related to RNIVs. 2013 2012 £m £m
Risks Not in VaR (RNIV) 30 94 Risks Not in SVaR (RNISV) 39 149 Stressed RNIV (SRNIV) 149 187
Historical stress tests form part of the Group market risk limit framework and their results are reported daily to senior management.
Bottom-up stress testing begins with the analysis of a portfolio and expresses the key vulnerabilities of the portfolio in terms of plausible, socalled vulnerability scenarios under which the portfolio would suffer material losses. These scenarios can be historical, forward-looking, macroeconomic or hypothetical. Bottom-up stress testing is used for internal management information and is not subject to limits. However, relevant scenarios are reported to senior management.
Economic capital A market risk economic capital framework was developed in 2013 and will be introduced in the Group’s internal reporting during 2014.
The associated models calculate the market and default risk in the trading book. The results are annualised to be consistent with the other Group economic capital models to permit consolidation of all risk types as part of the Group-wide economic capital programme.
Other risk measures In addition to SVaR and stress tests, the Group uses a range of other risk measures to complement VaR. These measures often represent local (small-amplitude) risk calculations which provide valuable additional controls, often at individual desk or business unit level. They mainly include, but are not limited to, sensitivity and position-based risk measures.
Position-based measures are also used and are stated in terms that relate directly to the business activity they are applied to. Examples of such measures include the aggregate open foreign exchange position or the long, short and net amount of security or currency held and aged inventory in trading books.
Market risk continued Traded market risk continued Regulatory capital* Regulatory treatment The market risks subject to capital requirements under Pillar 1 are primarily interest rate, credit spread and equity risks in the trading book and foreign exchange and commodity risks in both the trading and nontrading books. Interest rate and equity risks are split between general and specific risks. General risks represent market risks due to a move in a market as a whole, such as a main index or yield curve, while specific risks represent market risks arising from events particular to an underlying issuer.
RBS uses both methods, with the internal model approach being used to calculate about 86% of its capital charge.
VaR and SVaR capture general and specific risks but not risks arising from the impact of defaults and rating changes associated with traded credit products and their derivatives. For these risks, three productdependent approaches are used: • The Incremental Risk Charge (IRC) model captures risks arising from defaults and rating changes risks for the more liquid traded credit instruments and their derivatives.
Regulatory VaR* The Group’s VaR model has been approved by the PRA to calculate its regulatory market risk capital requirement for the trading book for those legal entities under its jurisdiction. These legal entities are The Royal Bank of Scotland plc, RBS Securities Inc, RBS Financial Products Inc, and National Westminster Bank Plc.
The calculation of regulatory VaR differs from that of the internal VaR as it takes into account only regulator-approved products, locations and legal entities and it is based on a ten-day, rather than a one-day, holding period for market risk capital calculations.
VaR back-testing* For the Group’s trading book, a green model status was maintained throughout 2013. For details of back-testing results for regulatory VaR, refer to the table on page 327.
Regulatory SVaR* The Group’s SVaR model has also been approved by the PRA for use in the capital requirement calculation. The regulatory SVaR differs from internal SVaR as it covers only regulator-approved products, locations and legal entities.
Incremental risk charge (IRC)* The IRC model aims to quantify the impact of defaults and rating changes on the market value of bonds, credit derivatives and other related positions held in the trading book. It also captures basis risks between different instruments, different product maturities and different but related reference entities. Like the internal ratings-based approach for credit risk, it is calculated over a one-year holding period at a 99.9% confidence level.
A constant level of risk is assumed and achieved by replacing positions that default or migrate in one period with equivalent positions. The average liquidity horizon at the year end was 3.7 months (2012 - 4.6 months).
This model is applied to the correlation trading portfolio subject to certain eligibility criteria (principally that the underlying names be liquid corporate CDS positions).
Market risk continued Traded market risk continued Market risk capital* Minimum capital requirements The following table analyses the market risk minimum capital requirement, calculated in accordance with Basel 2.5.
Interest rate position risk requirement 147 254 1,107 Equity position risk requirement 1 1 3 Option position risk requirement 10 26 26 Commodity position risk requirement 13 2 2 Foreign currency position risk requirement 39 12 10 Specific interest rate risk of securitisation positions 123 156 250 Total (standard method) 333 451 1,398 Pillar 1 model based position risk requirement 2,086 2,959 3,725 Total market risk minimum capital requirement 2,419 3,410 5,123
The following table analyses the principal contributors to the Pillar 1 model based position risk requirement presented in the previous table. 2013 Average (1) Maximum (1) Minimum (1) Period end 2012 2011 £m £m £m £m £m £m
Key points • The Group’s total market risk minimum capital requirement fell in 2013, largely driven by the Pillar 1 model-based contributors (primarily VaR, SVaR and RNIV). The standard method requirement also fell, driven by the interest rate position risk requirement and the specific interest rate risk of securitisation positions.
• The decline in the VaR and SVaR based charges was driven by significant de-risking of rates exposure in RBS plc in the first half of the year. In addition, the improved capture of valuation adjustments in CEM accompanied by market data improvements drove a further reduction in these charges, particularly during the second half of the year.
IRC by rating and product category The following table analyses the IRC by rating and product. Internal ratings (1)
AAA AA A BBB BB B CCC Total (1) 2013 £m £m £m £m £m £m £m £m
Key points • The Group’s IRC was approximately £23 million or 6% higher at 31
December 2013 than one year previously. This rise was primarily due to increased delta trading activity during the year, with significant growth in positions in BBB-rated sovereign issuers including Italy and Spain.
• A model parameter update at the end of 2013, chiefly incorporating additional rating information from the previous 12 months, produced an increased likelihood of certain counterparties being downgraded and, thus, had a moderate upward impact on the charge.
Ratings (1) Non Investment Capital AAA AA A BBB Grade Unrated Total (1,2) STD PRR (3) deductions
Non-traded market risk positions are reported on a regular basis to divisional Asset and Liability Management Committees (ALCOs) and monthly to the Group Balance Sheet Management Committee (BSMCo), Group Asset and Liability Committee (GALCO) and the Group Board, with the exception of equity positions, which are reported quarterly to GALCO.
Interest rate risk Non-traded interest rate risk (NTIRR) factors are grouped into the following categories: • Repricing risk, which arises when asset and liability positions either mature (in the case of fixed-rate positions) or their interest rates reset (in the case of floating-rate positions) at different dates. These mismatches may give rise to net interest income and economic value volatility as interest rates vary.
• Basis risk, which arises when related instruments with the same tenor are valued using different reference yield curves. Changes in the spread between the different reference curves can result in unexpected changes in the valuation of or income difference between assets, liabilities or derivative instruments. This occurs, for example, in the Group's retail and commercial portfolios, when products valued on the basis of the Bank of England base rate are funded with LIBOR-linked instruments.
The Group’s policy is to manage the interest rate sensitivity within risk limits that are approved by the ERF and endorsed by GALCO before being cascaded to divisions through divisional ALCOs. These include, in particular, interest rate sensitivity and VaR limits.
This task is primarily carried out by Group Treasury, to which all divisions except US Retail & Commercial and Markets transfer most of their NTIRR. On a monthly basis, the Group’s main exposures and limit utilisations are reported to the BSMCo, GALCO and the Group Board.
Foreign exchange exposures arising from customer transactions or profit and losses are sold down by divisions and businesses on a regular basis in line with Group policy.
Equity risk Non-traded equity risk is the potential variation in the Group’s income and reserves arising from changes in non-trading book equity valuations. Any such risk is identified prior to any investments and then mitigated through a framework of controls.
Risk measurement Interest rate risk NTIRR can be measured from either an economic value-based or earnings-based perspective (or both). Value-based approaches measure the change in value of the balance sheet assets and liabilities over a longer timeframe, including all cash flows. Earnings-based approaches measure the potential short-term (generally one year) impact on the income statement of charges in interest rates.
These two approaches provide different yet complementary views of the impact of interest rate risk on the balance sheet at a point in time. The scenarios employed in the NII sensitivity approach incorporate business assumptions and simulated modifications in customer behaviour as interest rates change. In contrast, the VaR approach assumes static underlying positions and therefore does not provide a dynamic measurement of interest rate risk. In addition, while the NII sensitivity calculations are measured to a 12-month horizon and thus provide a shorter-term view of the risks on the balance sheet, the VaR approach can identify risks not captured in the sensitivity analysis, in particular the impact of duration and repricing risk on earnings beyond 12 months.
• Euro VaR fell, reflecting action taken to reduce the Group’s exposure to euro-denominated fixed-rate assets.
• US dollar VaR rose, reflecting action taken by US Retail &
• These movements remained well within the Group’s approved market risk appetite.
In addition, the 12 month rolling forecast is re-run using alternative rates under various scenarios, incorporating changes in customer behaviour and business assumptions as appropriate. Variances between these scenarios are analysed to identify key drivers. These forecasts and sensitivities form part of the information used by senior management to manage the Group's NII targets.
The reported sensitivities will vary over time due to a number of factors such as market conditions and strategic changes to the balance sheet mix and should not therefore be considered predictive of future performance.
Euro Sterling US dollar Other Total 2013 £m £m £m £m £m
+ 100 basis point shift in yield curves 59 416 175 31 681 − 100 basis point shift in yield curves (29) (333) (82) (15) (459) Bear steepener 403 Bull flattener (273)
2012 + 100 basis point shift in yield curves (29) 472 119 27 589 − 100 basis point shift in yield curves (20) (257) (29) (11) (317) Bear steepener 216 Bull flattener (77)
• The increased sensitivity to the steepening and flattening scenarios is also primarily driven by the maturity profile of structural hedges.
The Group targets a weighted average life for these economic hedges. This is accomplished using a continuous rolling maturity programme to achieve the desired profile and is primarily managed by Group Treasury. The maturity profile of the hedge aims to reduce the potential sensitivity of income to rate movements. The structural hedging programme is Group wide, capturing the position within the UK banking group and regulated subsidiaries in other jurisdictions.
Product hedging* Product structural hedges are used to minimise the volatility on earnings related to specific products, primarily money transmission accounts.
Key point • The yield on product structural hedges declined in 2013 due to the low interest rate environment as maturing hedges were reinvested at lower interest rates.
Equity hedging* Equity structural hedges are used to minimise the impact of earnings volatility on equity. These hedges contributed £0.8 billion to the UK banking divisions in 2013 (2012 - £0.8 billion), which is an incremental benefit relative to LIBOR cash rates.
Net assets of Net investments Net Structural foreign Residual structural overseas RFS in foreign investment currency exposures Economic foreign currency operations MI operations hedges pre-economic hedges hedges (1) exposures 2013 £m £m £m £m £m £m £m
US dollar 16,176 — 16,176 (1,581) 14,595 (3,808) 10,787 Euro 6,606 9 6,597 (190) 6,407 (2,226) 4,181 Other non-sterling 4,233 372 3,861 (3,185) 676 — 676 27,015 381 26,634 (4,956) 21,678 (6,034) 15,644 2012 US dollar 17,313 1 17,312 (2,476) 14,836 (3,897) 10,939 Euro 8,903 2 8,901 (636) 8,265 (2,179) 6,086 Other non-sterling 4,754 260 4,494 (3,597) 897 — 897 30,970 263 30,707 (6,709) 23,998 (6,076) 17,922 2011 US dollar 17,570 1 17,569 (2,049) 15,520 (4,071) 11,449 Euro 8,428 (3) 8,431 (621) 7,810 (2,236) 5,574 Other non-sterling 5,224 272 4,952 (4,100) 852 — 852 31,222 270 30,952 (6,770) 24,182 (6,307) 17,875
• Net assets of overseas operations declined by £4.0 billion largely due to increased impairments in Ulster Bank Group and capital restructuring in US Retail & Commercial. Sterling strength also contributed approximately £0.5 billion to the reduction.
• Changes in foreign currency exchange rates affect equity in proportion to structural foreign currency exposure. A 5% strengthening in foreign currencies against sterling would result in a gain of £1.1 billion in equity (2012 and 2011 - £1.3 billion), while a 5% weakening would result in a loss of £1 billion in equity (2012 and 2011 - £1.2 billion).
Cumulative gains on equity securities designated at fair value through profit or loss but not held for trading purposes were £96 million for December 2013 (2012 - cumulative gains of £184 million).
Notes: (1) Collateralised debt obligations. (2) Collateralised loan obligations. (3) Mortgage-backed securities. (4) Asset-backed securities.
Key point • The total notional and fair value both decreased 67%, to £664 million and £480 million respectively. This was driven by the sale of underlying assets across all categories, in line with Non-Core strategy.
Regulatory capital The Group holds capital for two types of non-traded market risk exposures: NTIRR and non-trading book foreign exchange.
Capital for the Group’s NTIRR is captured under the Pillar 2A process. This is calculated by considering the potential impact on the economic value of the Group over a one year horizon. The four main sources of NTIRR - repricing, yield curve, basis and optionality risks - are captured in the calculation.
Pillar 1 capital must be held for non-trading book foreign exchange exposures, as outlined under BIPRU 7.5.3. The Group does not hold capital for its structural foreign exchange exposures as these are excluded from the calculations as outlined under BIPRU 7.5.4.
The Group’s capital calculations under ICAAP are also used for economic capital purposes.
External environment* Macroeconomic conditions stabilised in 2013 with signs of improvement in most mature economies. The US showed the strongest improvement, with private investment picking up, the housing sector continuing to strengthen, and unemployment falling. This led the Federal Reserve to announce in May plans to begin normalising monetary policy. In December it announced it would start reducing quantitative easing. This resulted in some volatility in higher-yield asset markets, particularly emerging markets, where those with the largest external financing needs saw capital outflows, currency depreciation and stock market losses.
The eurozone region as a whole remained in recession throughout the year, but signs of recovery were evident by the second half of the year. Germany led, but the periphery also showed notable signs of stabilisation, with Ireland, Spain and Portugal all growing in quarter-onquarter terms in the last quarter of 2013. Eurozone monetary policy support underpinned investor confidence, while progress was made in developing a banking union that should reduce the risk of a repeat of the financial crisis over the longer term. Nevertheless, France and Italy underperformed peers.
This led to a sharp round of capital outflows, particularly from equity markets, in the second quarter of 2013. Currency depreciations in a number of large emerging economies followed, especially in those with significant current account deficits. Among the better rated economies, India, Brazil, Indonesia, South Africa and Turkey, were particularly affected. To stem the outflow of foreign capital and limit the impact on domestic asset markets, some countries, including India, started tightening monetary policy and accelerated financial sector reforms. Some countries with sizeable accumulated reserve assets, including China and Russia, were able to use their reserves to ease the pressure on their currencies.
Outlook Further strengthening of economic growth in advanced economies is likely in 2014, but uncertainty over the impact of “tapering” is likely to contribute to further volatility in asset prices across most regions. The US is expected to perform quite strongly, with the eurozone also likely to continue its uneven recovery, although in both cases key areas of the economy will remain fragile. A more challenging year for emerging economies is expected as net capital inflows decline, resulting in more pronounced market volatility and differentiation. Further policy tightening is likely and growth rates are set to slow, especially in the weakest markets.
Unfavourable operating conditions may include the risk that a weak or creditor unfriendly legal system within a country makes it difficult for the Group to recover its claims in the event of customer default. An unreliable or unstable political system may lead to sudden compliance or reputational issues for the Group, or even expropriation without proper compensation.
Countries Watchlisted Amber (refer to Risk monitoring, reporting and control below) are monitored closely. Appetite for countries Watchlisted Red is limited to short-term business in areas such as trade finance and derivatives, unless the country is deemed a strategic priority country.
The actual country limits and medium-term sub-limits, with allocations to each division, are set by the GCRC (or the ERF above certain benchmark levels). The divisions manage their exposures within their country limit allocations. Divisions may agree re-allocations between themselves, and may further assign sub-allocations to business units or product groups in the division.
Country limits are set for almost all countries. The UK (and related European special territories of Guernsey, Jersey, the Isle of Man and Gibraltar) is an exception, given its home country status. The US is the other exception because of the specific local risk management structure, the size of the local portfolio and corresponding role in Group-wide risk management, together with the country's strong ratings.
Risk monitoring, reporting and control GCoR monitors and reports on Group-level exposures to all countries, and follows up with the divisions in the event of Group-level or divisional limit excesses. GCoR has delegated authority up to specified levels to decide on country limit increases and any such decision must be reported to the GCRC. Persistent excesses are escalated to the GCRC.
A country risk Watchlist process identifies emerging issues and facilitates the development of mitigation strategies. Coverage of the country Watchlist process was extended in 2013 to include all countries to which the Group has exposure.
Changes in sovereign ratings or country Watchlist status trigger review of appetite and are referred to GCRC for discussion.
The Group also estimates its funding mismatches at risk of redenomination in vulnerable eurozone countries. These mismatches are estimated in terms of potential for additional loss rather than amounts owed and are thus determined starting from the balance sheet exposure as defined on page 344 and excluding relevant offsetting positions. The latter include exposures at low risk of redenomination, as identified through consideration of the relevant documentation, particularly the currency of exposure, governing law, court of jurisdiction, precise definition of the contract currency (for euro facilities), and location of payment. The Group also deducts offsets for provisions taken and liabilities that would be expected to re-denominate at the same time.
Risk mitigation* Part of the Group’s exposure is mitigated by guarantors or insurers (including export credit agencies), credit default swap (CDS) protection providers, or cash or non-cash collateral (such as commercial or residential real estate) in third countries, which will not be directly affected by a country event in the obligor’s country. For further details on credit mitigation instruments, refer to the Credit risk section.
Country risk continued Basis of reporting The tables in this section show the Group’s exposure at 31 December 2013, 2012 and 2011. The numbers are reported by country of operation of the obligor, except exposures to governments and individuals which are shown by country of residence.
The exposures are stated before taking into account risk mitigants such as guarantees, insurance or collateral (with the exception of reverse repos) which may have been put in place to reduce or eliminate exposure to country risk events. The tables do separately show the Group’s CDS positions, as the Group may be either a net buyer or a net seller of protection. The CDS positions for 2013 and 2012 are by country of operation, those for 2011 are by country of incorporation.
Definitions Lending - Comprises gross loans and advances, including cash balances and risk elements in lending (REIL - refer to page 554 for definition).
Off-balance sheet - Comprises letters of credit, guarantees, other contingent obligations and legally committed undrawn facilities.
The column ‘CDS notional less fair value’ represents the net effect on exposure should the CDS contracts be triggered by a credit event, assuming a zero recovery rate on the reference exposure. This net effect would be the increase in exposure arising from sold positions netted against the decrease arising from bought positions. For a sold position, the change in exposure equals the notional less the fair value amount; this represents the amount the Group would owe to its CDS counterparties if the reference entity defaulted. Positive recovery rates would tend to reduce the gross components (increases and decreases) of those numbers.
Asset quality (AQ) - Refer to Asset quality on page 236.
