(l) Derivatives and hedging activities SFAS 133 ‘Accounting for Derivative Instruments and Hedging Activities’ was effective for the Group’s US GAAP information from 1 January 2001. The Group has not made changes in its use of non-trading derivatives to meet the hedge criteria of SFAS 133. As a result, from 1 January 2001, for US GAAP purposes, the Group’s portfolio of nontrading derivatives has been remeasured to fair value and changes in fair value reflected in net income. Under UK GAAP, these derivatives continue to be classified as nontrading and accounted for in accordance with the underlying transaction or transactions being hedged.
SFAS 133 does not permit a non-derivative financial instrument to be designated as the hedging instrument in a fair value hedge of the foreign exchange exposure of available-for-sale securities.
US GAAP does not permit a profit or loss to be recognised on transacting a derivative unless its valuation is based on observable market data. There is no similar requirement under UK GAAP. Inception profits and losses reflecting the application of the Group’s usual pricing methodologies are recognised as they arise.
(q) Offset arrangements Under UK GAAP, debit and credit balances with the same counterparty are aggregated into a single item where there is a right to insist on net settlement and the debit balance matures no later than the credit balance. Under US GAAP, agreements and balances with the same counterparty may be offset only where they have the same settlement date specified at inception and there is an intention to set off.
Recent developments in US GAAP The FASB issued SFAS 153 ‘Exchanges of Nonmonetary assets, an amendment of APB Opinion No. 29’ in December 2004. SFAS 153 provides for a general exception from fair value measurement for exchanges of nonmonetary assets that do not have commercial substance. The Statement is effective for fiscal years beginning after 15 June 2005 and is not expected to affect the Group's US GAAP reporting.
In December 2004, the FASB issued SFAS 123 (revised 2004) ‘Share-Based Payment’ which requires compensation costs related to share-based payment transactions to be recognised in the financial statements. The compensation cost will be based on the grant-date fair value of the equity issued and will be recognised over the period that an employee provides service in exchange for the award. SFAS 123 (revised 2004) would be effective for the Group from 1 January 2006. Entities that use the fair value method for either recognition or disclosure under SFAS 123 will apply the revised Statement using a modified version of prospective application whereby for that portion of outstanding awards for which the requisite service has not yet been rendered, compensation cost will be based on the grant-date fair value calculated under SFAS 123 for either recognition or pro forma disclosures. For periods before the effective date, entities may elect to apply a modified version of retrospective application under which financial statements for prior periods are adjusted on a basis consistent with the pro forma disclosures required by SFAS 123. The Group currently makes pro forma disclosures of the effect on net income of compensation costs determined under the fair value method of SFAS 123.
Selected figures in accordance with US GAAP The following tables summarise the significant adjustments to consolidated net income available for ordinary shareholders and shareholders’ equity which would result from the application of US GAAP instead of UK GAAP. Where applicable, the adjustments are stated gross of tax with the tax effect shown separately in total.
Long-term assurance business (27) (57) (37) Extinguishment of liabilities (94) (84) —
Derivatives and hedging 238 161 Software development costs 399 660 Share-based payment (58) (32)
Earnings per share Basic and diluted earnings per share (“EPS”) under US GAAP differ from UK GAAP only to the extent that the income calculated under US GAAP differs from that under UK GAAP.
Dilutive effect of share options and * US GAAP net income available to ordinary shareholders, see page 190.
The Group has convertible preference shares totalling £200 million (2003 and 2002 – £200 million), €750 million (2003 and $1,900 million). All of the convertible preference shares, with the exception of $1,500 million, have a dilutive effect in the current year and as such have been included in the computation of diluted earnings per share.
Fair value of plan assets at beginning of year 11,822 10,682 12,567 Actual return on plan assets 1,234 1,559 (1,521)
Benefits and expenses paid (527) (511) (473) Market value of plan assets at year end 13,598 11,822 10,682
Unrecognised net actuarial loss 5,990 5,078 5,266 Unrecognised prior service cost 12 13 14 Unrecognised transition amount (6) (14) (22) Prepaid pension cost at year end 3,402 2,936 3,414
Weighted average assumptions used at 31 December: % per annum % per annum % per annum
Discount rate for liabilities 5.40 5.60 5.75 Salary increases 3.95 3.95 3.50 Pension increases 2.70 2.70 2.25 Long-term rate of return on assets 6.95 7.20 7.20
Weighted-average allocations of market value of plan assets at 31 December: % % %
The Group expects to contribute £376 million to its main UK pension plan in 2005.
Loan impairment At 31 December 2004 and 2003, the Group estimated that the difference between the carrying value of its loan portfolio under US GAAP and its value in the Group’s UK GAAP financial statements was such that no adjustment to net income or consolidated shareholders’ equity was required. At 31 December 2004, the Group’s non-accrual loans, loans past due 90 days and troubled debt restructurings amounted to £5,529 million (2003 – £5,157 million). Specific provisions of £3,602 million (2003 – £2,782 million) were held against these loans. Average non-accrual loans, loans past due 90 days and troubled debt restructurings for the year to 31 December 2004 were £5,313 million (2003 – £5,166 million).
Gross interest income not recognised, but which would have been recognised under the original terms of non-accrual and restructured loans, amounted to £237 million for the year million) from domestic loans and £58 million for the year ended from foreign loans. Interest on non-accrual and restructured loans included in net income was £58 million for the year million) from domestic loans and £7 million for the year ended foreign loans.
Securities During 2004, net gains of £2 million were included in US GAAP net income from transfers of securities from the available-forsale category into the trading category. For 2004, net unrealised losses of £924 million on available-for-sale securities were included in US GAAP other comprehensive income and £672 million was reclassified from accumulated other comprehensive income into US GAAP net income.
US treasury and government and securities issued by US states 507 24 — — 507 24
Summary consolidated statements of cash flows presented on a US GAAP basis for each of the three years ended 31 December 2004 are set out below: £m £m £m
Cash flows from operating activities 8,062 8,534 11,008 Cash flows from investing activities (82,113) (31,879) (44,892) Cash flows from financing activities 77,644 34,872 37,245 Effect of exchange rate changes on cash and cash equivalents (807) (863) (115) Change in cash and cash equivalents 2,786 10,664 3,246 Cash and cash equivalents at beginning of the year 20,937 10,273 7,027 Cash and cash equivalents at end of the year 23,723 20,937 10,273
The composition of cash at 31 December 2004, 2003 and 2002 and the movement in cash for the years then ended are shown in Note 47 and Note 48 on the accounts respectively.
Stock-based compensation costs The Group grants share options to executive officers under an executive share option scheme (the “executive scheme”) and to employees under a savings-related sharesave scheme (the “savings scheme”) and the option 2000 scheme.
Executive scheme Under the terms of the executive scheme, senior management employees and executive directors of Group companies may participate in the executive scheme at the discretion of the Board of directors of the company. The executive scheme involves a participant being granted an option to subscribe for ordinary shares of the company at the higher of nominal value and market value of ordinary shares on the date of grant. Normally, options may be granted only within six weeks after the announcement of final or interim results of the Group for any particular year. Options may not be transferred or assigned. A participant may not be granted options over new shares to the extent that the aggregate subscription price would exceed four times his compensation. Options granted under the executive scheme are issued on a UK Inland Revenue approved or unapproved basis. Options are exercisable between the third and tenth anniversaries of the grant date, only if performance criteria are met. For options granted from 1996 to 1998, the criterion is the average growth in adjusted earnings per ordinary share to exceed the average increase in the UK Retail Prices Index by 2% per annum over a three year period. For options granted since 1999, the relevant percentage has been increased to 3% per annum.