Germany — 3,588 402 683 3,461 90 8,224 5,168 2,524 7,416 601 23,933 7,189 31,122 (1,340) 35,529 1,128 Netherlands — 1,713 355 627 2,122 22 4,839 4,661 819 5,697 107 16,123 9,763 25,886 (356) 15,388 835 France 406 — 1,844 195 1,796 79 4,320 1,692 1,678 5,660 631 13,981 9,807 23,788 (1,747) 30,644 7,536 Belgium — — 149 211 358 21 739 443 (480) 2,123 2 2,827 1,170 3,997 (123) 2,966 594 Luxembourg — 11 95 260 421 4 791 75 98 581 88 1,633 1,043 2,676 (58) 1,373 253 Other 73 — 10 36 743 18 880 510 331 918 74 2,713 1,202 3,915 (476) 3,554 622 Total eurozone 518 5,451 2,937 2,951 30,853 18,275 60,985 17,556 7,356 26,685 1,576 114,158 37,164 151,322 (5,619) 104,130 16,564
Other countries Japan — 1,600 431 61 670 35 2,797 72 (172) 2,365 202 5,264 352 5,616 4 9,057 16,445 China — 198 2,626 228 1,515 33 4,600 166 13 370 1 5,150 1,689 6,839 (14) 372 830 India — 63 759 69 2,000 36 2,927 571 160 92 — 3,750 813 4,563 (21) 190 45 Russia — 37 741 5 947 53 1,783 149 2 19 — 1,953 364 2,317 (65) 33 27 South Korea — — 622 75 426 2 1,125 179 154 250 — 1,708 681 2,389 176 541 50 Turkey 67 59 148 101 1,023 24 1,422 50 67 94 — 1,633 324 1,957 (32) 119 998 Brazil — — 842 — 132 3 977 — 268 84 — 1,329 245 1,574 12 118 —
Country risk continued Country exposure continued CDS Lending Debt securities Off- notional Central Other Other Total AFS & HFT Net Balance balance Total less fair Gross Govt banks banks FI Corporate Personal lending LAR (net) Derivatives SFT sheet sheet exposure value Derivatives SFT 2012 £m £m £m £m £m £m £m £m £m £m £m £m £m £m £m £m £m
Germany — 20,005 508 712 4,607 85 25,917 9,263 3,500 9,474 264 48,418 7,689 56,107 (1,448) 57,285 8,209 Netherlands 7 1,822 277 753 2,931 26 5,816 7,800 647 9,047 335 23,645 10,775 34,420 (1,030) 23,679 4,602 France 494 9 2,417 209 2,451 71 5,651 2,242 3,581 7,515 698 19,687 9,675 29,362 (2,288) 45,154 16,636 Belgium — — 164 276 464 22 926 844 564 3,130 — 5,464 1,041 6,505 (215) 4,902 476 Luxembourg — 13 149 493 600 4 1,259 59 192 709 141 2,360 1,285 3,645 (206) 2,018 3,858 Other 126 — 19 90 1,033 14 1,282 576 666 1,737 8 4,269 1,380 5,649 (437) 5,975 1,432 Total eurozone 678 21,956 3,856 3,837 36,806 18,509 85,642 27,236 10,686 37,846 1,949 163,359 39,347 202,706 (6,775) 158,864 40,767
Other countries Japan — 832 317 207 360 36 1,752 1,548 4,890 2,878 199 11,267 577 11,844 (71) 13,266 15,047 China 2 183 830 48 969 31 2,063 201 61 916 1 3,242 851 4,093 36 221 1,818 India — 100 1,023 49 2,628 106 3,906 683 391 74 — 5,054 930 5,984 (43) 177 108 Russia — 53 848 14 779 54 1,748 160 249 120 — 2,277 518 2,795 (251) 124 15 South Korea — 22 771 101 287 3 1,184 144 163 221 26 1,738 704 2,442 (58) 617 94 Turkey 115 163 82 94 983 12 1,449 56 125 93 — 1,723 481 2,204 (37) 111 449 Brazil — — 564 69 137 3 773 14 582 197 — 1,566 310 1,876 394 211 —
Ireland 45 1,467 137 320 19,098 18,855 39,922 488 398 1,815 539 43,162 2,872 46,034 53 20,466 4,622 Spain 9 3 90 172 5,782 362 6,418 6,514 (359) 2,391 2 14,966 2,598 17,564 (1,013) 6,775 589 Italy — 73 233 488 2,454 23 3,271 1,583 (325) 2,381 — 6,910 3,498 10,408 (452) 11,016 305 Portugal — — 10 — 495 5 510 194 (81) 520 — 1,143 460 1,603 55 634 217 Greece 7 6 — 31 307 11 362 312 97 337 — 1,108 67 1,175 1 524 — Cyprus — — — 2 139 13 154 — 2 24 — 180 39 219 — 25 182 Eurozone periphery 61 1,549 470 1,013 28,275 19,269 50,637 9,091 (268) 7,468 541 67,469 9,534 77,003 (1,356) 39,440 5,915
Banking (primarily trade facilities, other lending and off-balance sheet exposure to corporates and financial institutions); Markets (principally derivatives and securities financing transactions with financial institutions, and HFT debt securities); Ulster Bank (mostly lending to consumers and corporates in Ireland); and Group Treasury (largely cash balances at central banks and AFS debt securities including Spanish cedulas).
• Total eurozone - balance sheet exposure declined by £49.2 billion or 30% to £114.2 billion, caused mostly by significant reductions in liquidity held with the Bundesbank and in derivatives exposure to banks. Most of the latter reductions related to counterparties in the Netherlands, Germany and France, and were largely due to the sale of a part of the Group’s CDS positions.
° Spain - Group Treasury’s holdings of covered bonds (cedulas) decreased by £0.7 billion due to sales in improved market conditions. Corporate lending decreased by £1.3 billion to £2.9 billion, with commercial real estate lending more than halving, largely as a result of disposals in Non-Core, to £0.8 billion.
° Italy - the £1.3 billion decrease in exposure to £5.2 billion reflected reductions in lending and derivatives to corporate clients. Net HFT debt exposure fluctuates as the Group is a market-maker in Italian government bonds. Off-balance sheet exposure to corporates and non-bank financial institutions also declined, by £0.7 billion.
° Portugal - exposure declined further by £0.4 billion to £0.9 billion. The remaining exposure mainly consisted of corporate lending to a few large highly creditworthy clients and collateralised derivatives trading with the largest local banks.
° Greece - exposure decreased by £0.2 billion to £0.4 billion, caused by reductions in lending and derivatives. The remaining exposure comprised mostly of collateralised derivatives exposure to banks and corporate lending, including exposure to local subsidiaries of international companies.
° Cyprus - exposure increased slightly to £0.2 billion, most of which was covered by parental and export credit agency guarantees from elsewhere.
• Germany - balance sheet exposure decreased from £48.4 billion to £23.9 billion principally owing to a £16.4 billion reduction in cash balances held with the central bank. AFS government bonds decreased by £4.1 billion in line with treasury management strategies. Lending to corporate clients decreased by £1.1 billion, principally in the commercial real estate, oil and gas, and media sectors.
• China - lending to banks increased by £1.8 billion to £2.8 billion.
Corporate lending rose by £0.5 billion to £1.5 billion, reflecting customer demand. Derivatives exposure to public sector entities decreased by £0.5 billion to £0.4 billion owing to fluctuations in short-term hedging by clients.
• India - balance sheet exposure decreased by £1.3 billion to £3.8 billion, driven largely by reductions in lending to banks and to the telecommunications and oil and gas sectors.
• CDS positions - the Group approximately halved its European CDS
positions by consolidating its derivatives portfolio through contract terminations to reduce risks and capital requirements in line with strategic plans, while maturities reduced the positions further. This resulted in major reductions in the gross notional value of CDS protection bought and sold. Net bought protection in terms of CDS notional less fair value, also fell by £1.2 billion to £5.6 billion, with reductions particularly in the Netherlands and France.
Government 39 — — 140 (7) 9 13 136 13 — 188 2 190 22 — Central bank 116 — — — — — — — — — 116 — 116 — — Other banks 13 — — 47 (2) 33 22 58 544 73 688 — 688 1,810 2,329 Other FI 319 — — 46 — 116 12 150 92 — 561 521 1,082 389 — Corporate 17,440 11,114 8,855 — — 142 5 137 251 — 17,828 1,677 19,505 255 — Personal 17,667 3,306 1,846 — — — — — — — 17,667 511 18,178 — — 35,594 14,420 10,701 233 (9) 300 52 481 900 73 37,048 2,711 39,759 2,476 2,329
Lending REIL Provisions securities reserves Long Short securities Derivatives SFT sheet sheet exposure Derivatives SFT 2013 £m £m £m £m £m £m £m £m £m £m £m £m £m £m £m
CDS by reference entity 2013 2012 2011 Notional Fair value Notional Fair value Notional Fair value Bought Sold Bought Sold Bought Sold Bought Sold Bought Sold Bought Sold £m £m £m £m £m £m £m £m £m £m £m £m
Government — — — 704 (220) 4,336 4,725 315 90 — 405 — 405 142 — Central bank 73 — — — — — — — — — 73 — 73 — — Other banks 233 — — 119 (14) 67 88 98 1,063 — 1,394 28 1,422 9,117 305 Other FI 488 — — 685 (15) 40 13 712 758 — 1,958 1,489 3,447 760 — Corporate 2,454 361 113 75 — 58 — 133 470 — 3,057 1,968 5,025 997 — Personal 23 — — — — — — — — — 23 13 36 — — 3,271 361 113 1,583 (249) 4,501 4,826 1,258 2,381 — 6,910 3,498 10,408 11,016 305
Government — — — 72 (18) 28 15 85 17 — 102 — 102 17 — Other banks — — — 66 (12) 5 — 71 380 — 451 — 451 481 26 Other FI 128 — — 1 — 21 11 11 38 — 177 34 211 38 — Corporate 450 253 188 41 — 7 — 48 79 — 577 290 867 82 — Personal 7 — — — — — — — — — 7 8 15 — — 585 253 188 180 (30) 61 26 215 514 — 1,314 332 1,646 618 26
LAR debt AFS debt securities Total debt Net Balance balance Total Gross Lending REIL Provisions securities reserves Long Short securities Derivatives SFT sheet sheet exposure Derivatives SFT
Government 7 — — 312 — 102 5 409 — — 416 — 416 71 — Central bank 6 — — — — — — — — — 6 — 6 — — Other banks — — — — — — — — 290 — 290 — 290 405 — Other FI 31 — — — — — — — 12 — 43 13 56 12 — Corporate 307 256 256 — — — — — 35 — 342 45 387 36 — Personal 11 — — — — — — — — — 11 9 20 — — 362 256 256 312 — 102 5 409 337 — 1,108 67 1,175 524 —
Other risks 355 Conduct risk 356 Pension risk 358 Operational risk 360 Regulatory risk 361 Reputational risk 362 Business risk 363 Strategic risk 364 Developments in 2014
The Group’s compliance functions are responsible for the appropriate management of conduct risk, including Anti-Money Laundering (AML); Sanctions and Terrorist Financing (STF); and Anti-Bribery and Corruption (ABC). In doing so, they design, implement and maintain a management framework, the objective of which is the consistent identification, assessment, monitoring, and reporting of conduct risk.
A conduct risk governance structure, within which all divisions are represented by senior business leaders, provides clarity on roles, responsibilities and accountabilities for conduct risk. Key elements of the governance structure are set out below.
The Board receives updates on conduct risk via monthly risk reports.
In 2013, the Group continued to focus on strengthening the capabilities of its compliance functions, at both Group and divisional level through investment in training. To do so, it facilitated training on conduct risk, primarily through computer-based Group Policy Learning modules. Each module addresses the regulatory content of relevant Group Policy Standards.
Other risks* continued Conduct risk continued Risk mitigation Assurance and monitoring activities are essential to ensure that the Group can demonstrate compliance with existing rules and regulations, assess whether it is managing its conduct risks appropriately, and determine whether key controls are effective. In 2013, the Group Conduct and Regulatory Affairs assurance function provided Group-wide assurance over specific compliance topics, as well as thematic process reviews.
Sources of risk The Group has exposure to pension risk through its defined benefit schemes worldwide. The five largest schemes, which represent around 96% of the Group’s pension liabilities, are the Royal Bank of Scotland Group Pension Fund (‘main scheme’), the Ulster Bank Pension Scheme (Republic of Ireland), the Ulster Bank Pension Scheme, the Royal Bank of Scotland Americas Pension Plan and the Royal Bank of Scotland International Pension Trust. The main scheme is the principal source of pension risk.
Pension scheme liabilities vary with changes in long-term interest rates and inflation as well as with pensionable salaries, the longevity of scheme members and changes in legislation. Meanwhile, pension scheme assets vary with changes in interest rates, inflation expectations, credit spreads, exchange rates and equity and property prices. The Group is exposed to the risk that the market value of the schemes’ assets - together with future returns and any additional future contributions - becomes insufficient to meet liabilities as they fall due. In such circumstances, the Group could be obliged (or may choose) to make additional contributions to the schemes or be required to hold additional capital to mitigate this risk.
For further information on the Group’s risk governance, see page 176.
As the sponsor of its defined benefit pension schemes, the Group manages the risk it faces using a pension risk management framework. This encompasses risk monitoring, modelling, stress testing and reporting. As sponsor, the Group maintains an independent view of the risk inherent in its pension funds. In addition to the scrutiny provided by the Pension Risk Committee, the Group also achieves this through regular pension risk monitoring and reporting to the Group Board, Group Executive Committee and Group Board Risk Committee on the material pension schemes that the Group has an obligation to support.
In October 2012, the Group confirmed that it was offering employees the choice between an increase to the charge made through its flexible benefits programme for membership of the main scheme by 5% of salaries or an increase in their Normal Pension Age from 60 to 65 in respect of service from October 2012 with no additional charge.
Fall in nominal swap yields of 0.25% at all durations with no change in credit spreads or real swap yields 217 333 (116) Fall in real swap yields of 0.25% at all durations with no change in credit spreads or nominal swap yields 595 895 (300) Fall in credit spreads of 0.25% at all durations with no change in nominal or real swap yields 60 1,245 (1,185) Fall in equity values of 10% (894) — (894)
Sources of risk Operational risk may arise from a failure to manage appropriately the Group's operations, transactions and security. It may arise from other forms of human error, an inability to deliver change on time or adequately, or from the unavailability of technology services, or the loss of customer data. It could also result from a liability or a loss arising from a defective transaction. A failure to take appropriate measures to protect assets or to take account of changes in law, are sources of risk. Fraud and theft are important sources of operational risk, as is the impact of natural and man-made disasters.
Governance structure The Group operates with an independent Operational Risk Second Line of Defence function comprising both a central team and teams based in each business. The function plays a leadership role by providing a forward-looking, value-adding capability, working with the business to achieve a robust risk management culture across the bank. The Group Head of Operational Risk reports to the Group Chief Risk Officer.
To confirm that the Group operates within the set risk appetite, the highlevel statement is aligned with the strategic risk objectives of the Group. Group-level measures have been set and cascaded to divisions and supported by additional tolerances and key indicators.
Operational risk appetite measures and frameworks are reviewed annually at the ERF.
The operational risk cycle comprises four stages: • Identification of risks
• Management or control of risks to prevent their recurrence or minimise the potential impact
In 2013, the focus was on the continued implementation and embedding of risk assessments across the Group. This included the strengthening of links between risk assessments and other elements of the Group operational risk framework.
The Group New Business Forum reviews and challenges proposed high risk products to ensure material risks have been adequately identified and assessed so that new products are launched in line with the Group’s risk appetite and strategy.
Enhancements made during 2013 include the introduction of an improved product pipeline to provide more detail on product review and sign-off, and enhanced reporting to the Group New Business Forum to allow challenges to the risk classification of products assessed as low-risk by divisions.
Scenario analysis is an important component in the operational risk framework, providing senior management with valuable insight into risk exposures that could significantly affect the Group’s financial performance or reputation. Scenarios also provide an important link between operational risk management and measurement as a key input into the calculation of Economic Capital, and into the Group’s stress testing and reverse stress testing processes.
Scenarios are run in a workshop environment, bringing business and risk and control experts together, thereby providing a deeper understanding of risk exposures and allowing management to make more informed decisions on taking action.
The Group further refined its approach to assessing the impact of the economic cycle on its operational risk losses by specifically assessing the impact of the PRA’s published Anchor 5 scenario, which describes the impact of a series of country-specific shocks around the world on expected levels of operational risk losses and capital adequacy requirements for operational risk.
The impact of the PRA Anchor 5 scenario on the Group's operational risk capital, as calculated under the standardised approach, was also projected based on the outputs of the Group’s stress-testing exercises. Operational risk impacts are also assessed based on additional economic stress scenarios developed internally. This is used as part of the overall stress input to capital planning and ICAAP.
Operational risk is measured utilising a top-down assessment of risk through scenario analysis along with a bottom-up assessment of risk and controls.
Event and loss data management Event and loss data management covers a set of standard requirements for the management of operational risk events and loss data. It also provides for clear and consistent communication of operational risk events that meet defined threshold criteria to the Group’s senior management. The Group has continued to focus on the timely and accurate capture of operational risk losses; the use of a single Groupwide repository; and the escalation of material operational risk events.
All losses and recoveries associated with an operational risk event are reported based on the date of each financial impact. A single event can have multiple losses (or recoveries) which may take some time to crystallise. Losses and recoveries will also have been booked in 2013 on events which occurred, or were identified in, prior years.
Number of events (net loss greater than £10,000) At 31 December 2013, four categories accounted for around 90% of all operational risk events. These were: (i) clients, products and business practices; (ii) execution, delivery and process management; (iii) fraud; and (iv) employment practices and workplace safety. This proportion was broadly in line with 2012.
A small number of operational risk events contribute a high percentage of the total losses. In 2013, less than 1% of the events contributed around 98% of the losses. This was in line with 2012.
Capital The Group calculates the Pillar 1 capital requirement for operational risk using the standardised approach (TSA). For 2013, the Group’s minimum Pillar 1 capital requirement was £3.4 billion (2012 - £3.7 billion).
Control Environment Certification Control Environment Certification (CEC) is used by the Group Executive to review and assess its internal control framework. Members of the senior management team are required to provide a semi-annual assessment of the robustness of the Group’s internal control environment including: • Compliance with the requirements of the UK Corporate Governance
Governance structure The Group’s Regulatory Affairs team (“Regulatory Affairs”) maintains well-established policies and supporting processes to ensure timely identification of, and effective responses to, changes in official requirements affecting the Group. The function also maintains a structured and open engagement with the Group’s regulators. Regulatory Affairs underpin a range of other policies and processes that address ongoing compliance with regulatory obligations (refer to the section on Conduct Risk for further information).
A divisional Heads of Regulatory Developments Committee supports the maintenance and continuous development of the relevant policy, known as the Political, Legislative and Regulatory Environment Policy Standard, and supporting documents, together with associated processes, tools and governance. It also oversees the Group’s regulatory developments operating framework to ensure it meets the needs of all divisions and functions, as well as the maintenance of the policy known as the Group Relationships with Regulators Policy Standard.
Against the backdrop of intensified regulatory pressure, Regulatory Affairs has increased the size of its team, as well as improved and refined its operating model, tools, systems and processes.
Internal communications on regulatory issues were strengthened. This involved staff seminars and the publication of key information on internal websites, including the weekly Regulatory Affairs Flash Report, covering key regulatory developments and supervisory interactions.
All regulatory and compliance changes are managed so as to ensure timely compliance readiness. Those assessed as having a “High” or “Medium-High” impact are managed especially closely with the aim of mitigating the impact through, for instance, changes to strategy or business activities, or external engagement.
Reputational risk Definition Reputational risk is the risk of brand damage and/or financial loss owing to a failure to meet stakeholders’ expectations of the Group’s conduct and performance. Stakeholders include customers, investors, rating agencies, employees, suppliers, government, politicians, regulators, special interest groups, consumer groups, media and the general public. Brand damage can be detrimental to the business in a number of ways. It can hamper efforts to build or sustain business relationships with customers, affect staff morale, and reduce access to funding sources.
Governance structure The Group Board has the ultimate responsibility for managing the Group's reputation, although all parts of the Group have responsibility for any reputational impact arising from their operations, including relationships with customers. The Board has set the Group’s Purpose, Vision and Values (PVV), which outline a desired reputation for the Group “to be trusted, respected and valued by our customers, shareholders and communities”.
• The Board Risk Committee (BRC) oversees reputational issues and is directly engaged in strategic reputational management decisions (e.g. the customer redress policy following the Group’s IT incident).
• The Group Sustainability Committee (GSC) reviews reputational issues from a customer or sector perspective. It is responsible for reviewing the Group’s sustainability strategy, values and policies and aligning the Group’s approach to environmental, social and ethical (ESE) issues.
• The ESE risk management function provides guidance and sets policy to avoid reputational risk to the bank related to the Group’s business engagements and lending to customers in some sensitive industry sectors, such as mining. The function is supported by additional resource in the business divisions.
• The Group Risk Committee (GRC) reviews reputational issues from an organisational perspective. Its remit covers material and/or enterprise-wide risk and control matters across the Group, including reputational risk, as well as a review of the overall risk culture, capability and commitment across the Group.
Risk management and measurement The reputational risk management framework is aligned with the Group’s strategic objectives, its risk appetite its focus on serving customers well, its risk appetite and the Group’s PVV. It is designed to embed, at different points of decision-making processes, a series of reputational filters and controls that examine products, services and activities through the lens of sustainability, transparency and fairness.
The Group’s four corporate values (serving customers, working together, thinking long-term and doing the right thing) build on the advances made so far (e.g. strengthened governance and controls) to deliver the required cultural and behavioural change for the long term, with a set of supporting tangible measures. Key tools designed to embed the values include a revised code of conduct, a simple “YES-check” guide to decisions that need to be taken every day by employees and various training and accreditation programmes. Values will also be a core part of performance measures to endorse behaviours that benefit customers, manage risk and deliver long-term shareholder value.
Risk mitigation Several of the Group policies address key sources of reputational risk. These policies are implemented in accordance with the Group Policy Framework through divisional and functional policy standard owners. The effectiveness of these policies within each business unit is reported through the CEC process semi-annually. Reputational aspects also form a core part of the RBS conduct risk framework, with a series of enhanced policies being developed in line with the Group’s conduct risk appetite.
Business risk Definition Business risk is the risk that the Group suffers losses as a result of adverse variances in its revenues and/or costs related to its business plan and strategy. Such variances may be caused by internal factors such as volatility in pricing, sales volumes, and input costs or external factors such as the Group's exposure to macroeconomic, regulatory and industry risks.
Responsibility for the management of business risk lies primarily with the Group’s divisions, with oversight by Group Finance. The divisions are responsible for delivery of their business plans and the management of such factors as pricing, sales volumes, marketing spend and other factors that can introduce volatility into earnings.
Business risk is identified and managed at product and transaction level. Estimated revenue and costs, including the potential range of outcomes, are key elements in the design of any new product or investment decision. All policies that ultimately seek to manage and control financial impacts at the product and transaction level are therefore relevant to business risk management including policies on conduct, treasury and investment spend.
Business risk is reviewed and assessed through the Group’s planning cycles and performance management processes.
Expected profiles for revenues and costs are determined, on a bottom-up basis, through plans reflecting expectations of the external environment and the Group’s strategic priorities. These profiles are tested against a range of sensitivities and stresses to identify the key risk drivers behind any potential volatility, along with management actions to address and manage them.
Risk mitigation The Group operates a forecast process which identifies projected changes in, or risks to, key financial metrics and ensures appropriate actions are taken.
Other risks* continued Strategic risk continued Strategic plans are developed by each division on an annual cycle managed centrally, and are aggregated into a Group plan reviewed and challenged by the Group Chief Executive, Group Finance Director and Group Director of Strategy and Corporate Finance before presentation to the Group Board. The Board has ultimate responsibility for approving strategic plans, initiatives and changes to strategic direction. In addition to the annual cycle, each division presents a more detailed individual “Deep Dive” review of key dimensions of its strategy at a Group Board meeting at different points during the year.
In 2013, the Group began to focus on reducing strategic risk through a wide-ranging review to analyse core activities and formulate an appropriate plan, including rationalisation where necessary, to address the business challenges of the next five years
Strategic progress is also monitored through quarterly performance review meetings between divisional CEOs and the Group Chief Executive, Group Finance Director and Group Director of Strategy and Corporate Finance. While there is no formal Group statement on Strategic Risk appetite, the Group’s strategy is approved by the Group Board with consideration of the risks in pursuing that strategy.
Developments in 2014 In November 2013, the Group announced its intention to undertake a comprehensive business review. Over the remainder of 2013 and into the early months of 2014, it completed the review and developed a strategic plan, the objective of which is to position the Group as a UK-focused retail and corporate bank that earns its customers’ trust by serving them better than any other bank. Key to achieving this is combining customer groups with similar needs into three new businesses and reducing significantly the Group’s costs and complexity. While the Group is confident that the plan is appropriate, it may have underestimated the risks arising from concentrating its activities in the UK or misunderstood the needs of its customers or the strength of its competitive position.
• we have not identified material uncertainties related to events or conditions that may cast significant doubt on the Group’s ability to continue as a going concern which we believe would need to be disclosed in accordance with IFRSs as adopted by the European Union; and
Where appropriate, our work involved assessing third party valuations of collateral and external expert reports on borrowers’ business plans and enterprise valuations to determine whether appropriate valuation methodologies and assumptions were employed and to assess the objectivity of the external experts used, including assessing whether any inappropriate restrictions had been placed on their work.
We tested the key controls over the Group’s financial instrument valuation processes. Our work included testing a sample of the underlying models and assumptions used, by reference to trade data as well as peer group comparison, where available.
The estimation of the provisions held in relation to the ongoing regulatory investigations and litigation affecting the Group, including the mortgagebacked securities and securities related litigation, payment protection insurance and interest rate hedging products mis-selling, is highly judgemental given the uncertainties in relation to future regulatory and legal judgements, as well the uncertainties around key assumptions used to calculate these provisions such as average redress costs and the volumes of future complaints.
We assessed the legal advice and correspondence with regulators received in connection with legal proceedings, investigations and regulatory matters which the Group is party to. Where appropriate we additionally engaged in direct enquiry with the Group’s external legal counsel.
For redress costs we challenged the adequacy of provisions recognised by critically assessing the key assumptions used in the provision models, where possible comparing the assumptions to available peer and historic data.
We also challenged the appropriateness of the disclosures provided in relation to these matters, including those where a reliable estimate of the liability could not be calculated.
Identified deficiencies in the privileged access controls over a number of significant applications that run on the Group’s information technology systems, could have had a negative impact on the Group’s controls and financial reporting systems at a number of divisions.
Our assessment of the risks of material misstatement Our response to those risks The assessment of the appropriateness of the carrying value of deferred taxation, goodwill, and other intangible assets, is highly judgemental as these valuations depend upon assumptions on the future profitability of the divisions of the Group as described in more detail in notes 17 and 23 to the financial statements.
For each cash generating unit or legal entity as appropriate, we critically assessed the forecasts of the cash flows and the appropriateness of the key assumptions used; including forecast taxable profits, growth rates and discount rates, in order to challenge management’s calculation of the recoverable amount of deferred taxation, goodwill and intangible assets.
Opinion on other matters prescribed by the Companies Act 2006 In our opinion: • the part of the Directors’ remuneration report to be audited has been properly prepared in accordance with the Companies Act 2006; and • the information given in the Strategic report and the Directors’ report for the financial year for which the financial statements are prepared is consistent with the financial statements.
Matters on which we are required to report by exception Adequacy of explanations received and accounting records Under the Companies Act 2006 we are required to report to you if, in our opinion: • we have not received all the information and explanations we require for our audit; or • adequate accounting records have not been kept by the parent company, or returns adequate for our audit have not been received from branches not visited by us; or • the parent company financial statements are not in agreement with the accounting records and returns.
Directors’ remuneration Under the Companies Act 2006 we are also required to report if in our opinion certain disclosures of directors’ remuneration have not been made or the part of the Directors’ remuneration report to be audited is not in agreement with the accounting records and returns. Under the Listing Rules we are required to review certain elements of the Directors’ remuneration report. We have nothing to report arising from these matters or our review.
Fees and commissions receivable 2 5,460 5,709 6,379 Fees and commissions payable 2 (942) (834) (962) Income from trading activities 2 2,685 1,675 2,701 Gain on redemption of own debt 2 175 454 255
Loss from continuing operations (8,625) (5,718) (2,471) Profit/(loss) from discontinued operations, net of tax - Direct Line Group 20 127 (184) 301
Profit/(loss) from discontinued operations, net of tax 148 (172) 348 Loss for the year (8,477) (5,890) (2,123)
Note: (1) Ten B shares rank pari-passu with one ordinary share (see Note 26).
Cash and balances at central banks 10 82,659 79,290 79,269 Loans and advances to banks 10 54,071 63,951 83,310 Loans and advances to customers 10 440,722 500,135 515,606 Debt securities subject to repurchase agreements 30 55,554 91,173 79,480 Other debt securities 58,045 66,265 129,600
Prepayments, accrued income and other assets 19 7,614 7,820 10,976 Assets of disposal groups 20 3,017 14,013 25,450
Called-up share capital At 1 January 6,582 15,318 15,125 Ordinary shares issued 132 197 193 Share capital sub-division and consolidation — (8,933) —
Share premium account At 1 January 24,361 24,001 23,922 Ordinary shares issued 306 360 79
At 1 January 3,908 4,775 5,138 Retranslation of net assets (325) (1,056) (382) Foreign currency gains/(losses) on hedges of net assets 105 177 (10) Tax 6 17 23 Transfer to retained earnings — (2) — Recycled to profit or loss on disposal of businesses (3) (3) 6 At 31 December 3,691 3,908 4,775
Capital redemption reserve At 1 January 9,131 198 198 Share capital sub-division and consolidation — 8,933 — At 31 December 9,131 9,131 198
Retained earnings At 1 January 10,596 18,929 21,239 Transfer to non-controlling interests — (361) — (Loss)/profit attributable to ordinary and B shareholders and other equity owners - continuing operations (8,708) (5,694) (2,457) - discontinued operations 111 (60) 306 Equity preference dividends paid (349) (273) — Paid-in equity dividends paid, net of tax (49) (28) — Transfer from available-for-sale reserve — 59 — Transfer from foreign exchange reserve — 2 — Transfer from merger reserve — — 50 Transfer from contingent capital reserve (1,208) — — Termination of contingent capital agreement 320 — — Actuarial gains/(losses) recognised in retirement benefit schemes - gross 446 (2,158) (375) - tax (246) 352 34 Loss on disposal of own shares held (18) (196) — Shares issued under employee share schemes (77) (87) (58) Share-based payments - gross 48 117 200 - tax 1 (6) (10)
Currency translation adjustments and other movements (6) (18) (54) Profit/(loss) attributable to non-controlling interests - continuing operations 83 (24) (14)
Dividends paid (5) — (40) Movements in available-for-sale securities - unrealised gains 8 3 1 - recycled to profit or loss on disposal of businesses (3) (5) — — Equity raised — 875 — Equity withdrawn and disposals (1,429) (23) (421) Transfer from retained earnings — 361 —
Total comprehensive loss recognised in the statement of changes in equity is attributable to: Non-controlling interests 137 (129) (24) Preference shareholders 349 273 — Paid-in equity holders 49 28 — Ordinary and B shareholders (10,724) (7,269) (756)
Notes: (1) Paid-in equity was increased by £548 million on adoption of IFRS 10 - see page 377. (2) Net of tax - £35 million charge. (3) Net of tax - £1 million charge.
Interest on subordinated liabilities (958) (746) (714) Net cash flows from financing activities (2,728) 2,017 (1,741) Effects of exchange rate changes on cash and cash equivalents 512 (3,893) (1,473)
Net (decrease)/increase in cash and cash equivalents (11,664) (19,814) 125 Cash and cash equivalents at 1 January 132,841 152,655 152,530 Cash and cash equivalents at 31 December 37 121,177 132,841 152,655 *Restated
The company is incorporated in the UK and registered in Scotland and its accounts are presented in accordance with the Companies Act 2006. With the exception of investment property and certain financial instruments as described in Accounting policies 9, 15, 17 and 19 below, the accounts are presented on an historical cost basis.
In accordance with IFRS 5, Direct Line Group (DLG) was classified as a discontinued operation in 2012, and prior periods re-presented accordingly. From 13 March 2013, DLG was classified as an associate and at 31 December 2013 the Group’s interest in DLG was transferred to disposal groups.
The Group adopted a number of new and revised IFRSs effective 1 January 2013: IFRS 11 ‘Joint Arrangements’, which supersedes IAS 31 ‘Interests in Joint Ventures’, distinguishes between joint operations and joint ventures. Joint operations are accounted for by the investor recognising its assets and liabilities including its share of any assets held and liabilities incurred jointly and its share of revenues and costs. Joint ventures are accounted for in the investor’s consolidated accounts using the equity method. IFRS 11 requires retrospective application.
Implementation of the standards and amendments to standards above has not had a material effect on the financial statements of the Group or the company.
IAS 19 ‘Employee Benefits’ (revised) requires: the immediate recognition of all actuarial gains and losses; interest cost to be calculated on the net pension liability or asset at the long-term bond rate; and all past service costs to be recognised immediately when a scheme is curtailed or amended. Implementation of IAS 19 resulted in an increase in the loss after tax of £84 million for the year ended 31 December 2012 (2011 - £154 million) with a corresponding increase in other comprehensive income. This also resulted in an increase in the loss per ordinary and equivalent B share of 0.8p for the year ended 31 December 2012 (2011 - 1.4p). Prior periods have been restated.
IFRS 10 ‘Consolidated Financial Statements’ replaces SIC-12 ‘Consolidation - Special Purpose Entities’ and the consolidation elements of the existing IAS 27 ‘Consolidated and Separate Financial Statements’. IFRS 10 adopts a single definition of control: a reporting entity controls another entity when the reporting entity has the power to direct the activities of that other entity so as to vary returns for the reporting entity. IFRS 10 requires retrospective application. Following implementation of IFRS 10, certain entities that have trust preferred securities in issue are no longer consolidated by the Group. As a result there was a reduction in Non-controlling interests of £0.5 billion with a corresponding increase in Owners’ equity (Paid-in equity) as at 31 December 2012. This resulted in an increase in the loss attributable to non-controlling interests of £13 million for the year ended 31 December 2012 (2011 - nil), with a corresponding increase in the profit attributable to paid-in equity holders. There was no effect on the profit/(loss) attributable to ordinary and B shareholders. Prior periods have been restated accordingly.
Card related services - fees from credit card business include: • Commission received from retailers for processing credit and debit card transactions: income is accrued to the income statement as the service is performed.
5. Employee benefits Short-term employee benefits, such as salaries, paid absences, and other benefits are accounted for on an accruals basis over the period in which the employees provide the related services. Employees may receive variable compensation satisfied by cash, by debt instruments issued by the Group or by RBSG shares. The treatment of share-based compensation is set out in Accounting policy 26. Variable compensation that is settled in cash or debt instruments is charged to profit or loss over the period from the start of the year to which the variable compensation relates to the expected settlement date taking account of forfeiture and clawback criteria.
The charge to profit or loss for pension costs (recorded in operating expenses) comprises: • the current service cost
• interest, computed at the rate used to discount scheme liabilities, on the net defined benefit liability or asset
6. Intangible assets and goodwill Intangible assets acquired by the Group are stated at cost less accumulated amortisation and impairment losses. Amortisation is charged to profit or loss over the assets' estimated economic lives using methods that best reflect the pattern of economic benefits and included in Depreciation and amortisation. These estimated useful economic lives are: Core deposit intangibles 6 to 10 years Other acquired intangibles 5 to 10 years Computer software 3 to 12 years
8. Impairment of intangible assets and property, plant and equipment At each reporting date, the Group assesses whether there is any indication that its intangible assets, or property, plant and equipment are impaired. If any such indication exists, the Group estimates the recoverable amount of the asset and the impairment loss if any. Goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired.
12. General insurance Premiums earned - insurance and reinsurance premiums receivable for the whole period of cover provided by contracts incepted during the year are adjusted by an unearned premium provision, which represents the proportion of the premiums that relate to periods of insurance after the balance sheet date. Unearned premiums are calculated over the period of exposure under the policy, on a daily basis, 24ths basis or allowing for the estimated incidence of exposure under policies.
Deferred acquisition costs - acquisition costs relating to new and renewing insurance policies are matched with the earning of the premiums to which they relate. A proportion of acquisition costs incurred during the year are deferred to the subsequent accounting period to match the extent to which premiums written during the year are unearned at the balance sheet date. The principal acquisition costs deferred are direct advertising expenditure, third party administration fees, commission paid and costs associated with telesales and underwriting staff.
Contingent liabilities are possible obligations arising from past events, whose existence will be confirmed only by uncertain future events, or present obligations arising from past events that are not recognised because either an outflow of economic benefits is not probable or the amount of the obligation cannot be reliably measured. Contingent liabilities are not recognised but information about them is disclosed unless the possibility of any outflow of economic benefits in settlement is remote.
Except for US retail portfolios, where write off of the irrecoverable amount takes place within 60 - 180 days, the typical time frames from initial impairment to write off for the Group’s collectively-assessed portfolios are: • Retail mortgages: write off occurs within five years, and is accelerated where accounts are closed earlier.
• Credit cards: write off of the irrecoverable amount takes place at 12 months; the rest is expected to be recovered over a further three years following which any remaining amounts outstanding are written off.
Financial liabilities that the Group designates on initial recognition as being at fair value through profit or loss are recognised at fair value, with transaction costs being recognised in profit or loss, and are subsequently measured at fair value. Gains and losses on financial liabilities that are designated as at fair value through profit or loss are recognised in profit or loss as they arise.
Fair value - the Group’s approach to determining the fair value of financial instruments measured at fair value is set out in the section of Critical accounting policies and key sources of estimation uncertainty entitled Fair value - financial instruments; further details are given in Note 11.
Impairment testing inherently involves a number of judgmental areas: the preparation of cash flow forecasts for periods that are beyond the normal requirements of management reporting; the assessment of the discount rate appropriate to the business; estimation of the fair value of cashgenerating units; and the valuation of the separable assets of each business whose goodwill is being reviewed. Sensitivity to changes in assumptions are discussed in Note 17 on page 445.
Provisions for liabilities As set out in Note 22, at 31 December 2013 the Group recognised provisions for liabilities in respect of Payment Protection Insurance, £926 million (2012 - £895 million; 2011 - £745 million), Interest Rate Hedging Products, £1,077 million (2012 - £676 million; 2011 - nil), LIBOR investigations, £416 million (2012 - £381 million; 2011 - nil) and other regulatory proceedings and litigation, £2,168 million (2012 - £368 million; 2011 - £241 million). Provisions are liabilities of uncertain timing or amount, and are recognised when there is a present obligation as a result of a past event, the outflow of economic benefit is probable and the outflow can be estimated reliably. Judgement is involved in determining whether an obligation exists, and in estimating the probability, timing and amount of any outflows. Where the Group can look to another party such as an insurer to pay some or all of the expenditure required to settle a provision, any reimbursement is recognised when, and only when, it is virtually certain that it will be received.
Payment Protection Insurance - the Group has established a provision for redress payable in respect of the mis-selling of Payment Protection Insurance policies. The provision is management’s best estimate of the anticipated costs of redress and related administration expenses. The determination of appropriate assumptions to underpin the provision requires significant judgement by management. The principal assumptions underlying the provision together with sensitivities to changes in those assumptions are given in Note 22.
Interest Rate Hedging Products - the Group has agreed to a redress exercise and past business reviews in relation to the sale of Interest Rate Hedging Products to some small and medium sized businesses classified as retail clients. The ultimate cost of this exercise to the Group is uncertain. Estimating the liability depends on a number of assumptions. These assumptions and the sensitivity of the provision to changes in them are discussed in Note 22.
Deferred tax The Group makes provision for deferred tax on temporary differences where tax recognition occurs at a different time from accounting recognition. Deferred tax assets of £3,478 million were recognised as at 31 December 2013 (2012 - £3,443 million; 2011 - £3,878 million).
At 31 December 2013, loans and advances to customers classified as loans and receivables totalled £364,772 million (2012 - £397,846 million; 2011 - £427,805 million) and customer loan impairment provisions amounted to £25,153 million (2012 - £21,136 million; 2011 - £19,760 million). Loan impairment provisions charged to profit or loss in 2013 amounted to £8,427 million (2012 - £5,292 million; 2011 - £7,241 million). These include loan impairment provisions in respect of loans to be transferred to RBS Capital Resolution Group. These loans are expected to be exited within three years and impairment provisions in respect of these loans have been reassessed in the light of this change in recovery strategy.
Debt securities (held-for-trading, designated as at fair value though profit or loss and available-for-sale) - debt securities include those issued by governments, municipal bodies, mortgage agencies and financial institutions as well as corporate bonds, debentures and residual interests in securitisations.
Where the market for a financial instrument is not active, fair value is established using a valuation technique. These valuation techniques involve a degree of estimation, the extent of which depends on the instrument’s complexity and the availability of market-based data. More details about the Group’s valuation methodologies and the sensitivity to reasonably possible alternative assumptions of the fair value of financial instruments valued using techniques where at least one significant input is unobservable are given in Note 11 on pages 412 to 432.
Effective for 2014 ‘Offsetting Financial Assets and Financial Liabilities (Amendments to IAS 32)’ adds application guidance to IAS 32 to address inconsistencies identified in applying some of the standard’s criteria for offsetting financial assets and financial liabilities.
The implementation of these requirements is not expected to have a material effect on the Group’s financial statements.
In October 2010, IFRS 9 was updated to include requirements in respect of the classification and measurement of liabilities. These do not differ markedly from those in IAS 39 except for the treatment of changes in the fair value of financial liabilities that are designated as at fair value through profit or loss attributable to own credit; these must be presented in other comprehensive income.
The amendments also: • revised IFRS 9 to allow an entity to elect to apply its requirement to present changes in the fair value of liabilities designated as at fair value through profit or loss attributable to own credit risk in other comprehensive income without applying the other requirements of the standard; otherwise all phases of IFRS 9 must be applied from the same effective date.
At its February 2014 meeting the IASB tentatively agreed on 1 January 2018 as the effective date for IFRS 9.