Dividends paid on non-equity shares Returns on investments and Financing activities servicing of finance
Purchase and sale of associated and Acquisitions and disposals Investing activities subsidiary undertakings
Purchase and sale of investment securities Capital expenditure and Investing activities and fixed assets financial investment
The following is a summary of outstanding options under the various schemes: Savings scheme Executive scheme Option 2000 scheme Total
Savings scheme Under the Inland Revenue rules, a participant in a savings scheme is permitted to make a maximum monthly saving of £250 under approved savings schemes. Employees of Group companies in the UK and Ireland and certain offshore jurisdictions are offered participation in the savings scheme. Participants can make monthly savings for a period of three, five or seven years. Options may be granted at not less than 80% of the average market value of ordinary shares of the company by reference to dealings in the ordinary shares over the last three trading days of the week immediately preceding the date of an invitation to participate, or, if higher, at par. Options comprise, as nearly as possible, such number of ordinary shares as may be purchased at the option price with the proceeds on maturity after either three, five or seven years of the savings contract, and options may normally be exercised only within six months after the third, fifth or seventh anniversary of the savings contract. Options may not be transferred or assigned.
(ii) During a five year period, no more than 5% in aggregate of the issued ordinary share capital of the company from time to time may be issued pursuant to all of the employee share schemes operated by the company.
The following table summarises fair values of options issued in each year: Exercise price Fair value Life Exercise price Fair value Life Exercise price Fair value Life
Note: (1) For the purposes of calculating a fair value on executive scheme options, an option life of 5 years, being the mid-point on the 10 year option, has been assumed. Historical exercise trends have not been used as these are not felt to be indicative of future trends given changes to the scheme rules and participants in the scheme.
Weighted Weighted Weighted Number of average Number of average Number of average options exercise price options exercise price options exercise price Year exercisable 000’s pence 000’s pence 000’s pence
Goodwill and intangible assets other than goodwill The Group fully implemented SFAS 142 ‘Goodwill and Other Intangible Assets’ from 1 January 2002. Under this standard, goodwill and intangible assets deemed to have indefinite lives are not amortised and are subject to annual impairment tests. Other intangible assets continue to be amortised over their useful lives. The Group has completed the impairment tests required under SFAS 142 and no impairment has been recognised as a result.
Securitisations The Group engages in securitisation activities pertaining to certain of its assets including US commercial and residential mortgage loans, commercial and residential mortgage related securities, US Government agency collateralised mortgage obligations, and other types of financial assets. Additionally, the Group acts as an underwriter and depositor in securitisation transactions involving both client and proprietary transactions. The Group has classified these activities into three broad securitisation categories, US Agency based, consumer based, and commercial based securitisations.
During 2004, the Group received proceeds of approximately £31.4 billion (2003 – £37.5 billion) from securitisation trusts in connection with new securitisations.
Intangible assets other than goodwill A summary of the carrying value of intangible assets other than goodwill is as follows: Gross Net Gross Net Gross Net carrying Accumulated carrying carrying Accumulated carrying carrying Accumulated carrying amount amortisation amount amount amortisation amount amount amortisation amount £m £m £m £m £m £m £m £m £m.
Weighted average life 1-19 years 1-16 years 1-7 years Cash flow discount rate 2-27% 2-78% 2-12%
Key economic assumptions and the sensitivity of the current fair value of retained interests at 31 December 2004 to immediate adverse changes, as indicated below, in those assumptions are as follows: U.S. Agency Consumer Commercial retained retained retained
Fair value of retained interests at 31 December 2004 £509m £864m £56m
Impact on fair value of 10% adverse change N/A £7.0m N/A Impact on fair value of 20% adverse change N/A £14.3m N/A
Notes: (1) Constant prepayment rate – the CPR range represents the low and high points of a dynamic CPR curve
(3) Population consists of securities whose collateral is guaranteed by US Government Sponsored Entities and therefore, no credit loss has been assumed.
In some instances, the Group retained certain interests. The Group typically does not retain a significant portion of the loans or securities that it securitises. This reduces the impact that changes to fair values of retained interests might have on the Group’s financial results.
At 31 December 2004, the fair value of the Group’s retained interests was approximately £1.4 billion (2003 – £1.5 billion). These retained interests comprises approximately £509 million in US Agency based retained interests, £864 million in consumer based retained interests and £56 million in commercial based retained interests. These retained interests primarily relate to mortgage loans and securities and arose from securitisations that have taken place in current and prior years.