Changes in fair value of own debt and derivative liabilities attributable to own credit - debt securities in issue 131 (1,473) 225
Notes: (1) The analysis of income from trading activities is based on how the business is organised and the underlying risks managed. Income from trading activities comprises gains and losses on financial instruments held for trading, both realised and unrealised, interest income and dividends and the related funding costs. The types of instruments include: - Foreign exchange: spot foreign exchange contracts, currency swaps and options, emerging markets and related hedges and funding. - Interest rate: interest rate swaps, forward foreign exchange contracts, forward rate agreements, interest rate options, interest rate futures and related hedges and funding. - Credit: asset-backed securities, corporate bonds, credit derivatives and related hedges and funding. - Equities: equities, equity derivatives and related hedges and funding. - Commodities: commodities, commodity contracts and related hedges and funding.
Temporary and contract costs 650 699 786 Social security costs 486 562 615 Share-based compensation 49 126 197 Pension costs - defined benefit schemes (see Note 4) 517 528 554 - curtailment and settlement gains (see Note 4) (7) (41) —
Write-down of goodwill and other intangible assets (see Note 17) 1,403 124 80 *Restated
Note: (1) Includes Bank levy, Payment Protection Insurance costs, Interest Rate Hedging Products redress and related costs, and regulatory and legal actions, which are discussed in more detail below.
Bank levy The UK bank levy was charged at a rate of 0.13% on chargeable liabilities in excess of £20 billion, and amounted to £200 million for 2013 (2012 - 0.088%, £175 million; 2011 - average 0.075%, £300 million).
Interest Rate Hedging Products (IRHP) redress and related costs Following an industry-wide review conducted in conjunction with the Financial Services Authority (now being dealt with by the Financial Conduct Authority (FCA)), a charge of £700 million was booked in 2012 for redress in relation to certain interest rate hedging products sold to small and medium-sized businesses classified as retail clients under FSA rules. £575 million was earmarked for client redress and £125 million for administrative expenses. The estimate for administrative costs was increased by £50 million in Q1 2013 following development of the plan for administering this process in accordance with FSA guidelines. The provision was further increased in Q4 2013 by £500 million, reflecting both higher volumes and anticipated redress payments, recalibration of our methodology based on experience during Q4 2013 and additional administration charges. The cumulative charge for IRHP is £1.3 billion, of which £1.0 billion relates to redress and £0.3 billion relates to administrative expenses. Customers may also be entitled to be compensated for any consequential losses they may have suffered. The Group is not able to measure reliably any liability it may have and has accordingly not made any provision.
3 Operating expenses continued The Group expects to complete its review of sales of IRHP and provide basic redress to all customers who are entitled to it by the end of 2014. On 23 October 2013, the Group announced that it would split redress payments for all customers who may have been mis-sold IRHP. Customers will receive redress monies without having to wait for the assessment of any additional consequential loss claims which are outside the allowance for such claims included in the 8% interest on redress due.
Restructuring costs included in operating expenses comprise: 2013 2012 2011 £m £m £m
Share-based payments As described in the Remuneration report on page 88, the Group grants share-based awards to employees principally on the following bases: Award plan Eligible employees Nature of award (1) Vesting conditions (2) Settlement
Options are exercisable within six months of vesting; 1.3 million were exercisable at 31 December 2013 (2012 - 0.2 million; 2011 - 0.3 million). The weighted average share price at the date of exercise of options was £3.36 (2012 - £2.78; 2011 - £4.21). At 31 December 2013, exercise prices ranged from £2.33 to £39.27 and the average contractual life was 3.5 years (2012 - £2.33 to £39.27 and 3.9 years; 2011 - £2.33 to £39.27 and 3.7 years). The fair value of options granted in 2013 was £25 million (2012 - £28 million; 2011 - £43 million).
The awards granted in 2013 vest evenly over the following three anniversaries.
Value Shares Options Value Shares Options Value Shares Options at grant awarded over shares at grant awarded over shares at grant awarded over shares £m (million) (million) £m (million) (million) £m (million) (million)
At 31 December 2013, a provision of £1 million had been made in respect of 0.1 million options over shares that may be cash-settled (2012 - £1 million in respect of 0.1 million share awards and 0.3 million options over shares; 2011 - £3 million in respect of 0.4 million share awards and 1.4 million options over shares).
Variable compensation as a % of operating profit (4) 19% 19% 27% 16% Proportion of variable compensation that is deferred 88% 85% 96% 91% - Of which deferred bond awards 37% 86% 19% 82% - Of which deferred share awards 63% 14% 81% 18%
Reconciliation of variable compensation awards to income statement charge £m £m £m
Variable compensation awarded 576 679 789 Less: deferral of charge for amounts awarded for current year (245) (262) (298) Income statement charge for amounts awarded in current year 331 417 491
4 Pensions The Group sponsors a number of pension schemes in the UK and overseas whose assets are independent of the Group’s finances.
The Royal Bank of Scotland Group Pension Fund (the “Main scheme”) operates under UK trust law and is managed and administered on behalf of its members in accordance with the terms of the trust deed, the scheme rules and UK legislation (principally the Pension Schemes Act 1993, the Pensions Act 1995 and the Pensions Act 2004). Under UK legislation a defined benefit pension scheme is required to meet the statutory funding objective of having sufficient and appropriate assets to cover its liabilities. Pension fund trustees are required to: prepare a statement of funding principles; obtain regular actuarial valuations and reports; put in place a recovery plan addressing any funding shortfall; and send regular summary funding statements to members of the scheme.
The sterling yield curve (applied to 92% of the Group’s defined benefit obligations) is constructed by reference to yields on ‘AA’ corporate bonds from which a single discount rate is derived based on a cash flow profile similar in structure and duration to the pension obligations. Significant judgement is required when setting the criteria for bonds to be included in the population from which the yield curve is derived. The criteria include issue size, quality of pricing and the exclusion of outliers. Judgement is also required in determining the shape of the yield curve at long durations: a constant credit spread relative to gilts is assumed.
Prior to 2012 the discount rate was determined by reference to the upper quartile yield on the iBoxx over 15 year sterling corporate bond index, less a margin determined by reference to the shape of the yield curve and the spread of yields among the index’s constituents.
Discount rates for other currencies are derived using a variety of methodologies. In the case of US dollar defined benefit obligations, a matching portfolio of high-quality ‘AA’ corporate bonds is used for the first 30 years’ cash flows; cash flows beyond 30 years are discounted using a yield curve determined in a similar way to the UK. For euro defined benefit obligations, a similar approach to the UK has been used at 31 December 2013. However, at longer durations, rates are derived by extrapolating yields on ‘A’ and ‘AAA’ corporate bonds to derive equivalent ‘AA’ yields. Prior to 2012, extrapolation was not used at longer durations and different criteria were used to determine the reference pool of ‘AA’ bonds.
Unquoted assets Corporate and other bonds 2.1 1.6 0.8 1.9 1.5 0.7 Hedge funds 5.2 2.2 2.5 5.1 2.5 2.4 Real estate 4.0 4.3 3.5 4.0 4.2 3.6 Derivatives 3.0 2.2 2.4 2.8 2.0 2.1 Cash and other assets 6.0 8.7 13.8 7.1 9.0 13.7 Equity exposure of equity futures 8.0 9.0 17.7 8.0 8.4 15.7 Cash exposure of equity futures (7.7) (8.9) (17.5) (7.7) (8.4) (15.0)
Inflation rate swaps 6,273 258 141 5,474 20 335 2,585 67 178 Interest rate swaps 22,108 3,283 2,867 19,304 3,424 2,811 15,149 2,232 1,864 Total return swaps 187 1 — 515 6 — 2,085 169 — Currency swaps 2,196 813 720 2,539 326 259 2,861 116 117 Credit default swaps 900 13 16 709 11 12 238 6 — Equity and bond futures 1,904 71 2 2,109 16 17 3,745 80 10 Currency forwards 9,182 66 — 8,551 41 — 2,078 8 — Equity and bond call options 4,102 108 63 963 94 — 814 67 4 Equity and bond put options 4,071 11 90 963 13 31 665 11 —
Present value Present value Fair value of defined Fair value of defined of plan benefit Net pension of plan benefit Net pension assets obligation deficit assets obligation deficit
Currency translation and other adjustments — — — (65) (77) (12) Income statement Expected return 1,028 (1,028) 1,211 (1,211)
Statement of comprehensive income - Experience gains and losses 301 232 (69) 485 207 (278) - Actuarial gains and losses due to changes in financial assumptions — 1,750 1,750 — 2,402 2,402 - Actuarial gains and losses due to changes in demographic assumptions — 6 6 — 34 34
Contributions by plan participants and other scheme members — — — 10 10 —
Assets and obligations extinguished on settlements — — — (360) (360) — Transfer to disposal groups — — — (64) (61) 3
Currency translation and other adjustments — — — 1 14 13 Income statement Expected return 1,011 (1,011) 1,173 (1,173)
4 Pensions continued The pension charge to the income statement comprises: *Restated
Experience gains/(losses) on plan liabilities 102 (232) (208) (858) 135 176 (207) (200) (882) 328 Experience gains on plan assets 986 301 935 1,830 1,065 1,097 485 842 1,941 1,382 Actual return on pension schemes assets 1,997 1,329 1,966 2,779 2,002 2,270 1,696 2,065 3,170 2,875 Actual return on pension schemes assets - % 8.9% 6.3% 10.3% 16.7% 13.5% 8.6% 6.8% 9.1% 11.4% 11.2%
5 Auditor’s remuneration Amounts paid to the Group's auditors for statutory audit and other services are set out below. All audit-related and other services are approved by the Group Audit Committee and are subject to strict controls to ensure the external auditor’s independence is unaffected by the provision of other services. The Group Audit Committee recognise that for certain assignments the auditors are best placed to perform the work economically; for other work the Group selects the supplier best placed to meet its requirements. The Group’s auditors are permitted to tender for such work in competition with other firms where the work is permissible under audit independence rules.
Taxation compliance services 0.2 0.2 Taxation advisory services 0.1 0.1 Other assurance services 2.3 2.2 Corporate finance services (2) 0.8 5.7 Consulting services 0.2 1.5 Total other services 3.6 9.7
Fees payable to the auditor and its associates in respect of audits of associated pension schemes 0.5 0.5 Total 34.0 43.2
- regulatory and legal actions (144) (93) — - employee share schemes (11) (9) (113)
Non-cumulative preference shares of US$0.01 226 153 — Non-cumulative preference shares of €0.01 121 115 — Non-cumulative preference shares of £1 2 5 —
Paid-in equity holders Interest on securities classified as equity, net of tax 49 28 — Total (1) 398 301 —
9 Earnings per ordinary and equivalent B share Earnings per ordinary and equivalent B share have been calculated based on the following: Earnings
Loss attributable to ordinary and B shareholders (8,995) (6,055) (2,151) (Profit)/loss from discontinued operations attributable to ordinary and B shareholders (111) 60 (306) Loss from continuing operations attributable to ordinary and B shareholders (9,106) (5,995) (2,457)
10 Financial instruments - classification The following tables analyse the Group’s financial assets and liabilities in accordance with the categories of financial instruments in IAS 39 with assets and liabilities outside the scope of IAS 39 shown separately.
Held-for- through profit Hedging Available- Loans and instruments Finance assets/ trading or loss derivatives for-sale receivables (amortised cost) leases liabilities Total 2013 £m £m £m £m £m £m £m £m £m
Cash and balances at central banks — — — 79,290 79,290 Loans and advances to banks - reverse repos 33,394 — — 1,389 34,783
Loans and advances to customers - reverse repos 70,025 — — 22 70,047
Settlement balances — — 5,878 5,878 Short positions 27,591 — 27,591
Cash and balances at central banks — — — 79,269 79,269 Loans and advances to banks - reverse repos 34,659 — — 4,781 39,440
Loans and advances to customers - reverse repos 53,584 — — 7,910 61,494
Intangible assets 14,858 14,858 Property, plant and equipment 11,868 11,868 Deferred tax 3,878 3,878 Prepayments, accrued income and other assets — — — 1,309 9,667 10,976 Assets of disposal groups 25,450 25,450
Settlement balances — — 7,477 7,477 Short positions 41,039 — 41,039
Accruals, deferred income and other liabilities — — 1,683 19 21,502 23,204 Retirement benefit liabilities 2,239 2,239 Deferred tax 1,945 1,945 Insurance liabilities 6,233 6,233
Amounts included in the consolidated income statement: (Losses)/gains on financial assets/liabilities designated as at fair value through profit or loss (113) (2,612) 1,761 (Losses)/gains on disposal or settlement of loans and receivables (248) (76) 59
IFRS agreement/similar Cash Other financial netting arrangements Gross offset Balance sheet agreements collateral collateral and related collateral
Derivatives 545,867 (265,709) 280,158 (242,836) (24,288) (5,990) 7,044 Reverse repurchase agreements 115,715 (40,658) 75,057 (11,379) — (63,589) 89 Loans to customers 3,438 (3,438) — — — — — Settlement balances 2,950 (2,672) 278 (262) — — 16 667,970 (312,477) 355,493 (254,477) (24,288) (69,579) 7,149
Gross offset Balance sheet agreement collateral collateral and related collateral 2011 £m £m £m £m £m £m £m
Amount recognised in Amount that Reduction/ the income statement would have been (increase) in Impairment recognised had profit or loss
Carrying Fair (losses) reclassification as a result of value value Income /releases not occurred reclassification 2013 £m £m £m £m £m £m
Reclassified from AFS to LAR (2) Debt securities — — 4 7 — (11)
Carrying Fair releases/ reclassification as a result of value value Income (losses) not occurred reclassification 2012 £m £m £m £m £m £m
Reclassified from HFT to AFS (1) Debt securities 1,548 1,548 (158) (20) 25 203
Valuation models are subject to a review process which requires different levels of model documentation, testing and review, depending on the complexity of the model and the size of the Group's exposure. A key element of the control environment for model use is a Modelled Product Review Committee, made up of valuations experts from several functions within the Group. This committee sets the policy for model documentation, testing and review, and prioritises models with significant exposure for review by the Group's Quantitative Research Centre (QuaRC). Potential valuation uncertainty is a key input in determining model review priorities at these meetings. The QuaRC team within Group Risk, which is independent of the trading businesses, assesses the appropriateness of the application of the model to the product, the mathematical robustness of the model, and where appropriate, considers alternative modelling approaches.
The Management Valuation Control Committees meet formally on a monthly basis to discuss independent pricing, reserving and valuation issues relating to both Markets and Non-Core exposures. All material methodology changes require review and ratification by these committees. The committees, which include valuation specialists representing several independent review functions, comprise Market Risk, QuaRC, Finance and senior business representatives.
The Group Executive Valuation Committee discusses the issues escalated by the Modelled Product Review Committee, Markets and NonCore Management Valuations Control Committees and other relevant issues. This committee covers key material and subjective valuation issues within the trading businesses and provides a ratification to the appropriateness of areas with high levels of residual valuation uncertainty. Committee members include the Group Finance Director, the Group Chief Accountant, the Group Head of Market Risk, the Markets Chief Financial Officer, the Non-Core Chief Financial Officer, the Head of QuaRC, the Head of GPU and representation from Front Office Trading and Finance.
Initial classification of a financial instrument is carried out by the Business Unit Control team following the principles in IFRS. The Business Unit Control team base their judgment on information gathered during the IPV process for instruments which include the sourcing of independent prices and model inputs. The quality and completeness of the information gathered in the IPV process gives an indication as to the liquidity and valuation uncertainty of an instrument.
Valuation techniques The Group derives fair value of its instruments differently depending on whether the instrument is a non-modelled or a modelled product.
• Foreign currency exchange rates - there are observable markets both for spot and forward contracts and futures in the world's major currencies.
Where unobservable inputs are used, the Group may determine a range of possible valuations derived from differing stress scenarios to determine the sensitivity associated with the valuation. When establishing the fair value of a financial instrument using a valuation technique, the Group considers adjustments to the modelled price which market participants would make when pricing that instrument. Such adjustments include the credit quality of the counterparty and adjustments to compensate for model limitations.
Credit valuation adjustments Credit valuation adjustments represent an estimate of the adjustment to fair value that a market participant would make to incorporate the counterparty credit risk inherent in derivative exposures.
Credit valuation adjustments - monoline insurers and credit derivative product companies (CDPC) 99 506 2,232 - other counterparties 1,667 2,308 2,254 1,766 2,814 4,486 Other valuation reserves - bid-offer 513 625 806 - funding valuation adjustment 424 475 552 - product and deal specific 745 763 1,040 - other 8 134 306 1,690 1,997 2,704 Valuation reserves 3,456 4,811 7,190
AAA 104 AA to AA+ 13 A to AA- 168 BBB- to A- 446 Non-investment grade 936 1,667 Sector: Banks 89 Other financial institutions 199 Corporate 1,126 Government 253 1,667
• Other counterparties: the decrease in CVA during the year was driven by tighter credit spreads, reduction in exposure due to market movements together with realised default losses and reserve releases on certain exposures following restructuring. The net impact of updates to counterparty ratings and recovery rate assumptions also contributed to the decrease. This was partially offset by an increase in CVA due to methodology refinements.
For the majority of trades the gross mark-to-market of the monoline protection is determined directly from the fair value price of the underlying reference instrument. However, for the remainder of the trades the gross mark-to-market is determined using industry standard models.
The CVA methodology uses market implied probability of defaults and internally assessed recovery rates to determine the level of expected loss on monoline exposures of different maturities. The probability of default is calculated with reference to market observable credit spreads and recovery levels. CVA is calculated at a trade level by applying the expected loss corresponding to each trade’s expected maturity, to the gross mark-to-market of the monoline protection. The expected maturity of each trade reflects the scheduled notional amortisation of the underlying reference instruments and whether payments due from the monoline are received at the point of default or over the life of the underlying reference instruments.
Credit derivative product companies (CDPC) A CDPC is a company that sells protection on credit derivatives. CDPCs are similar to monoline insurers, however they are not regulated as insurers. The Group's exposure to CDPCs is predominantly due to tranched credit derivatives (“tranches”). A tranche references a portfolio of loans and bonds and provides protection against total portfolio default losses exceeding a certain percentage of the portfolio notional (the attachment point) up to another percentage (the detachment point).
The correlation between exposure and counterparty risk is also incorporated within the CVA calculation where this risk is considered significant. The risk primarily arises on credit derivative trades where the default risk of the referenced entity is correlated with the counterparty risk. The risk also arises on trades with emerging market counterparties where the gross mark-to-market value of the trade, and therefore the counterparty exposure, increases as the strength of the local currency declines.
11 Financial instruments - valuation continued Bid-offer, liquidity and other reserves Fair value positions are adjusted to bid or offer levels, by marking individual cash positions directly to bid or offer or by taking bid-offer reserves calculated on a portfolio basis for derivatives exposures. The bid-offer approach is based on current market spreads and standard market bucketing of risk.
Product related risks such as correlation risk, attract specific bid-offer reserves. Additional reserves are provided for exotic products to ensure overall reserves match market close-out costs. These market close-out costs inherently incorporate risk decay and cross-effects (taking into account how changes in one risk factor may affect other inputs rather than treating all risk factors independently) that are unlikely to be adequately reflected in a static hedge based on vanilla instruments. Where there is limited bid-offer information for a product, the pricing approach and risk management strategy are taken into account when assessing the reserve.
Funding levels are applied to estimated potential future exposures, the modelling of which is consistent with the approach used in the calculation of CVA relating to Other counterparties. The counterparty contingent nature of the exposures is now reflected in the calculation.
Amounts deferred on initial recognition On initial recognition of financial assets and liabilities valued using valuation techniques incorporating information other than observable market data, any difference between the transaction price and that derived from the valuation technique is deferred. Such amounts are recognised in profit or loss over the life of the transaction; when market data becomes observable; or when the transaction matures or is closed out as appropriate. At 31 December 2013, net gains of £205 million (2012 - £153 million; 2011 - £161 million) were carried forward. During the year, net gains of £134 million (2012 - £39 million; 2011 - £89 million) were deferred and £82 million (2012 - £47 million; 2011 - £95 million) recognised in the income statement.
Own credit The Group takes into account the effect of its own credit standing when valuing financial liabilities recorded at fair value in accordance with IFRS. Own credit spread adjustments are made when valuing issued debt held at fair value, including issued structured notes, and derivatives. An own credit adjustment is applied to positions where it is believed that counterparties would consider the Group's creditworthiness when pricing trades.
For issued debt and structured notes this adjustment is based on debt issuance spreads above average inter-bank rates (at a range of tenors). Secondary senior debt issuance spreads are used in the calculation of the own credit adjustment applied to senior debt.