Cash flows received in 2004 from retained interests held at 31 December 2004 in connection with securitisations that took place in current and prior years amounted to approximately 53 Significant differences between UK and US generally accepted accounting principles (continued)
Consolidation Special purpose entities (“SPEs”) The Group is the primary beneficiary of a number of commercial paper conduits and other asset securitisation vehicles that meet FIN 46R’s definition of a variable interest entity. These entities, with total assets of £8.6 billion at 31 December 2004 (2003 – £6.9 billion), acquire financial assets from third parties or from the Group funded by the issue of commercial paper or other debt instruments. The Group supplies certain administrative services and provides credit enhancement, liquidity facilities and derivative transactions to some or all of these entities on an arm’s length basis. In the case of commercial paper conduits, the Group provides programme-wide credit enhancement by letters of credit or loan facilities across all tranches of assets funded by conduits.
The trust preferred securities and partnership preferred securities issued by the Group’s subsidiaries are deconsolidated, resulting in a US GAAP balance sheet reclassification from minority interests to subordinated liabilities. The effect on US GAAP net income and equity is negligible.
A d d iti on al in fo rm at io n
Contents 202 Five year financial summary 206 Analysis of loans and advances to customers 207 Provisions for bad and doubtful debts 210 Risk elements in lending and potential problem loans 211 Analysis of deposits 212 Short term borrowings 212 Certificates of deposit and other time deposits 213 Exchange rates 214 Off balance sheet arrangements 216 Economic and monetary environment 216 Supervision and regulation 220 Description of property and equipment 220 Major shareholders 220 Material contracts
A dd iti on al in fo rm a tio n Additional information
Five year financial summary The Group’s accounts are prepared in accordance with UK GAAP, which differs in certain material respects from US GAAP. For a discussion of such differences and a reconciliation between UK GAAP and US GAAP, see Note 53 on the accounts. The dollar financial information included below has been translated for convenience at the rate of £1.00 to US$1.916, the Noon Buying Rate on 31 December 2004.
Additional Value Shares dividend – non-equity — — 1,463 798 399 — Profit attributable to ordinary shareholders 8,155 4,256 2,254 2,034 1,868 1,572
Amounts in accordance with US GAAP: Net income available for ordinary shareholders 7,564 3,948 2,564 3,108 2,062 2,102
Non-cumulative convertible preference shares of US$0.01 – Series 1 91.18 49.05 54.89 59.15 62.70 50.22
Non-cumulative convertible preference shares of €0.01 – Series 1 84.67 44.19 49.58 44.45 41.34 34.55
Non-cumulative convertible preference shares of £0.01 – Series 1 141.53 73.87 73.87 73.87 73.87 3.28
Non-cumulative convertible preference shares of £0.25 — — — — 0.08 0.07
Ordinary dividends 2004 2004 2003 2002 2001 2000 Amount per share cents pence pence pence pence pence
Amounts in accordance with UK GAAP (1): Loans and advances to banks (net of provisions) 111,626 58,260 51,891 44,296 38,513 32,061 Loans and advances to customers (net of provisions) 661,918 345,469 252,531 223,324 190,492 168,076 Debt securities and equity shares 180,432 94,171 82,249 68,928 65,597 59,342
Amounts in accordance with US GAAP: Notes: (1) The data as at 31 December 2003 and 2002 has been restated following the implementation of FRS 17. It is not practicable to restate prior years.
Other financial data based upon UK GAAP (1): Earnings per ordinary share – pence 138.0 76.9 70.6 67.6 66.9 Diluted earnings per ordinary share – pence (2) 136.9 76.3 69.6 66.3 66.2 Adjusted earnings per ordinary share – pence 172.5 157.2 146.3 127.9 101.2 Dividends per ordinary share – pence 58.0 50.3 43.7 38.0 33.0
Share price per ordinary share at period end – £ 17.52 16.46 14.88 16.72 15.82 Market capitalisation at period end – £bn 55.6 48.8 43.2 47.8 42.4 Net asset value per ordinary share – £ 8.62 7.82 7.43 7.79 7.08 Return on average total assets (3) 0.82% 0.51% 0.52% 0.53% 0.58% Return on average equity shareholders’ funds (4) 16.0% 9.8% 8.8% 8.9% 9.9% Adjusted return on average equity shareholders’ funds (5) 20.1% 20.1% 18.3% 16.8% 14.9% Average shareholders’ equity as a percentage
Return on average total assets (3) 0.71% 0.55% 0.75% 0.57% 0.77% Return on average equity shareholders’ funds (4) 12.8% 9.5% 12.1% 8.8% 12.0% Average shareholders’ equity as a percentage
Ratio of earnings to combined fixed charges and preference share dividends (6)
(2) Convertible preference shares totalling nil (2003 and 2002 – £200 million; 2001 and 2000 – £800 million), nil (2003, 2002, 2001 and 2000 – €750 million) and $1,500 million (2003, 2002, 2001 and 2000 – $1,900 million) have not been included in the computation of diluted earnings per share as their effect is anti-dilutive.
Provisions for bad and doubtful debts For a discussion of the factors considered in determining the amount of the provisions, see ‘Provisions’ on page 101 and ‘Critical accounting polices – Provisions for bad and doubtful debts’ on page 61.
Currency translation and other adjustments Domestic (8) (2) (4) 4 (1)
The following table presents additional information with respect to the provisions for bad and doubtful debts.
Loans and advances to customers (gross) 349,691 256,453 227,244 194,137 171,215
Provisions at end of period: Customer provision at end of period as % of loans and advances to customers at end of period: Average loans and advances to customers (gross) 298,150 245,798 211,206 181,584 142,288
Analysis of closing provisions for bad and doubtful debts The following table analyses customer provisions for bad and doubtful debts by geographical area and type of domestic customer.
Service industries and business activities 516 8.8 599 11.4 699 11.5 627 12.9 665 12.2
Finance leases and instalment credit 122 3.7 136 4.6 208 5.2 164 5.8 149 6.3
Service industries and business activities 1 3 1 5 45 Agriculture, forestry and fishing — — — — 3
Loans accounted for on a non-accrual basis (3): Accruing loans which are contractually overdue 90 days or more as to principal or interest (4): Loans not included above which are classified as ‘troubled debt restructurings’ by the SEC: Total risk elements in lending 5,529 5,157 4,871 4,493 3,821 Potential problem loans (5)
Closing provisions for bad and doubtful debts as a % of total risk elements in lending 76% 76% 80% 81% 82% Closing provisions for bad and doubtful debts as a % of total risk elements in lending and potential problem loans 73% 68% 65% 65% 68% Risk elements in lending as a % of gross loans
Analysis of deposits – product analysis The following table shows the distribution of the Group’s deposits by type and geographical area: £m £m £m
Analysis of deposits – currency analysis The following table shows the distribution of deposits by banks and customer accounts by sterling and other currencies: £m £m £m
Certificates of deposit and other time deposits The following table shows details of the Group’s certificates of deposit and other time deposits over $100,000 or equivalent by remaining maturity.
Over 3 months Over 6 months Within but within but within Over 2004 3 months 6 months 12 months 12 months Total £m £m £m £m £m
Noon Buying Rate Period end rate 1.9160 1.7842 1.6095 1.4543 1.4955 Average rate for the period (1) 1.8356 1.6450 1.5043 1.4396 1.5204
(2) The rates used by the Group for translating dollars into sterling in the preparation of its financial statements.
(3) On 22 February 2005, the Noon Buying Rate was £1.00 = $1.9092.