The fair value of the Group's derivative financial liabilities has also been adjusted to reflect the Group's own credit risk (DVA). Expected gains are applied to estimated potential future negative exposures, the modelling of which is consistent with the approach used in calculation of CVA relating to Other counterparties. Expected gains are determined from market implied probabilities of default and recovery levels. Weightings that were previously applied in the expected gains calculation were removed during the period in line with market developments. FVA is also now considered the primary adjustment applied to derivative liabilities; the extent to which DVA and FVA overlap is eliminated from DVA.
The methodology refinements also related to other valuation adjustments, and the impact of the refinements was reported as part of the reported profit or loss for the other valuation adjustments.
The cumulative own credit adjustment (OCA) recorded on securities held-for-trading (HFT), designated as at fair value through profit or loss (DFV) and derivative liabilities are set out below.
• Senior issued debt OCA is determined by reference to secondary debt issuance spreads. The five year spread tightened to 92 basis points (31 December 2012 - 102 basis points; 31 December 2011 - 451 basis points). As senior debt classified as DFV includes greater proportion of longer term debt, the impact of spread tightening and discounting is more significant, resulting in a credit balance at 31 December 2013.
2013 2012 2011 Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total Level 1 Level 2 Level 3 Total £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn
Debt securities Other Government 0.1 — — — — — — — — Corporate 0.3 20 (10) 0.1 10 (10) 0.5 30 (30)
Of which AFS debt securities Corporate 0.1 10 (10) 0.1 10 — 0.2 10 (10)
Of which AFS ABS RMBS 0.1 — — 0.2 10 — 0.2 10 (10)
(6) Transfers between levels are deemed to have occurred at the beginning of the quarter in which the instruments were transferred. (7) Level 1: valued using unadjusted quoted prices in active markets, for identical financial instruments. Examples include G10 government securities, listed equity shares, certain exchange-traded derivatives and certain US agency securities.
The type of instruments that trade in markets that are not considered to be active, but are based on quoted market prices, banker dealer quotations, or alternative pricing sources with reasonable levels of price transparency and those instruments valued using techniques include non-G10 government securities, most government agency securities, investment-grade corporate bonds, certain mortgage products, including CLOs, most bank loans, repos and reverse repos, less liquid listed equities, state and municipal obligations, most notes issued, and certain money market securities and loan commitments and most OTC derivatives.
• The favourable and unfavourable effects of reasonably possible alternative assumptions on level 3 instruments carried at fair value were £0.7 billion (31 December 2012 - £1.0 billion) and £0.5 billion (31 December 2012 - £0.7 billion) respectively.
Level 3 (£bn) Range Financial instruments Assets Liabilities Valuation technique Unobservable inputs Low High
Probability of default (5) 2% 11% Other ABS 0.3 Price based Price (2) 0% 100%
Interest rate 1.4 0.6 Option pricing model Correlation (9) (55%) 100%
(5) Probability of default: This is a measure of the expected rate of losses in an underlying portfolio of mortgages or other receivables. The higher the probability of default the lower the value of the underlying portfolio. The cumulative losses tend to move conversely to prepayment rates and in line with constant default rates. The higher the rate, the higher the expected number of defaults and therefore the expected losses. An increase in the default rate is likely to reduce the value of an asset.
(6) Volatility: A measure of the tendency of a price to change with time. (7) Conditional prepayment rate: The measure of the rate at which underlying mortgages or loans are prepaid. An increase in prepayment rates in a portfolio may increase or decrease its value depending upon the credit quality and payment terms of the underlying loans. For example an increase in prepayment rate of a portfolio of high credit quality underlying assets may reduce the value and size of the portfolio whereas for lower credit quality underlyings it may increase the value.
(8) EBITDA (earnings before interest, tax, depreciation and amortisation) multiple: This is a commonly used valuation technique for equity holdings. The EBITDA of a company is used as a proxy for the future cash flows and when multiplied by an appropriate factor gives an estimate for the value of the company.
(9) Correlation: Measures the degree by which two prices or other variables are observed to move together. If they move in the same direction there is positive correlation; if they move in opposite directions there is negative correlation. Correlations typically include relationships between: default probabilities of assets in a basket (a group of separate assets), exchange rates, interest rates and other financial variables.
The level 3 sensitivities above are calculated at a trade or low level portfolio basis. They are not calculated on an overall portfolio basis and therefore do not reflect the likely overall potential uncertainty on the whole portfolio. The figures are aggregated and do not reflect the correlated nature of some of the sensitivities. In particular, for some of the portfolios the sensitivities may be negatively correlated where a downwards movement in one asset would produce an upwards movement in another, but due to the additive presentation of the above figures this correlation cannot be displayed. The actual potential downside sensitivity of the total portfolio may be less than the noncorrelated sum of the additive figures as shown in the above table.
Judgmental issues The diverse range of products traded by the Group results in a wide range of instruments that are classified into level 3 of the hierarchy. Whilst the majority of these instruments naturally fall into a particular level, for some products an element of judgment is required. The majority of the Group’s financial instruments carried at fair value are classified as level 2: inputs are observable either directly (i.e. as a price) or indirectly (i.e. derived from prices).
Where markets are liquid or very liquid, little judgment is required. However, when the information regarding the liquidity in a particular market is not clear, a judgment may need to be made. This can be made more difficult as assessing the liquidity of a market may not always be straightforward. For an equity traded on an exchange, daily volumes of trading can be seen, but for an over-the counter (OTC) derivative assessing the liquidity of the market with no central exchange can be more difficult.
11 Financial instruments - valuation continued The breadth and depth of this data allows a rules based quality assessment to be made of market activity, liquidity and pricing uncertainty, which assists with the process of allocation to an appropriate level. Where suitable independent pricing information is not readily available, the quality assessment will result in the instrument to be considered as level 3.
As part of the Group’s IPV process, data are gathered at a trade level from market trading activity, trading systems, pricing services, consensus pricing providers, brokers and research material amongst other sources.
Modelled products For modelled products the market convention is to quote these trades through the model inputs or parameters as opposed to a cash price equivalent. A mark-to-market is derived from the use of the independent market inputs calculated using the Group’s model.
Level 3 portfolios and sensitivity methodologies For each of the portfolio categories shown in the tables above, there follows a description of the types of products that comprise the portfolio and the valuation techniques that are applied in determining fair value, including a description of valuation techniques used for levels 2 and 3 and inputs to those models and techniques. Where reasonably possible alternative assumptions of unobservable inputs used in models would change the fair value of the portfolio significantly, the alternative inputs are indicated. Where there have been significant changes to valuation techniques during the year a discussion of the reasons for this are also included.
Overview of sensitivity methodologies Reasonably possible alternative assumptions of unobservable inputs are determined based on a 95% confidence interval. The assessments recognise different favourable and unfavourable valuation movements where appropriate. Each unobservable input within a product is considered separately and sensitivity is reported on an additive basis.
Loans to emerging market counterparties The trades in each loan structure are valued using curves using a proxy methodology. Each curve consists of the independent proxy value and various basis adjustments, such as those relating to loan-CDS basis, credit basis, tenor and liquidity. For the low and high valuation scenarios for the structures, these different bases are flexed within the range that each one is deemed to span. The resultant maximum and minimum scenario curves are used to value the assets and liabilities in the structure separately. The low valuation scenario is the one that minimises the assets and maximises the liabilities. The high valuation scenario is the converse.
Residential mortgages These pools of residential mortgages were mostly acquired for securitisation before the 2008 financial crisis. Factors that affect the value, or liquidation level, of these loans are geographic location, current loan-to-value, condition of the home, and availability of eligible buyers. The loans are serviced by various mortgage servicers. Operations and the Front Office monitor the performance of these loans and the valuations are tested against an estimated recovery level as part of the IPV process. The market for non-agency securitisation remains extremely weak and is restricted to new issue prime loans.
In determining whether an instrument is similar to that being valued, the Group considers a range of factors, principally: the lending standards of the brokers and underwriters that originated the mortgages, the lead manager of the security, the issue date of the respective securities, the underlying asset composition (including origination date, loan to value ratios, historic loss information and geographic location of the mortgages), the credit rating of the instrument, and any credit protection that the instrument may benefit from, such as insurance wraps or subordinated tranches. Where there are instances of market observable data for several similar RMBS tranches, the Group considers the extent of similar characteristics shared with the instrument being valued, together with the frequency, tenor and nature of the trades that have been observed. This method is most frequently used for US and UK RMBS. RMBS of Dutch and Spanish originated mortgages guaranteed by those governments are valued using the credit spreads of the respective government debt and certain assumptions made by the Group, or based on observable prices from Bloomberg or consensus pricing services.
11 Financial instruments - valuation continued Collateralised debt obligations (CDO) CDOs purchased from third-parties are valued using independent, thirdparty quotes or independent lead manager indicative prices. For super senior CDOs which have been originated by the Group no specific thirdparty information is available. The valuation of these super senior CDOs therefore takes into consideration outputs from a proprietary model, market data and appropriate valuation adjustments.
For CLOs originated and still held by the Group, the fair value is determined using a correlation model based on a Monte Carlo simulation. The main model inputs are credit spreads and recovery rates of the underlying assets and their correlation. A credit curve is assigned to each underlying asset based on prices from third party dealer quotes and cash flow profiles, sourced from an industry standard model. Losses are calculated taking into account the attachment and detachment point of the exposure. Where the correlation inputs to this model are not observable, CLOs are classified as level 3.
Other asset-backed and corporate debt securities Where observable market prices for a particular debt security are not available, the fair value will typically be determined with reference to observable market transactions in other related products, such as similar debt securities or credit derivatives. Assumptions are made about the relationship between the individual debt security and available benchmark data. Where significant management judgment has been applied in identifying the most relevant related product, or in determining the relationship between the related product and the instrument itself, the instrument is classified as level 3.
The Group considers that valuations may rely significantly on the judgments and estimates made by the fund managers, particularly in assessing private equity components. Given the decline in liquidity in world markets, and the level of subjectivity, these are included in level 3.
Credit derivatives The Group's other credit derivatives include vanilla and bespoke portfolio tranches, gap risk products and certain other unique trades.
The bespoke portfolio tranches are synthetic tranches referenced to a bespoke portfolio of corporate names on which the Group purchases credit protection. Bespoke portfolio tranches are valued using Gaussian Copula, a standard method which uses observable market inputs (credit spreads, index tranche prices and recovery rates) to generate an output price for the tranche by way of a mapping methodology. In essence this method takes the expected loss of the tranche expressed as a fraction of the expected loss of the whole underlying portfolio and calculates which detachment point on the liquid index, and hence which correlation level, coincides with this expected loss fraction. Where the inputs to this valuation technique are observable in the market, bespoke tranches are considered to be level 2 assets. Where inputs are not observable, bespoke tranches are considered to be level 3 assets. However, all transactions executed with a CDPC counterparty are considered level 3 as the credit valuation adjustment applied to these exposures is a significant component of these valuations.
Exotic valuation inputs include the correlation between interest rates, foreign exchange rates and commodity prices. Correlations for more liquid rate pairs are valued using independently sourced consensus pricing levels. Where a consensus pricing benchmark is unavailable, these instruments are classified as level 3.
Funding related adjustments The discount rates applied to derivative cash-flows in determining fair value reflect any underlying collateral agreements. Collateralised derivative exposures are generally discounted at the relevant OIS rates whilst funding valuation adjustments are applied to uncollateralised derivative exposures. Whilst these adjustments reference certain inputs which are not based on observable market data, these inputs are not considered to have a significant effect on the valuation of the individual trades. The classification of derivatives is not determined by the observability of these adjustments, and any related sensitivity does not form part of the level 3 sensitivities presented.
Amount recorded in the Level 3 transfers Foreign Income statement on At Income exchange At balances at year end 1 January statement (1) SOCI (2) In Out Purchases Issuances Settlements Sales and other 31 December Unrealised Realised 2013 £m £m £m £m £m £m £m £m £m £m £m £m £m
Of which ABS - FVTPL (3) 1,304 162 — 576 (32) 1,050 — (188) (1,515) (7) 1,350 (23) 29 - AFS 5,622 (12) 86 317 (457) 36 — (995) (1,778) (4) 2,815 (131) 34
Debt securities in issue 2,199 158 — 9 (1) — 530 (1,521) — (11) 1,363 169 — Short positions 291 (269) — — — 3 — — (23) — 2 — — Derivatives 3,811 (375) — 877 (513) 161 12 (636) 24 (44) 3,317 (593) — 6,323 (399) — 936 (514) 171 542 (2,157) 1 (53) 4,850 (346) (2)
At Income exchange At Income statement on 1 January statement (1) SOCI (2) In Out Purchases Issuances Settlements Sales and other 31 December balances at year end 2011 £m £m £m £m £m £m £m £m £m £m £m £m
Notes: (1) Net losses on HFT instruments of £543 million (2012 - £1,528 million; 2011 - £860 million) and net gains on other instruments of £11 million (2012 - £141 million; 2011 - £143 million) were recorded in other operating income, interest income and impairment losses as appropriate. (2) Consolidated statement of comprehensive income. (3) Fair value through profit or loss comprises held-for-trading predominantly and designated at fair value through profit of loss.
Fair value approximates Carrying Fair value of hierarchy level carrying value value Fair value Level 2 Level 3 2013 £bn £bn £bn £bn £bn
Cash and balances at central banks 82.7 Loans and advances to banks - items in the course of collection from other banks 1.5 - other 16.8 16.8 6.0 10.8 Loans and advances to customers UK Retail 111.0 110.3 UK Corporate 99.7 96.4 Wealth 16.6 16.6 International Banking 35.5 35.1 Ulster Bank 26.1 20.5 US Retail & Commercial 49.3 49.5 Markets and other 11.7 11.0 Non-Core 21.7 20.6 Total loans and advances to customers 371.6 360.0 13.5 346.5
Financial liabilities Deposits by banks - items in the course of transmission to other banks 0.8 - other 20.3 20.3 6.9 13.4 Customer accounts - demand deposits 268.7 - other 133.8 134.0 89.4 44.6 Debt securities in issue 43.4 44.7 40.5 4.2 Settlement balances 5.3 Notes in circulation 1.8 Subordinated liabilities 23.1 22.5 22.3 0.2
Financial assets Cash and balances at central banks 79.3 79.3 79.3 79.3 Loans and advances to banks 17.3 17.3 28.3 28.2 Loans and advances to customers 405.1 385.4 436.2 406.3 Debt securities 4.5 4.0 6.1 5.5 Settlement balances 5.7 5.7 7.8 7.8
Financial liabilities Deposits by banks 34.5 34.5 51.3 50.7 Customer accounts 420.7 421.0 417.5 417.6 Debt securities in issue 60.1 59.8 115.4 112.7 Settlement balances 5.9 5.9 7.5 7.5 Notes in circulation 1.7 1.7 1.7 1.7 Subordinated liabilities 25.6 24.3 25.4 19.2
The assumptions and methodologies underlying the calculation of fair values of financial instruments at the balance sheet date are as follows: For certain short-term financial instruments: cash and balances at central banks, items in the course of collection from other banks, settlement balances, items in the course of transmission to other banks, customer demand deposits and notes in circulation, fair value approximates to carrying value.
Debt securities in issue and subordinated liabilities Fair values are determined using quoted prices where available or by reference to valuation techniques, adjusting for own credit spreads where appropriate.
12 Financial instruments - maturity analysis Remaining maturity The following table shows the residual maturity of financial instruments, based on contractual date of maturity.
Less than More than Less than More than Less than More than 12 months 12 months Total 12 months 12 months Total 12 months 12 months Total £m £m £m £m £m £m £m £m £m
Assets and liabilities by contractual cash flow maturity The tables below show the contractual undiscounted cash flows receivable and payable, up to a period of 20 years, including future receipts and payments of interest of financial assets and liabilities by contractual maturity. The balances in the following tables do not agree directly with the consolidated balance sheet, as the tables include all cash flows relating to principal and future coupon payments, presented on an undiscounted basis. The tables have been prepared on the following basis: Financial assets have been reflected in the time band of the latest date on which they could be repaid, unless earlier repayment can be demanded by the Group. Financial liabilities are included at the earliest date on which the counterparty can require repayment, regardless of whether or not such early repayment results in a penalty. If the repayment of a financial instrument is triggered by, or is subject to, specific criteria such as market price hurdles being reached, the asset is included in the time band that contains the latest date on which it can be repaid, regardless of early repayment.
Cash and balances at central banks 82,659 — — — — — Loans and advances to banks 16,096 1,876 279 4 74 5 Debt securities 3,078 5,044 10,667 11,310 14,189 7,238 Settlement balances 5,591 — — — — — Total maturing assets 107,424 6,920 10,946 11,314 14,263 7,243 Loans and advances to customers 70,511 48,027 84,836 65,542 74,296 69,242 Derivatives held for hedging 545 1,282 2,148 427 115 93 178,480 56,229 97,930 77,283 88,674 76,578
For the notes relating to this table refer to page 436.
Maturity gap 60,630 (12,613) (25,521) 2,707 (6,587) 1,533 Cumulative maturity gap 60,630 48,017 22,496 25,203 18,616 20,149
12 Financial instruments - maturity analysis continued 0-3 months 3-12 months 1-3 years 3-5 years 5-10 years 10-20 years 2011 £m £m £m £m £m £m
Cash and balances at central banks 79,269 — — — — — Loans and advances to banks 26,326 1,294 544 121 114 — Debt securities 7,237 9,569 23,137 21,003 39,148 15,869 Settlement balances 7,759 8 — 1 — — Other financial assets 397 158 — 16 738 — Total maturing assets 120,988 11,029 23,681 21,141 40,000 15,869 Loans and advances to customers 97,318 90,894 108,331 55,785 62,085 56,259 Derivatives held for hedging 519 1,556 3,438 1,695 596 138 218,825 103,479 135,450 78,621 102,681 72,266
Transfers (to)/from disposal groups — — (9) (9) 764 (773) Currency translation and other adjustments 77 36 8 121 (310) (283)
Recoveries of amounts previously written-off 95 161 — 256 341 527 Charge to income statement - continuing operations 6,904 1,464 44 8,412 5,315 7,241
13 Financial assets – impairments continued 2013 2012 2011 Impairment losses/(recoveries) charged to the income statement £m £m £m
2013 2012 2011 Carrying Carrying Carrying Cost Provision value Cost Provision value Cost Provision value £m £m £m £m £m £m £m £m £m
Loans and advances to banks (1) 70 63 7 134 114 20 137 123 14 Loans and advances to customers (2) 37,101 23,150 13,951 38,352 19,176 19,176 38,610 17,774 20,836
Carrying Carrying Carrying value value value 2013 2012 2011 £m £m £m
Loans and receivables Debt securities 585 1,008 234 760 1,264 1,164
The following table shows financial and non-financial assets, recognised on the Group's balance sheet, obtained during the year by taking possession of collateral or calling on other credit enhancements.
Residential property 18 67 60 Other property 13 46 73 Cash 44 49 56 Other assets 2 1 2 77 163 191
For cash flow hedge relationships of interest rate risk, the hedged items are actual and forecast variable interest rate cash flows arising from financial assets and financial liabilities with interest rates linked to LIBOR, EURIBOR or the Bank of England Official Bank Rate. The financial assets are customer loans and the financial liabilities are customer deposits and LIBOR linked medium-term notes and other issued securities. At 31 December 2013, variable rate financial assets of £74 billion (2012 - £61 billion; 2011 - £49 billion) and variable rate financial liabilities of £10 billion (2012 - £9 billion; 2011 - £13 billion) were hedged in such cash flow hedge relationships.
The initial and ongoing prospective effectiveness of fair value hedge relationships is assessed on a cumulative basis by comparing movements in the fair value of the hedged item attributable to the hedged risk with changes in the fair value of the hedging interest rate swap. Retrospective effectiveness is assessed by comparing the actual movements in the fair value of the hedged items attributable to the hedged risk with actual movements in the fair value of the hedging derivative over the life to date of the hedging relationship.
2013 2012 2011 Notional Notional Notional amount Assets Liabilities amount Assets Liabilities amount Assets Liabilities £bn £m £m £bn £m £m £bn £m £m
Spot, forwards and futures 2,041 24,495 24,136 2,259 23,237 22,721 2,127 30,249 28,868 Currency swaps 956 18,576 22,846 1,071 22,238 30,223 1,071 25,212 33,541 Options purchased 792 18,852 — 683 17,580 — 640 19,031 — Options written 766 — 18,767 684 — 17,536 641 — 18,571
Interest rate contracts Interest rate swaps 27,483 179,891 172,618 25,474 300,907 286,620 29,976 346,682 333,968 Options purchased 1,568 37,437 — 1,934 61,798 — 2,398 74,600 — Options written 1,513 — 35,410 1,884 — 58,289 2,592 — 71,998 Futures and forwards 5,025 712 669 4,191 749 653 3,756 874 743
Included in the table above are derivatives held for hedging purposes as follows: 2013 2012 2011 Assets Liabilities Assets Liabilities Assets Liabilities £m £m £m £m £m £m
Cash flow hedging Interest rate contracts 2,390 1,602 4,854 1,276 3,985 1,445
Net investment hedging Exchange rate contracts 55 38 6 32 148 148
Hedge ineffectiveness recognised in other operating income comprised: 2013 2012 2011 £m £m £m
Forecast receivable cash flows 303 284 243 206 144 271 — — 1,451 Forecast payable cash flows (33) (22) (18) (15) (14) (64) (101) (19) (286)
Hedged forecast cash flows affect on profit or loss Forecast receivable cash flows 302 281 239 201 138 261 — — 1,422 Forecast payable cash flows (32) (22) (18) (16) (13) (64) (101) (19) (285)
Hedged forecast cash flows affect on profit or loss Forecast receivable cash flows 277 257 225 171 132 180 — — 1,242 Forecast payable cash flows (55) (44) (36) (35) (35) (173) (257) (37) (672)
Central and local government financial Of which UK US Other Banks institutions Corporate Total ABS (1)
Held-for-trading 6,764 10,951 22,794 1,720 12,406 1,947 56,582 10,674 Designated as at fair value through profit or loss — — 104 — 17 1 122 15 Available-for-sale 6,436 12,880 10,303 5,974 17,330 184 53,107 24,174 Loans and receivables 10 1 — 175 3,466 136 3,788 3,423 13,210 23,832 33,201 7,869 33,219 2,268 113,599 38,286
Available-for-sale Gross unrealised gains 201 428 445 70 386 11 1,541 458 Gross unrealised losses (69) (86) (32) (205) (493) (2) (887) (753)
2011 Held-for-trading 9,004 19,636 36,928 3,400 23,160 2,948 95,076 20,816 Designated as at fair value through profit or loss 1 — 127 53 457 9 647 558 Available-for-sale 13,436 20,848 25,552 13,175 31,752 2,535 107,298 40,735 Loans and receivables 10 — 1 312 5,259 477 6,059 5,200 22,451 40,484 62,608 16,940 60,628 5,969 209,080 67,309
Gross gains of £3 million (2012 - £78 million; 2011 - £87 million) and gross losses of nil (2012 - £12 million; 2011 - £34 million) were realised on the sale of available-for-sale securities in discontinued operations.
Within 1 year After 1 but within 5 years After 5 but within 10 years After 10 years Total Amount Yield Amount Yield Amount Yield Amount Yield Amount Yield 2013 £m % £m % £m % £m % £m %
Central and local governments - UK 251 4.4 1,792 2.3 3,167 3.0 1,226 3.4 6,436 2.9 - US 896 1.7 6,011 2.7 2,892 2.7 3,081 2.4 12,880 2.6 - other 2,347 1.3 4,417 2.7 1,745 2.5 1,794 3.7 10,303 2.5 Banks 2,071 1.1 3,284 1.2 438 3.7 181 1.9 5,974 1.4 Other financial institutions 1,013 1.7 3,416 2.4 3,950 2.8 8,951 1.8 17,330 2.1 Corporate 1 0.1 69 1.3 114 6.9 - - 184 4.8 6,579 1.5 18,989 2.3 12,306 2.9 15,233 2.3 53,107 2.3
16 Equity shares 2013 2012 2011 Listed Unlisted Total Listed Unlisted Total Listed Unlisted Total £m £m £m £m £m £m £m £m £m
Dividend income from available-for-sale equity shares was £87 million (2012 - £59 million; 2011 - £54 million).
17 Intangible assets Core Other Internally deposit purchased generated Goodwill intangibles intangibles software Total 2013 £m £m £m £m £m
Accumulated amortisation and impairment At 1 January 14,022 83 596 3,060 17,761 Transfers to disposal groups — — (9) (1) (10) Currency translation and other adjustments 62 13 (37) (10) 28 Disposals and write-off of fully amortised assets — (1) (10) (1,221) (1,232) Charge for the year - continuing operations — 31 122 404 557 Write-down of goodwill and other intangible assets - continuing operations 1,059 49 80 215 1,403 At 31 December 15,143 175 742 2,447 18,507
Goodwill intangibles intangibles software Total 2011 £m £m £m £m £m
Accumulated amortisation and impairment At 1 January 14,611 462 1,822 3,441 20,336 Transfers to disposal groups (80) — — — (80) Currency translation and other adjustments (203) (5) (55) 13 (250) Disposals and write-off of fully amortised assets — — — (220) (220) Charge for the year - continuing operations — 38 184 363 585 - discontinued operations — — — 23 23 Write-down of goodwill and other intangible assets - continuing operations 80 — — — 80 - discontinued operations 11 — — — 11 At 31 December 14,419 495 1,951 3,620 20,485
Direct Line Group was reclassified as a disposal group in 2012 and its goodwill was assessed as part of its fair value at 31 December 2012.
The results of the annual impairment test for 2011 are presented using the Group's 2011 reportable segments which differ as a result of the changes to the Group’s structure implemented during 2012. The change in reportable segments in 2012 did not impact the impairment tests performed in 2011.
At 1 January 3,111 2,998 289 1,732 4,606 3,325 16,061 Transfers to disposal groups (26) (30) — (12) (45) — (113) Currency translation and other adjustments 34 (10) (2) (15) (42) (1) (36) Reclassifications — 5 — 4 (9) — — Additions 121 49 9 102 411 60 752 Expenditure on investment properties 13 — — — — — 13 Change in fair value of investment properties (281) — — — — — (281) Disposals and write-off of fully depreciated assets (339) (34) (10) (79) (677) (1,485) (2,624)
Net book value at 31 December 2,633 2,015 117 752 1,263 1,129 7,909 2012 Cost or valuation
Disposals and write-off of fully depreciated assets (1,425) (85) (37) (177) (83) (916) (2,723)
Accumulated impairment, depreciation and amortisation At 1 January — 736 114 850 3,035 1,187 5,922 Transfers from/(to) disposal groups — 43 6 66 (65) — 50 Currency translation and other adjustments — (9) 11 (114) (157) (21) (290) Reclassifications — (7) 7 — — — — Write down of property, plant and equipment — 9 7 1 — — 17 Disposals and write-off of fully depreciated assets — (15) (4) (16) (36) (462) (533) Charge for the year - continuing operations — 94 10 137 438 418 1,097 - discontinued operations — 1 — — 13 — 14 At 31 December — 852 151 924 3,228 1,122 6,277
Accumulated impairment, depreciation and amortisation At 1 January — 702 118 793 2,700 1,849 6,162 Transfers to disposal groups — (43) (6) (66) (26) (730) (871) Currency translation and other adjustments — 6 4 (1) (28) 15 (4) Reclassifications — 3 (9) 7 — (1) — Write down of property, plant and equipment — — 3 1 1 — 5 Disposals and write-off of fully depreciated assets — (29) — (32) (110) (466) (637) Charge for the year - continuing operations — 95 4 148 487 520 1,254 - discontinued operations — 2 — — 11 — 13 At 31 December — 736 114 850 3,035 1,187 5,922
Investment property valuations principally employ present value techniques that discount expected cash flows. Expected cash flows reflect rental income, occupancy and residual market values; valuations are sensitive to changes in these factors. The fair value measurement of non-specialised properties in locations where the market for such properties is active and transparent are categorised as level 2 (46%); otherwise investment property fair value measurements are categorised as level 3 (54%).
Rental income from investment properties was £244 million (2012 - £267 million; 2011 - £270 million). Direct operating expenses of investment properties were £91 million (2012 - £125 million; 2011 - £110 million).
Property, plant and equipment, excluding investment properties, include £42 million (2012 - £35 million; 2011 - £186 million) assets in the course of construction.
On 20 September 2013, the Group sold a further 20% of ordinary shares in DLG and at 31 December held 28.5% of the issued ordinary share capital of DLG.
Net premium income 699 3,718 4,256 Other income 62 (16) 30 Total income 761 3,702 4,286 Operating expenses (171) (1,406) (892) Profit before insurance net claims and impairment losses 590 2,296 3,394 Insurance net claims (445) (2,427) (2,968) Impairment losses — — (2) Operating profit/(loss) before tax 145 (131) 424 Tax charge (18) (53) (123) Profit/(loss) after tax from discontinued general insurance business 127 (184) 301
Cash and balances at central banks 2 18 127 Loans and advances to banks 63 2,112 87 Loans and advances to customers 1,765 1,863 19,405 Debt securities and equity shares 24 7,191 5 Derivatives 1 15 439 Intangible assets 30 750 15 Settlement balances — — 14 Property, plant and equipment 32 223 4,749 Interests in associates 879 — — Other assets 58 1,666 456 Discontinued operations and other disposal groups 2,854 13,838 25,297 Assets acquired exclusively with a view to disposal 163 175 153 3,017 14,013 25,450
Liabilities of disposal groups Deposits by banks — 1 1 Customer accounts 3,273 753 22,610 Derivatives 1 7 126 Settlement balances — — 8 Insurance liabilities — 6,193 — Subordinated liabilities — 529 — Other liabilities 102 2,679 1,233 Discontinued operations and other disposal groups 3,376 10,162 23,978 Liabilities acquired exclusively with a view to disposal 2 8 17 3,378 10,170 23,995
20 Discontinued operations and assets and liabilities of disposal groups continued DLG is included in disposal groups at 31 December 2013 and 2012.
Allocated goodwill of £80 million was written off against operating expenses in respect of the UK branch-based businesses. No adjustment was made in respect of the RBS Aviation Capital business.
The Group’s interest in DLG at 31 December 2013 is recognised under equity accounting, being the fair value of its share of net equity on 13 March 2013 plus the subsequent attributable comprehensive income, less the dividends received by the Group, less the share of net assets attributable to the subsequent disposal on 20 September 2013. At 31 December 2012, DLG’s carrying amount exceeded its fair value less costs to sell (based on the quoted price for DLG shares on 31 December 2012) by £394 million and goodwill attributable to DLG was written down by this amount. The write down was recorded in other expenses within discontinued operations.
Notes in circulation 1,759 1,684 1,683 Current tax 516 527 700 Accruals 3,116 3,579 4,941 Deferred income 589 875 3,481 Provisions for liabilities and charges (see table below) 5,489 3,147 1,311 Other liabilities (1) 4,548 4,989 11,088 16,017 14,801 23,204 Note: (1) Other liabilities include £25 million (2012 - £24 million; 2011 - £15 million) in respect of share-based compensation.
Payment Interest Rate Other Other Technology Protection Hedging customer regulatory incident
The table below shows the sensitivity of the provision to changes in the principal assumptions (all other assumptions remaining the same).
Take up rate 36% 38% +/-5 +/-45 Uphold rate (1) 84% 83% +/-5 +/-30 Average redress £1,733 £1,646 +/-5 +/-26 Note: (1) Uphold rates exclude claims where no PPI policy was held.
The principal assumptions underlying the Group’s provision are: • the proportion of relevant customers that will not opt in to the review • the number of transactions that qualify for redress • the nature of the redress (in particular whether a product is terminated or replaced with an alternative product and/or a different profile) • the cost of the review
Proportion of relevant customers that will not opt in to the review +/-5 +/-47 Proportion of customer transactions qualifying for redress +/-5 +/-71 Average redress +/-5 +/-71
(4) On 6 February 2013, the Group reached agreement with the FSA, the US Department of Justice and the Commodity Futures Trading Commission in relation to the setting of LIBOR and other trading rates, including financial penalties of £381 million and a provision for this amount was recognised in 2012. The Group continues to cooperate with other governmental and regulatory authorities and, as a result of progress on these matters in 2013, the provision was increased by £315 million. For further details see Note 32.
(6) Arising out of its normal business operations, the Group is party to legal proceedings in the United Kingdom, the United States and other jurisdictions. Litigation provisions at 31 December 2012 related to a number of proceedings; no individual provision was material. An additional charge of £2,050 million was recorded in 2013 as a result of greater levels of certainty on expected outcomes, primarily in respect of matters relating to mortgage-backed securities and securities-related litigation following third party litigation settlements and regulatory decisions. Detailed descriptions of the Group’s legal proceedings and discussion of the associated uncertainties are given in Note 32.
(7) In June 2012, the Group experienced a technology incident that affected its transaction batch processing. Provisions of £175 million were charged during 2012 to meet the waiver of fees and interest; redress for customers of the Group; and other costs principally staff costs. These costs have now been settled.
Deferred tax liability 507 1,141 1,945 Deferred tax asset (3,478) (3,443) (3,878) Net deferred tax asset (2,971) (2,302) (1,933)
Net deferred tax asset comprised: Fair Available- Tax Accelerated value of for-sale Cash losses capital Deferred IFRS financial financial flow Share carried Pension allowances Provisions gains transition instruments assets Intangibles hedging schemes forward Other Total £m £m £m £m £m £m £m £m £m £m £m £m £m
(Disposal)/acquisition of subsidiaries — (21) 5 — — — — — — — — — (16) Charge/(credit) to income statement - continuing operations 60 (445) (439) (60) 68 16 (60) 4 54 1 1,086 (89) 196 Charge/(credit) to other comprehensive income 245 — (3) — — — (93) — (633) (1) (348) (3) (836) Currency translation and other adjustments — (20) 25 2 1 (5) 3 (5) 3 — (3) (14) (13)
UK tax losses carried forward - The Royal Bank of Scotland plc 1,693 2,654 2,623 - UK branch of RBS N.V. — 322 166 - National Westminster Bank Plc 718 66 93 - RBS Management Services (UK) Ltd — 30 51 2,411 3,072 2,933 Overseas tax losses carried forward - Ulster Bank Ireland 74 72 284 - RBS Citizens Financial Group 11 87 — - RBS N.V. Australia — — 77 85 159 361 2,496 3,231 3,294
National Westminster Bank Plc - the deferred tax asset in respect of tax losses at 31 December 2013 relates to residual unrelieved trading losses that arose between 2009 and 2013. 60% of the losses that arose were relieved against taxable profits arising in other UK Group companies. Based on the Group’s strategic plan, the residual carried forward losses will be fully utilised against future taxable profits of the company by the end of 2018. A 20% reduction in forecast profits would extend the recovery period by one year.
Overseas tax losses Ulster Bank Ireland - a deferred tax asset has been recognised in respect of £592 million of total tax losses of £11,575 million carried forward at 31 December 2013. These losses arose principally as a result of significant impairment charges reflecting deteriorating economic conditions in the Republic of Ireland. Impairment charges are expected to reduce in the future. Based on the Group’s strategic plan, the losses on which a deferred tax asset has been recognised will be utilised against future taxable profits of the company by the end of 2018. A 20% reduction in forecast profits would extend the recovery period by one year.
Unrecognised deferred tax Deferred tax assets of £4,942 million (2012 - £3,827 million; 2011 - £3,246 million) have not been recognised in respect of tax losses carried forward of £28,099 million (2012 - £20,432 million; 2011 - £16,691 million) in jurisdictions where doubt exists over the availability of future taxable profits. Of these losses, £187 million expire within one year, £1,901 million within five years and £8,673 million thereafter. The balance of tax losses carried forward has no time limit.
Deferred tax liabilities of £186 million (2012 - £214 million; 2011 - £249 million) have not been recognised in respect of retained earnings of overseas subsidiaries and held-over gains on the incorporation of overseas branches. Retained earnings of overseas subsidiaries are expected to be reinvested indefinitely or remitted to the UK free from further taxation. No taxation is expected to arise in the foreseeable future in respect of held-over gains. Changes to UK tax legislation largely exempts overseas dividends received on or after 1 July 2009 from UK tax.
Sterling 1 103 695 290 518 59 198 1,864 US dollar 3,084 2,701 426 1,849 3,447 848 10 12,365 Euro 326 1,267 657 4,098 560 166 51 7,125 Other 761 1,230 292 375 — — — 2,658 4,172 5,301 2,070 6,612 4,525 1,073 259 24,012 2013 2014 2015-2017 2018-2022 Thereafter Perpetual Total 2012 - final redemption £m £m £m £m £m £m £m
Sterling 24 429 60 826 715 36 212 2,302 US dollar 2,577 3,546 664 1,767 2,408 1,009 — 11,971 Euro — 3,509 289 2,863 2,427 397 45 9,530 Other — 1,192 — 1,214 564 — — 2,970 2,601 8,676 1,013 6,670 6,114 1,442 257 26,773 2012 2013 2014-2016 2017-2021 Thereafter Perpetual Total 2011 - final redemption £m £m £m £m £m £m £m
The Royal Bank of Scotland plc €1,000 million 6% subordinated notes (redeemed May 2013) Lower Tier 2 — 869 921 US$50 million floating rate subordinated notes (redeemed October 2013) Lower Tier 2 — 36 37 €500 million 6% subordinated notes (redeemed May 2013) Lower Tier 2 — 415 426 £150 million 10.5% subordinated bonds (redeemed March 2013) Lower Tier 2 — 164 171 AUD397 million (2011 - AUD590 million) floating rate subordinated notes 2014 (callable quarterly from October 2009) (2) Lower Tier 2 216 257 392 AUD265 million (2011 - AUD410 million) floating rate subordinated notes 2014 (callable quarterly from October 2009) (2) Lower Tier 2 144 171 272 CAD217 million (2011 - CAD700 million) floating rate subordinated notes 2015 (callable quarterly from March 2010) (2) Lower Tier 2 123 135 444 £250 million 9.625% subordinated bonds 2015 Lower Tier 2 287 289 297 US$322 million (2011 - US$750 million) floating rate Bermudian callable subordinated notes 2015 (callable quarterly from September 2010) (2) Lower Tier 2 195 199 485 €750 million 4.875% subordinated notes 2015 Lower Tier 2 678 688 709
First Active plc £60 million floating rate subordinated bonds 2018 Lower Tier 2 60 63 64
RBS NV and subsidiaries €250 million floating rate subordinated notes 2019 Lower Tier 2 221 199 136 €100 million 5.13% flip flop Bermudan callable subordinated notes (redeemed July 2013) Lower Tier 2 — 72 78 €13 million zero coupon subordinated notes (redeemed July 2013) Lower Tier 2 — 11 14 €170 million floating rate sinkable subordinated notes 2041 Lower Tier 2 167 166 81 €15 million CMS linked floating rate subordinated notes 2020 Lower Tier 2 12 10 7 €415 million (2012 and 2011 - €1,500 million) floating rate Bermudan subordinated notes 2015 (callable quarterly from June 2010, partially redeemed June 2013) Lower Tier 2 344 1,215 1,246 €5 million floating rate Bermudan callable subordinated notes 2015 (callable quarterly from October 2010) Lower Tier 2 4 4 4 US$120 million (2011 - US$165 million) 6.14% subordinated notes 2019 Lower Tier 2 75 75 76 US$72 million 5.98% subordinated notes 2019 Lower Tier 2 36 57 47 US$500 million 4.65% subordinated notes 2018 Lower Tier 2 324 347 354 US$564 million ( 2012 and 2011 - US$1,500 million) floating rate Bermudan subordinated notes 2015 (callable quarterly from March 2010, partially redeemed March 2013) Lower Tier 2 340 892 930 AUD575 million floating rate Bermudan subordinated notes 2018 (callable quarterly from May 2013) Lower Tier 2 305 366 378 AUD175 million floating rate Bermudan subordinated notes 2018 (callable quarterly from May 2013) Lower Tier 2 93 109 111 €26 million 7.42% subordinated notes 2016 Lower Tier 2 25 25 25 €7 million 7.38% subordinated notes 2016 Lower Tier 2 7 7 7 US$136 million (2011 - US$250 million) 7.75% fixed rate subordinated notes 2023 Lower Tier 2 83 85 90 US$150 million 7.13% fixed rate subordinated notes 2093 Lower Tier 2 91 94 100
Notes: (1) On-lent to The Royal Bank of Scotland plc on a subordinated basis. (2) Partially repurchased following completion of an exchange offer in March 2012 (3) In the event of certain changes in tax laws, dated loan capital issues may be redeemed in whole, but not in part, at the option of the issuer, at the principal amount thereof plus accrued interest, subject to prior regulatory approval. (4) Except as stated above, claims in respect of the Group's dated loan capital are subordinated to the claims of other creditors. None of the Group's dated loan capital is secured. (5) Interest on all floating rate subordinated notes is calculated by reference to market rates.