Under UK GAAP, the Group accounts for securitisations of assets originated by the Group in accordance with FRS 5 ‘Reporting the Substance of Transactions’. Assets are derecognised and a gain or loss on disposal recognised if all significant rights or access to benefits relating to those assets and all significant risks in those benefits are transferred to others. In cases where there is a significant change in the entity’s rights to benefit and exposure to risk, the description or monetary amount relating to an asset should be changed and a liability recognised for any obligation to transfer benefits that is assumed. Where a transaction in previously recognised assets results in no significant change in the entity’s rights to benefits in the assets or its exposure to risks inherent in those benefits, the assets should continue to be recognised and no gain or loss recognised. FRS 5 requires a linked presentation where a transaction is in substance the financing of an asset or pool of assets but where the item is financed in such a way that the Group can suffer a loss which is limited to a fixed monetary amount. The linked presentation involves showing the gross amount of assets securitised less the related finance on the face of the balance sheet – the net amount is included in total assets. Profit is recognised on entering into the arrangement only to the extent that non-returnable proceeds exceed the previous carrying value of the assets securitised. The Group securitises mortgage loans and other assets.
Under US GAAP, transfers of financial assets are accounted for and reported based on the application of a financialcomponents approach that focuses on control. Under this approach, after a transfer of financial assets, the Group recognises the assets it controls and the liabilities it has incurred, derecognises financial assets when control has been surrendered, and derecognises liabilities when extinguished.
Following the issue of FASB Interpretation (“FIN”) No. 46 (revised), the Group has consolidated SPVs acting as commercial paper conduits and involved in other asset-backed transactions in its US GAAP disclosures. Further information on FIN 46R can be found in Note 53 on page 199.
Guarantees and other contingent liabilities The Group gives guarantees on behalf of customers. A financial guarantee represents an irrevocable undertaking that the Group will meet a customer’s obligations to third parties if the customer fails to do so. The maximum amount that the Group could be required to pay under a guarantee is its principal amount. The Group expects most guarantees it provides to expire unused. Other contingent liabilities include contingent liabilities arising out of acceptances, endorsements,
Less than less than less than Over 1 year 3 years 5 years 5 years Total 2004 £m £m £m £m £m
Acceptances and endorsements 362 — — — 362 Guarantees and assets pledged as collateral security 3,974 1,729 1,893 2,842 10,438
Documentary credits and trade related transactions 135 30 6 11 182 Undrawn formal standby facilities, credit lines and other commitments to lend 118,367 23,045 21,216 16,602 179,230
Documentary credits and trade related transactions 368 210 2 25 605 Undrawn formal standby facilities, credit lines and other commitments to lend 95,062 18,082 14,053 10,054 137,251
Unconditional obligations to purchase goods or services 552 346 148 152 1,198
Unconditional obligations to purchase goods or services 661 211 3 — 875
The tables above do not include undated loan capital. The maturity of deposits by banks is given in Note 23 on the accounts, of customer accounts in Note 24, and of debt securities in issue in Note 25.
The Bank of England has operational independence in setting the repo rate to achieve the inflation target. The Bank was given independence by the Chancellor of the Exchequer in 1997, with the aim of making monetary policy free from political influence, and therefore more stable and credible. The Bank’s Monetary Policy Committee ("MPC") meets each month to agree any change to interest rates, and the minutes of these meetings are published two weeks later. One-off meetings can also be held in exceptional circumstances. In response to the downturn in the global economy and the terrorist attacks, the Bank of England, along with other major central banks around the world, cut rates sharply in 2001. Rates remained at exceptionally low levels throughout 2002, and were reduced again in the first half of 2003, reflecting the uncertain nature of the global and domestic economic circumstances. However, signs of recovery in the global economy led the Bank of England to increase rates five times since November 2003, to 4.75%.
The value of sterling is also important for UK monetary conditions. The monetary authorities do not have an exchange rate target, but movements in sterling played a role in the MPC’s monthly debates.
European Economic and Monetary Union (“EMU”) The new European single currency, the euro, came into being on 1 January 1999. The third stage of EMU started on schedule on 1 January 1999. During the course of 1998, it was determined that eleven countries (Austria, Belgium, Finland, France, Germany, Ireland, Italy, Luxembourg, the Netherlands, Portugal and Spain) would participate. The UK, along with Denmark, exercised its right to opt out at that stage, and Sweden also determined not to be part of this first wave.