Undated loan capital Capital 2013 2012 2011 treatment £m £m £m
The Royal Bank of Scotland Group plc €391 million floating rate 2042 (callable quarterly from June 2012) (2,3) Tier 1 326 319 340 US$486 million 6.8% 2042 (callable quarterly from March 2008) (2,4) Tier 1 294 302 309 US$318 million floating rate (callable quarterly from July 2013) (2,5) Tier 1 192 199 210 US$394 million 6.425% 2043 (callable quarterly from January 2034) (2,6) Tier 1 301 365 382 US$106 million undated floating rate primary capital notes (callable semi-annually from December 1990) (1) Upper Tier 2 65 66 69 US$762 million 7.648% perpetual regulatory (callable quarterly from September 2031) (8) Tier 1 465 477 497
National Westminster Bank Plc US$193 million primary capital floating rate notes, Series A (callable semi-annually from July 1990) Upper Tier 2 117 119 124 US$229 million primary capital floating rate notes, Series B (callable semi-annually from August 1990) Upper Tier 2 139 142 148 US$285 million primary capital floating rate notes, Series C (callable quarterly from November 1990) Upper Tier 2 173 177 184 €178 million floating rate undated subordinated notes (callable quarterly from October 2009) Upper Tier 2 149 146 150 €10 million floating rate undated step-up notes (callable quarterly from October 2009) Upper Tier 2 9 9 9 £87 million floating undated subordinated step-up notes (callable every five years from January 2010) Upper Tier 2 92 92 91 £53 million 7.125% undated subordinated step-up notes (callable every five years from October 2022) Upper Tier 2 54 55 56 £35 million 11.5% undated subordinated notes (callable any time from December 2022) (1,9) Upper Tier 2 35 38 42
First Active plc £20 million 11.75% perpetual Lower Tier 2 25 25 26 £1.3 million floating rate perpetual Lower Tier 2 1 2 2
Non-cumulative convertible preference shares of US$0.01 Series 1 US$65 million 9.118% (callable any time from March 2010) Tier 1 40 41 43
Notes: (1) Further details of the contractual terms of the preference shares are given in Note 26. (2) Series C preference shares each carry a gross dividend of 8.625% inclusive of associated tax credit. Redeemable at the option of the issuer at par.
Ordinary shares of £1 6,071 132 6,203 B shares of £0.01 510 — 510 Dividend access share of £0.01 (1) — — — Non-cumulative preference shares of US$0.01 1 — 1 Non-cumulative convertible preference shares of US$0.01 — — — Non-cumulative preference shares of €0.01 — — — Non-cumulative convertible preference shares of £0.01 — — — Non-cumulative preference shares of £1 — — — Cumulative preference shares of £1 1 — 1
Notes: (1) One dividend access share in issue. (2) In June 2012, the ordinary shares of 25p each were initially sub-divided into 59,554,319,127 ordinary shares of 10p each and 59,554,319,127 deferred shares of 15p each. The deferred shares created by virtue of the sub-division were cancelled with the nominal value transferred to capital redemption reserve. The 59,554,319,127 ordinary shares of 10p were consolidated into 5,955,431,912 ordinary shares of £1 each.
Ordinary shares There is no authorised share capital under the company’s constitution. The directors have the authority to issue £17.7 billion nominal of ordinary shares in connection with a conversion of B shares. At 31 December 2013 they had a remaining authority granted at the 2013 Annual General Meeting to issue up to £227 million nominal of ordinary shares other than by pre-emption to existing shareholders.
The dividend access share does not generally carry voting rights at general meetings of ordinary shareholders and is not convertible into ordinary shares.
Non-cumulative convertible preference shares of £0.01 Series 1 14,866 7.387% 31 December 2010 £1,000 Debt
27 Other equity Paid-in equity - comprises equity instruments issued by the company other than those legally constituted as shares.
EMTN notes US$564 million 6.99% capital securities (callable October 2017) 275 CAD321 million 6.666% notes (callable October 2017) 156
Trust preferred issues: subordinated notes (1) US$357 million 5.512% 2044 (callable September 2014) (2) 195 US$276 million 3 month US$ LIBOR plus 0.80% 2044 (callable September 2014) (3) 150 €166 million 4.243% 2046 (callable January 2016) (4) 110 £93 million 5.6457% 2047 (callable June 2017) (5) 93 979
Notes: (1) Subordinated notes issued to limited partnerships that have in turn issued partnership preferred securities to trusts that have issued trust preferred securities to investors. The trust preferred securities are redeemable only at the issuer’s option and dividends are payable at the Group’s discretion. On maturity of the subordinated notes, the partnerships are required to reinvest in eligible capital instruments issued by the Group. Prior to the implementation of IFRS 10, the limited partnerships and the trusts were consolidated and the trust preferred securities recorded as non-controlling interests.
(2) Preferred securities in issue - US$357 million RBS Capital Trust III, fixed/floating noncumulative trust preferred securities.
Finance lease contracts and hire purchase agreements assets: Gross Present value Other Present future minimum amounts adjustments movements value lease rentals Year in which receipt will occur £m £m £m £m £m
Amounts recognised as income and expense Finance leases - contingent rental income (94) (110) (133) Operating leases - minimum rentals payable 389 392 490
Within 1 but within but within After 5 year 2 years 5 years years Total 2013 £m £m £m £m £m
Operating leases - transportation 197 34 217 134 582 - cars and light commercial vehicles 18 8 7 — 33 - other 24 25 32 1 82 Finance lease contracts 41 53 198 429 721 Hire purchase agreements — 1 — 1 2 280 121 454 565 1,420
Operating leases - transportation 284 182 207 333 1,006 - cars and light commercial vehicles 317 44 49 1 411 - other 30 19 39 3 91 Finance lease contracts 38 47 148 318 551 Hire purchase agreements 1 — 1 — 2 670 292 444 655 2,061
29 Structured entities A structured entity (SE) is an entity that has been designed such that voting or similar rights are not the dominant factor in deciding who controls the entity, for example when any voting rights relate to administrative tasks only and the relevant activities are directed by means of contractual arrangements. SEs are usually established for a specific, limited purpose, they do not carry out a business or trade and typically have no employees. They take a variety of legal forms - trusts, partnerships and companies - and fulfil many different functions. As well as being a key element of securitisations, SEs are also used in fund management activities to segregate custodial duties from the fund management advice.
The Group applies IFRS 10 ‘Consolidated Financial Statements’ in determining whether or not to consolidate an SE. Entities, including SEs, are consolidated where the Group has power over the investee; exposure, or rights, to variable returns from its involvement with the entity; and the ability to use its power over the entity to affect the amount of the Group’s returns.
Consolidated structured entities Securitisations In a securitisation, assets, or interests in a pool of assets, are transferred generally to an SE which then issues liabilities to third party investors. The majority of securitisations are supported through liquidity facilities or other credit enhancements. The Group arranges securitisations to facilitate client transactions and undertakes own asset securitisations to sell or to fund portfolios of financial assets. The Group also acts as an underwriter and depositor in securitisation transactions in both client and proprietary transactions.
The Group’s involvement in client securitisations takes a number of forms. It may: sponsor or administer a securitisation programme; provide liquidity facilities or programme-wide credit enhancement; and purchase securities issued by the vehicle.
2013 2012 2011 Debt securities in issue Debt securities in issue Debt securities in issue
Asset type £m £m £m £m £m £m £m £m £m £m £m £m
Mortgages - UK 14,434 4,876 10,978 15,854 16,448 6,462 11,963 18,425 49,549 10,988 47,324 58,312 - Irish 9,300 1,890 8,751 10,641 10,587 3,217 7,634 10,851 12,660 3,472 8,670 12,142 UK credit cards 3,261 500 1,625 2,125 3,019 1,243 1,736 2,979 4,037 500 110 610 UK personal loans 3,382 — 3,677 3,677 4,658 — 4,283 4,283 5,168 — 4,706 4,706 Other loans (2) 12,326 488 12,078 12,566 18,008 1,059 18,064 19,123 19,778 4 20,577 20,581 42,703 7,754 37,109 44,863 52,720 11,981 43,680 55,661 91,192 14,964 81,387 96,351 Cash deposits 6,245 5,366 11,164 48,948 58,086 102,356
Notes: (1) Debt securities retained by the Group may be pledged with central banks. (2) Corporate, social housing and student loans.
Commercial paper conduits The Group consolidates a number of asset-backed commercial paper (ABCP) conduits. A conduit is an SE that issues commercial paper and uses the proceeds to purchase or fund a pool of assets. The commercial paper is secured on the assets and is redeemed by further commercial paper issuance, repayment of assets or funding from liquidity facilities. Commercial paper is typically short-dated, usually up to three months. At 31 December 2013 assets held by the conduits totalled £1.6 billion (2012 - £3.6 billion; 2011 - £13.1 billion). At 31 December 2013 and at 31 December 2012 the conduits were funded entirely by the Group.
Covered bond programme Certain loans and advances to customers have been assigned to bankruptcy remote limited liability partnerships to provide security for issues of debt securities by the Group. The Group retains all of the risks and rewards of these loans, the partnerships are consolidated, the loans retained on the Group’s balance sheet and the related covered bonds included within debt securities in issue. At 31 December 2013, £16,177 million of mortgages provided security for debt securities in issue of £9,041 million (2012: mortgages £15,990 million, bonds £10,139 million; 2011: mortgages £15,441 million, bonds £9,107 million).
Loans and advances to customers — 3,967 26 30 4,023 Debt securities 481 19,926 8 43 20,458 Total 481 23,893 34 73 24,481
Transfers that do not qualify for derecognition Securities repurchase agreements and lending transactions The Group enters into securities repurchase agreements and securities lending transactions under which it transfers securities in accordance with normal market practice.
Assets subject to securities repurchase agreements or security lending transactions £m £m £m
Transfers that continue to be recognised to the extent of the Group’s continuing involvement (IAS 39) In certain securitisations of US residential mortgages, substantially all the risks and rewards have been neither transferred nor retained, but the Group has retained control of the assets and continues to recognise the assets to the extent of its continuing involvement, as defined by IAS 39, which takes the form of retaining certain subordinated bonds issued by the securitisation vehicles.
At 31 December 2013, securitised assets were £0.3 billion (2012 - £0.4 billion; 2011 - £0.6 billion); retained interest at fair value £59 million (2012 - £61 million; 2011 - £72 million); subordinated assets £35 million (2012 - £1 million; 2011 - £3 million); and related liabilities £35 million (2012 - £1 million; 2011 - £3 million).
Qualifying Tier 2 capital Undated subordinated debt 2,109 2,194 1,838 Dated subordinated debt - net of amortisation 12,436 13,420 14,527 Unrealised gains on AFS equity shares 114 63 108 Collectively assessed impairment provisions 395 399 635 Non-controlling Tier 2 capital — — 11
Tier 2 deductions 50% of securitisation positions (748) (1,107) (2,019) 50% of standardised expected losses less impairment provisions (25) (2,522) (3,451)
Supervisory deductions Unconsolidated investments - Direct Line Group (1) — (2,081) (4,354)
Note: (1) From 1 January 2013 material holdings in insurance companies are deducted 50% from Tier 1 and 50% from Tier 2.
It is the Group's policy to maintain a strong capital base, to expand it as appropriate and to utilise it efficiently throughout its activities to optimise the return to shareholders while maintaining a prudent relationship between the capital base and the underlying risks of the business. In carrying out this policy, the Group has regard to the supervisory requirements of the PRA. The PRA uses risk asset ratio (RAR) as a measure of capital adequacy in the UK banking sector, comparing a bank's capital resources with its risk-weighted assets (the assets and off-balance sheet exposures are ‘weighted’ to reflect the inherent credit and other risks); by international agreement, the RAR should be not less than 8% with a Tier 1 component of not less than 4%. The Group has complied with the PRA’s capital requirements throughout the year.
Other commitments - these include documentary credits, which are commercial letters of credit providing for payment by the Group to a named beneficiary against presentation of specified documents, forward asset purchases, forward deposits placed and undrawn note issuance and revolving underwriting facilities, and other short-term trade related transactions.
The FSCS has borrowed from HM Treasury to fund compensation costs associated with the failure of Bradford & Bingley, Heritable Bank, Kaupthing Singer & Friedlander, Landsbanki ‘Icesave’ and London Scottish Bank plc. The interest rate on these borrowings is subject to a floor being the higher of 12 month LIBOR plus 100 basis points or the relevant gilt rate for the equivalent cost of borrowing from HMT. The FSCS and HM Treasury have agreed that the period of these loans will reflect the expected timetable for recoveries from the estates of Bradford & Bingley and the other failed banks. The FSCS will levy the deposit taking sector for its share of the balance of the principal outstanding for the non-Bradford & Bingley loan prior to the FSCS loan facility with HMT expiring in March 2016. In addition, the FSCS recently announced HMT’s intention to collect an interim payment relating to resolution costs for Dunfermline Building Society of £100 million. The capital element of the levy is expected to rise to £399 million (£363 million in the 2013/14 scheme year).
The Group has accrued £144 million for its share of estimated FSCS levies for the 2013/14 and 2014/15 scheme years.
Other than those discussed below, no member of the Group is or has been involved in governmental, legal or regulatory proceedings (including those which are pending or threatened) that are material individually or in aggregate.
Litigation Shareholder litigation RBS and certain of its subsidiaries, together with certain current and former officers and directors were named as defendants in purported class actions filed in the United States District Court for the Southern District of New York involving holders of RBS preferred shares (the Preferred Shares litigation) and holders of American Depositary Receipts (the ADR claims).
In the Preferred Shares litigation, the consolidated amended complaint alleged certain false and misleading statements and omissions in public filings and other communications during the period 1 March 2007 to 19 January 2009, and variously asserted claims under Sections 11, 12 and 15 of the US Securities Act of 1933, as amended (Securities Act). The putative class is composed of all persons who purchased or otherwise acquired Group Series Q, R, S, T and/or U non-cumulative dollar preference shares issued pursuant or traceable to the 8 April 2005 US Securities and Exchange Commission (SEC) registration statement. In September 2012, the Court dismissed the Preferred Shares litigation with prejudice. On 25 September 2013, the United States Court of Appeals for the Second Circuit (Second Circuit Court of Appeals) affirmed the lower Court’s dismissal of the litigation. The deadline for plaintiffs to appeal from the Second Circuit Court of Appeals to the United States Supreme Court has expired.
Additionally, between March and July 2013, claims were issued in the High Court of Justice of England and Wales by sets of current and former shareholders, against the Group (and in one of those claims, also against certain former individual officers and directors) alleging that untrue and misleading statements and/or improper omissions were made in connection with the rights issue announced by the Group on 22 April 2008 in breach of the Financial Services and Markets Act 2000. On 30 July 2013 these and other similar threatened claims were consolidated by the Court via a Group Litigation Order. The Group’s defence to the claims was filed on 13 December 2013.
Other securitisation and securities related litigation in the United States Group companies have been named as defendants in their various roles as issuer, depositor and/or underwriter in a number of claims in the United States that relate to the securitisation and securities underwriting businesses. These cases include actions by individual purchasers of securities and purported class action suits. Together, the pending individual and class action cases involve the issuance of more than US$67 billion of mortgage-backed securities (MBS) issued primarily from 2005 to 2007. Although the allegations vary by claim, in general, plaintiffs in these actions claim that certain disclosures made in connection with the relevant offerings contained materially false or misleading statements and/or omissions regarding the underwriting standards pursuant to which the mortgage loans underlying the securities were issued. Group companies remain as defendants in more than 40 lawsuits brought by purchasers of MBS, including the purported class actions identified below.
Among these MBS lawsuits are four cases filed on 2 September 2011 by the US Federal Housing Finance Agency (FHFA) as conservator for the Federal National Mortgage Association (Fannie Mae) and the Federal Home Loan Mortgage Corporation (Freddie Mac). The primary FHFA lawsuit remains pending in the United States District Court for the District of Connecticut, and it relates to approximately US$32 billion of MBS for which Group entities acted as sponsor/depositor and/or lead underwriter or co-lead underwriter. Of these approximately US$10.5 billion were outstanding at 31 December 2013 with cumulative losses of approximately US$0.9 billion (being the loss of principal value suffered by security holders). On 30 September 2013, the Court denied the defendants’ motion to dismiss FHFA’s amended complaint in this case. Discovery is ongoing.
The purported MBS class actions in which Group companies are defendants include New Jersey Carpenters Health Fund v. Novastar Mortgage Inc. et al. and In re IndyMac Mortgage-Backed Securities Litigation. A third MBS class action, New Jersey Carpenters Vacation Fund et al. v. The Royal Bank of Scotland plc et al., has been settled in principle for US$275 million subject to documentation and court approval. There is a provision that fully covers the settlement amount. The case relates to more than US$15 billion of the issued MBS that are the subject of MBS claims pending against Group companies. The outcome in this case should not be seen as indicative of how other MBS lawsuits may be resolved.
RBS Securities Inc. was also a defendant in Luther v. Countrywide Financial Corp. et al. and related class action cases (the “Luther Litigation”). On 5 December 2013, the court granted final approval of a US$500 million settlement of plaintiffs’ claims to be paid by Countrywide without contribution from RBS Securities Inc. Several members of the settlement class are appealing the court-approved settlement to the United States Court of Appeals for the Ninth Circuit.
Certain other institutional investors have threatened to bring claims against the Group in connection with various mortgage-related offerings. The Group cannot predict whether any of these individual investors will pursue these threatened claims (or their outcome), but expects that several may. If such claims are asserted and were successful, the amounts involved may be material.
Most of the USD LIBOR-related actions in which Group companies are defendants, including all purported class actions relating to USD LIBOR, have been transferred to a coordinated proceeding in the United States District Court for the Southern District of New York. In the coordinated proceeding, consolidated class action complaints were filed on behalf of (1) exchange-based purchaser plaintiffs, (2) over-the-counter purchaser plaintiffs, and (3) corporate debt purchaser plaintiffs. On 29 March 2013, the Court dismissed plaintiffs' antitrust claims, claims under RICO (Racketeer Influenced and Corrupt Organizations Act), and certain state law claims, but declined to dismiss certain other claims. Discovery is stayed. Over 35 other USD LIBOR-related actions involving RBS have been stayed pending further order from the Court.
32 Memorandum items continued Certain members of the Group have also been named as defendants in class actions relating to (i) JPY LIBOR and Euroyen TIBOR (the "Yen action") and (ii) Euribor (the "Euribor action"), both of which are pending in the United States District Court for the Southern District of New York.
Thornburg adversary proceeding RBS Securities Inc. and certain other Group companies, as well as several other financial institutions, are defendants in an adversary proceeding filed in the U.S. bankruptcy court in Maryland by the trustee for TMST, Inc. (formerly known as Thornburg Mortgage, Inc.). The trustee seeks recovery of transfers made under certain restructuring agreements as, among other things, avoidable fraudulent and preferential conveyances and transfers.
Complex Systems RBS N.V. is a defendant in an action pending in the United States District Court for the Southern District of New York filed by Complex Systems, Inc (CSI). The plaintiff alleges that RBS N.V. has since late 2007 been using the plaintiff's back-office trade finance processing software without a valid licence, in violation of the US Copyright Act. On 17 October 2013, the Court granted summary judgment to CSI on the issue of liability. The plaintiff was seeking in excess of US$300 million in alleged profits that the plaintiff claimed was attributable to RBS N.V.'s use of the disputed software, but on 8 November 2013, the Court barred the plaintiff from recovering any such profits although the plaintiff continues to seek actual damages of an unspecified amount. On 25 October 2013, the plaintiff filed a motion for a permanent injunction against RBS N.V.'s further use of the software, and a hearing on that motion, which RBS N.V. opposes, has been scheduled for 14 March 2014.
CPDO Litigation CPDO claims have been served on RBS N.V. in England, the Netherlands and Australia relating to the sale of a type of structured financial product known as a constant proportion debt obligation (CPDO). In November 2012, the Federal Court of Australia issued a judgment against RBS N.V. and others in one such case. It held that RBS N.V. and others committed certain wrongful acts in connection with the rating and sale of the CPDO. In March 2013, RBS N.V. was ordered to pay A$19.7 million. RBS N.V. has appealed this decision and the appeal is due to be heard in March 2014. The judgment may potentially have significance to the other claims served and to any future similar claims.
RBS Securities Japan Limited is taking steps to address the issues raised in compliance with that order. In June 2013, RBS was listed amongst the 20 banks found by the Monetary Authority of Singapore (MAS) to have deficiencies in the governance, risk management, internal controls and surveillance systems relating to benchmark submissions following a finding by the MAS that certain traders made inappropriate attempts to influence benchmarks in the period 2007 - 2011. RBS was ordered at that time to set aside additional statutory reserves with MAS of SGD1-1.2 billion and to formulate a remediation plan. RBS has submitted its remediation plan to the MAS.
The Group is co-operating with investigations and new and ongoing requests for information by various other governmental and regulatory authorities, including in the UK, US and Asia, into its submissions, communications and procedures relating to a number of trading rates, including LIBOR and other interest rate settings, ISDAFIX and nondeliverable forwards. The Group is also under investigation by competition authorities in a number of jurisdictions stemming from the actions of certain individuals in the setting of LIBOR and other trading rates, as well as interest rate-related trading.
The incident, the Group's handling of the incident, and the systems and controls surrounding the processes affected, are the subject of regulatory investigations in the UK and in the Republic of Ireland.
On 9 April 2013, the UK Financial Conduct Authority (FCA) announced that it had commenced an enforcement investigation into the incident. This is a joint investigation conducted by the FCA together with the UK Prudential Regulation Authority (PRA). The FCA and PRA will reach their conclusions in due course and will decide whether or not to initiate enforcement action following that investigation. While the outcomes of the FCA and PRA investigations will be separate, the regulators have indicated that they will endeavour to co-ordinate the timescales of their respective investigations. Separately the Central Bank of Ireland has initiated an investigation.
Interest rate hedging products In June 2012, following an industry wide review, the FSA announced that the Group and other UK banks had agreed to a redress exercise and past business review in relation to the sale of interest rate hedging products to some small and medium sized businesses who were classified as retail clients or private customers under FSA rules. On 31 January 2013, the FSA issued a report outlining the principles to which it wished the Group and other UK banks to adhere in conducting the review and redress exercise.
The redress exercise and the past business review are being scrutinised by an independent reviewer, who will review and agree any redress, and will be overseen by the FCA.
The Group has decided to undertake a similar exercise and past business review in relation to the sale of interest rate hedging products to retail designated small and medium sized businesses in the Republic of Ireland and to customers of RBS International.
The Group has made provisions totalling £1.25 billion to date for this matter, including £550 million in 2013, of which £0.2 billion has been utilised at 31 December 2013.
Retail banking Since initiating an inquiry into retail banking in the European Union (EU) in 2005, the European Commission (EC) continues to keep retail banking under review. In late 2010 the EC launched an initiative pressing for greater transparency of bank fees and is currently proposing to legislate for increased harmonisation of terminology across Member States. The Group cannot predict the outcome of these actions at this stage.
FSA mystery shopping review On 13 February 2013, the FSA announced the results of a mystery shopping review it undertook into the investment advice offered by banks and building societies to retail clients. As a result of that review the FSA announced that firms involved were cooperative and agreed to take immediate action. The Group was one of the firms involved. The action required includes a review of the training provided to advisers, considering whether changes are necessary to advice processes and controls for new business, and undertaking a past business review to identify any historic poor advice (and where breaches of regulatory requirements are identified, to put this right for customers). The Group will be required to appoint an independent third party to either carry out or oversee this work. The scope and terms of the past business review and the appointment of the independent third party remain under discussion. The Group cannot predict the outcome of this review at this stage.
On 9 April 2013, the EC announced it was opening a new investigation into interbank fees payable in respect of payments made in the EEA by MasterCard cardholders from non-EEA countries.
In March 2008, the EC opened a formal inquiry into Visa’s MIF arrangements for cross border payment card transactions with Visa branded debit and consumer credit cards in the EEA. In April 2009 the EC announced that it had issued Visa with a formal Statement of Objections. In April 2010 Visa announced it had reached an agreement with the EC as regards immediate cross border debit card MIF rates only and in December 2010 the commitments were finalised for a four year period commencing December 2010 under Article 9 of Regulation 1/2003. In July 2012 Visa made a request to re-open the settlement in order to modify the fee. The EC rejected the request and in October 2012 Visa filed an appeal to the General Court seeking to have that decision annulled. That appeal is ongoing. The EC is continuing its investigations into Visa’s cross border MIF arrangements for deferred debit and credit transactions. On 31 July 2012 the EC announced that it had issued Visa with a supplementary Statement of Objections regarding consumer credit cards in the EEA. On 14 May 2013, the EC announced it had reached an agreement with Visa regarding immediate cross border credit card MIF rates. The agreement has now been market tested and its final publication is awaited.
The outcomes of these ongoing investigations, proceedings and proposed regulation are not yet known, but they may have a material adverse effect on the structure and operation of four party card payment schemes in general and, therefore, on the Group’s business in this sector.
The FSA published a final policy statement in August 2010 imposing significant changes with respect to the handling of complaints about the mis-selling of PPI. In October 2010, the British Bankers’ Association (BBA) filed an application for judicial review of the FSA’s policy statement and of related guidance issued by the FOS. In April 2011 the High Court issued judgment in favour of the FSA and the FOS and in May 2011 the BBA announced that it would not appeal that judgment. The Group then reached agreement with the FSA on a process for implementation of its policy statement and for the future handling of PPI complaints. Implementation of the agreed processes is currently under way. The Group has made provisions totalling £3.1 billion to date for this matter, including £900 million in 2013, of which £2.2 billion has been utilised at 31 December 2013.
The first six-monthly review was completed in September 2010. The OFT noted progress in switching, transparency and unarranged overdrafts for the period March to September 2010 and highlighted further changes it wanted to see in the market. In March 2011, the OFT published the next update report in relation to PCAs. This noted further progress in improving consumer control over the use of unarranged overdrafts. In particular, the Lending Standards Board had led on producing standards and guidance to be included in a revised Lending Code. The OFT stated it would continue to monitor the market and would consider the need for, and appropriate timing of, further update reports in light of other developments, in particular the work of the UK Government’s Independent Commission on Banking (ICB).
SME banking market study The OFT announced its market study on competition in banking for SMEs in England and Wales, Scotland and Northern Ireland on 19 June 2013. The OFT has been seeking views on the scope of the market study and on 27 September 2013 published an update paper setting out its proposed scope. The OFT expects to report on the market study in early 2014.
Securitisation and collateralised debt obligation business In the United States, the Group is involved in reviews, investigations and proceedings (both formal and informal) by federal and state governmental law enforcement and other agencies and self-regulatory organisations relating to, among other things, issuance, underwriting and trading in mortgage-backed securities, collateralised debt obligations (CDOs), and synthetic products. In connection with these inquiries, Group companies have received requests for information and subpoenas seeking information about, among other things, the structuring of CDOs, financing to loan originators, purchase of whole loans, sponsorship and underwriting of securitisations, due diligence, representations and warranties, communications with ratings agencies, disclosure to investors, document deficiencies, trading activities and repurchase requests.
On 7 November 2013, the Group announced that it had settled with the US Securities and Exchange Commission (‘the SEC’) over its investigation of RBS Securities Inc. relating to due diligence conducted in connection with a 2007 offering of residential mortgage-backed securities and corresponding disclosures. Pursuant to the settlement, RBS Securities Inc., without admitting or denying the SEC's allegations, consented to the entry of a final judgment ordering certain relief, including an injunction and the payment of approximately US$153 million in disgorgement, penalties, and interest. The settlement was subsequently approved by the United States District Court for the District of Connecticut. The Group co-operated fully with the SEC throughout the investigation.
Also in October 2010, the SEC commenced an inquiry into document deficiencies and repurchase requests with respect to certain securitisations, and in January 2011, this was converted to a formal investigation. Among other matters, the investigation seeks information related to document deficiencies and remedial measures taken with respect to such deficiencies. The investigation also seeks information related to early payment defaults and loan repurchase requests.
In 2007, the New York State Attorney General issued subpoenas to a wide array of participants in the securitisation and securities industry, focusing on the information underwriters obtained from the independent firms hired to perform due diligence on mortgages. The Group completed its production of documents requested by the New York State Attorney General in 2008, principally producing documents related to loans that were pooled into one securitisation transaction. In May 2011, at the New York State Attorney General's request, representatives of the Group attended an informal meeting to provide additional information about the Group's mortgage securitisation business. The investigation is ongoing and the Group continues to provide the requested information.
US mortgages - loan repurchase matters The Group’s Markets business in North America has been a purchaser of non-agency US residential mortgages in the secondary market, and an issuer and underwriter of non-agency residential mortgage-backed securities (RMBS). Markets did not originate or service any US residential mortgages and it was not a significant seller of mortgage loans to government sponsored enterprises (GSEs) (e.g. the Federal National Mortgage Association and the Federal Home Loan Mortgage Association).
In issuing RMBS, Markets generally assigned certain representations and warranties regarding the characteristics of the underlying loans made by the originator of the residential mortgages; however, in some circumstances, Markets made such representations and warranties itself. Where Markets has given those or other representations and warranties (whether relating to underlying loans or otherwise), Markets may be contractually required to repurchase such loans or indemnify certain parties against losses for certain breaches of such representations and warranties. In certain instances where it is required to repurchase loans or related securities, Markets may be able to assert claims against third parties who provided representations or warranties to Markets when selling loans to it, although the ability to recover against such parties is uncertain. Between the start of 2009 and 31 December 2013, Markets received approximately US$741 million in repurchase demands in respect of loans made primarily from 2005 to 2008 and related securities sold where obligations in respect of contractual representations or warranties were undertaken by Markets. However, repurchase demands presented to Markets are subject to challenge and rebuttal by Markets.
The Group cannot currently estimate what the ultimate exposure may be with respect to repurchase demands. Furthermore, the Group is unable to estimate the extent to which the matters described above will impact it, and future developments may have an adverse impact on the Group’s net assets, operating results or cash flows in any particular period.
32 Memorandum items continued • a plan to oversee compliance by the Group’s U.S. operations with all applicable U.S. laws, rules, regulations, and supervisory guidance,
US/Swiss tax programme In August 2013, the DOJ announced a programme for Swiss banks (the Programme), to settle the long-running dispute between the US tax authorities and Switzerland regarding the role of Swiss banks in concealing the assets of US tax payers in offshore accounts. The Programme provides Swiss banks with an opportunity to obtain resolution, through non-prosecution agreements or non-target letters, concerning their status in connection with the DOJ’s investigations.
Coutts & Co AG (Coutts), a member of the Group incorporated in Switzerland, has notified the DOJ that it intends to participate in the Programme based on the possibility that some of its clients may not have declared their assets in compliance with US tax laws. The Programme requires a detailed review of all US related accounts. The review is due to be completed and the results presented to the DOJ later in 2014.
Fair value given for businesses acquired — (68) (44) Net assets sold 1,435 1,317 (299) Non-cash consideration 3 (90) — Profit/(loss) on disposal 240 95 (28) Net cash and cash equivalents disposed 210 — — Net inflow/(outflow) of cash in respect of disposals 1,888 1,322 (327) Dividends received from associates 134 22 11 Cash expenditure on intangible assets (872) (924) (1,068) Net inflow/(outflow) 1,150 352 (1,428)
35 Interest received and paid 36 Analysis of changes in financing during the year
37 Analysis of cash and cash equivalents 2013 2012 2011 £m £m £m
At 1 January - cash 91,658 109,888 102,573 - cash equivalents 41,183 42,767 49,957 132,841 152,655 152,530 Net cash (outflow)/inflow (11,664) (19,814) 125 At 31 December 121,177 132,841 152,655
Note: (1) Includes cash collateral posted with bank counterparties in respect of derivative liabilities of £10,342 million (2012 - £12,784 million; 2011 - £19,691 million).
The ceding of control which resulted from the partial disposal of the Group’s shareholding in Direct Line Group (DLG) has resulted in the Group no longer treating DLG as an operating segment. Comparative data have been restated.
Markets is a leading origination, sales and trading business across debt finance, fixed income and currencies. The division offers a unified service to the Group’s corporate and institutional clients. The Markets’ origination, sales and research teams build strong ongoing client partnerships, provide market perspective and access, and work with the division’s trading and structuring teams to meet the client’s objectives across financing, risk management, investment, securitisation and liquidity.
Central Functions comprises Group and corporate functions, such as treasury, finance, risk management, legal, communications and human resources. The Centre manages the Group's capital resources and Group-wide regulatory projects and provides services to the operating divisions.
Net Depreciation interest Non-interest Total Operating and Impairment Operating income income income expenses amortisation losses profit/(loss)
Reconciling items Own credit adjustments — (120) (120) — — — (120) Payment Protection Insurance costs — — — (900) — — (900) Interest Rate Hedging Products redress and related costs — — — (550) — — (550) Regulatory and legal actions — — — (2,394) — — (2,394) Integration and restructuring costs — — — (650) (6) — (656) Gain on redemption of own debt — 175 175 — — — 175 Write-down of goodwill — — — (1,059) — — (1,059) Amortisation of purchased intangible assets — — — — (153) — (153)
UK Retail 4,302 1,206 5,508 (2,699) — (788) 2,021 UK Corporate 3,092 1,771 4,863 (1,974) (172) (793) 1,924 Wealth 645 459 1,104 (846) 9 (25) 242 International Banking 1,157 1,398 2,555 (1,623) (9) (168) 755 Ulster Bank 736 211 947 (546) (1) (1,384) (984) US Retail & Commercial 1,879 1,152 3,031 (1,962) (206) (326) 537 Markets 67 4,348 4,415 (3,319) (159) (38) 899 Central items (178) 205 27 648 (711) 2 (34)
Reconciling items Own credit adjustments — 1,914 1,914 — — — 1,914 Payment Protection Insurance costs — — — (850) — — (850) Sovereign debt impairment and related interest rate hedge adjustments — — — — — (1,268) (1,268)
Gain on redemption of own debt — 255 255 — — — 255 Asset Protection Scheme — (906) (906) — — — (906) Amortisation of purchased intangible assets — — — — (222) — (222)
Bonus tax — — — (27) — — (27) Bank levy — — — (300) — — (300)
Reconciling items Own credit adjustments (120) — (120) (4,649) — (4,649) 1,914 — 1,914 Integration and restructuring costs — — — — — — (5) — (5) Gain on redemption of own debt 175 — 175 454 — 454 255 — 255 *Restated
Reconciling items Own credit adjustments (120) — (120) (4,649) — (4,649) 1,914 — 1,914 Integration and restructuring costs — — — — — — (5) — (5) Gain on redemption of own debt 175 — 175 454 — 454 255 — 255 *Restated 2013 2012* 2011* Cost to Cost to Cost to acquire fixed acquire fixed acquire fixed assets and assets and assets and intangible intangible intangible
Assets Liabilities assets Assets Liabilities assets Assets Liabilities assets Total assets £m £m £m £m £m £m £m £m £m
Reconciling items Direct Line Group — — — 12,697 9,267 275 12,912 8,077 99 *Restated
Currency translation and other adjustments — — 2 19 (88) — — — (67) Write-down of goodwill — — — (1,059) — — — — (1,059)
Net interest income 7,794 2,200 746 241 10,981 Net fees and commissions 2,544 1,099 663 212 4,518 Income from trading activities 1,474 1,013 106 92 2,685 Other operating income 644 382 242 305 1,573 Total income 12,456 4,694 1,757 850 19,757
Operating profit/(loss) before tax 667 1,794 (3,419) (438) (1,396) Total assets 1,007,096 359,592 66,239 73,940 1,506,867 Of which total assets held for sale 19,343 53 6,011 43 25,450 Total liabilities 936,477 341,631 82,059 70,647 1,430,814 Of which total liabilities held for sale 21,903 104 1,988 — 23,995 Net assets attributable to equity owners and non-controlling interests 70,619 17,961 (15,820) 3,293 76,053 Contingent liabilities and commitments 118,702 95,703 51,465 12,949 278,819 Cost to acquire property, plant and equipment and intangible assets 2,522 500 1,484 58 4,564 *Restated
No directors are accruing benefits under defined benefit schemes (2012 - nil). One director is accruing benefits under a money purchase scheme (2012 - one).
The executive directors may participate in the company's long-term incentive plans, executive share option and sharesave schemes and details of their interests in the company's shares arising from their participation are given in the Directors' remuneration report. Details of the remuneration received by each director is also given in the Directors' remuneration report.
(b) For the purposes of IAS 24 ‘Related Party Disclosures’, key management comprise directors of the company and members of the Group Management Committee. The captions in the Group's primary financial statements include the following amounts attributable, in aggregate, to key management: Loans and advances to customers 10,750 11,748 Customer accounts 33,279 36,250
41 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.
At 31 December 2013, the Group had no amounts outstanding under these facilities (2012 and 2011 - nil).
At 31 December 2013, the Group had no debt outstanding guaranteed by the UK Government (2012 - nil; 2011 - £21.3 billion).
National Loan Guarantee Scheme The Group participated in the National Loan Guarantee Scheme (NLGS), providing loans and facilities to eligible customers at a discount of one percent. It did not issue any guaranteed debt under the scheme and consequently, it was not committed to providing a particular volume of reduced rate facilities. At 31 December 2013 the Group had no amounts outstanding under the scheme (2012 - £898 million). The NLGS was superseded by the Funding for Lending Scheme.
Sale of selected Chicago-area operations of RBS Citizens On 7 January 2014, the Group announced that RBS Citizens Financial Group, Inc. had reached agreement to sell its Chicago-area retail branches, small business operations and select middle market relationships in the Chicago market to U.S. Bank National Association, a subsidiary of U.S. Bancorp. The sale includes 94 Charter One branches in the Chicago area, $5.3 billion in local deposits and $1.1 billion in locally originated loans for a deposit premium of approximately $315 million, or 6 percent of deposits. The transaction is subject to regulatory approval and is anticipated to close in mid-2014.
As described on page 8, the Group has announced the results of its Strategic review, resulting in it being realigned into three businesses: Personal & Business Banking, Commercial & Private Banking, and Corporate & institutional Banking. In addition, the Group will be rationalising and simplifying its systems, based on a target architecture with improved resilience.
Direct Line Insurance Group (DLG) On 26 February 2014 RBS announced that it had entered into a placing agreement to complete the sale of its residual interest in DLG (except for 4.2 million shares held to satisfy long term incentive plan awards granted by RBS to DLG management). Accordingly, on settlement of the placing, the Group will have completed the disposal as required by the European Commission.
Other than as detailed above, there have been no significant events between 31 December 2013 and the date of approval of these accounts which would require a change to or additional disclosure in the accounts.
Statement of changes in equity for the year ended 31 December 2013 2013 2012 2011 £m £m £m
Called-up share capital At 1 January 6,582 15,318 15,125 Ordinary shares issued 132 197 193 Share capital sub-division and consolidation — (8,933) — At 31 December 6,714 6,582 15,318
Share premium account At 1 January 24,361 24,001 23,922 Ordinary shares issued 306 360 79 At 31 December 24,667 24,361 24,001
Merger reserve At 1 January 2,341 2,341 2,391 Transfer to retained earnings — — (50)
At 1 January 17,336 18,308 18,365 Profit/(loss) attributable to ordinary and B shareholders and other equity owners 964 (684) (107) Equity preference dividends paid (349) (273) — Paid-in equity dividends paid, net of tax (30) (15) — Transfer from merger reserve — — 50 Transfer from contingent capital reserve (1,208) — — Termination of contingent capital agreement 320 — — At 31 December 17,033 17,336 18,308
The accompanying notes on pages 501 to 507 form an integral part of these financial statements.
Operating profit/(loss) before tax 998 (529) (34) Adjustments for: Profit on disposal of investments in subsidiaries (676) (157) — Write-down of investment in subsidiaries — 1,785 570 Interest on subordinated liabilities 619 486 419 (Recoveries)/impairment of loans to Group entities (44) 1,409 — Elimination of foreign exchange differences (118) (194) (4) Other non-cash items (723) (1) (5) Net cash flows from trading activities 56 2,799 946 Changes in operating assets and liabilities (2,735) (3,725) 2,964 Net cash flows from operating activities before tax (2,679) (926) 3,910 Income taxes paid (186) (58) (95) Net cash flows from operating activities 12 (2,865) (984) 3,815
The company is incorporated in the UK and registered in Scotland. The accounts are prepared on the historical cost basis except that derivative financial instruments are stated at fair value. Recognised financial assets and financial liabilities in fair value hedges are adjusted for changes in fair value in respect of the risk that is hedged.
Total comprehensive income/(loss) is attributable to: Preference shareholders 349 273 — Paid-in equity holders 30 15 — Ordinary and B shareholders 585 (972) (107)