On 31 December 1998, the European Currency Unit (the "ECU") was replaced by the euro on the international currency markets, on a one-for-one basis. The rates for the euro against other international currencies were based upon the official closing rates for the ECU. The bilateral rates for the legacy currencies of the participating states were derived from their rates within the Exchange Rate Mechanism and the closing value of the ECU. These rates, between the legacy currencies and between these currencies and the euro, were fixed as of 1 January 1999. The euro became the formal currency for all eleven then-participating states.
Uncertainty continues on the likelihood and timing of the euro being introduced in the UK. It is not possible to estimate with any degree of certainty the ultimate cost of making systems and operations fully compliant. Expenditure in the year ended 31 December 2004 in preparation for the possible introduction of the euro in the UK was minimal.
Supervision and regulation 1 United Kingdom 1.1 The regulatory regime applying to the
UK financial services industry The Financial Services and Markets Act 2000 (“FSMA 2000”), containing an integrated legislative framework for regulating most of the UK financial services industry, came into force at the end of 2001. This established the Financial Services Authority (the “FSA”) as the single statutory regulator responsible for regulating deposit taking, insurance and investment business in the UK.
The FSA supervises the banking business of the UK based banks in the Group, including The Royal Bank of Scotland plc (“The Royal Bank”), National Westminster Bank Plc (“NatWest”), Coutts & Co, Ulster Bank Limited and Tesco Personal Finance Limited.
The FSA can request information from and give directions to, authorised firms. It may also require authorised firms to provide independent reports prepared by professionals. The FSA can exercise indirect control over the holding companies of authorised firms via its statutory powers to object to persons who are, or will become, “controllers” of these firms.
Setting standards for firms The FSA carries out the prudential supervision and conduct of business regulation of all authorised firms and also regulates the conduct of their business in the UK.
The EU Financial Groups Directive came into force on 1 January 2005 and was implemented as part of the FSA’s IPSB requirements. This will create an additional set of regulatory requirements recognising the insurance, investment and banking business of certain financial sector groups as financial conglomerates.
Many of the standards relating to the capital, which firms must hold to absorb losses arising from risks to its business, are determined by EU legislation or are negotiated internationally. The current capital adequacy regime requires firms to maintain certain levels of capital, of certain specified types (or tiers), against particular business risks.
A dd iti on al in fo rm a tio n Additional information continued
As regards the insurance industry, the FSA’s primary objective is to regulate and supervise the industry so that policyholders have confidence that they have bought appropriate products, that UK insurers are able to meet their liabilities and that they treat customers fairly. The FSA sets requirements relating to “margins of solvency” (i.e. the excess of the value of assets over the amount of liabilities). Companies carrying out insurance business are required to submit regular returns covering reserves and solvency to the FSA.
The FSA’s high level principles require all regulated firms to treat their customers fairly. Since 2000 the FSA has undertaken a number of industry wide thematic reviews on this issue, and this activity will continue into 2005. The FSA have indicated that they will include assessment of firms’ effectiveness in this area in the firms’ ARROW assessments from 2005.
The Financial Services Compensation Scheme (financed by levies on authorised firms) is available to provide compensation up to certain limits if a firm collapses owing money to investors, depositors or policyholders.
1.5 Fraud Towards the end of October 2004, the FSA launched its new policy on combating fraud in the financial services industry – Fighting Fraud in Partnership. The FSA is working on a programme of activities focusing on (i) actions that the FSA will take, (ii) FSA support for work by trade associations and the industry, (iii) creating closer relationships with law enforcement agencies and, (iv) the Government making fraud a higher law enforcement priority leading the development of a fraud strategy.
The FSA also has powers under certain consumer legislation to take action against authorised firms to address unfair terms in financial services consumer contracts.
1.7 Extension of the FSA’s responsibilities From 31 October 2004, the scope of the FSA’s responsibilities was widened to cover the regulation and supervision of mortgage lending and administration and the provision of mortgage advice. Arrangements relating to the sale and administration of general insurance (and certain other insurance) contracts became regulated from 15 January 2005. These activities are undertaken by companies in the Group and this extension of the scope of statutory regulation is likely to have a significant impact on how the relevant businesses operate in the future.
A dd iti on al in fo rm a tio n A
3 Regulatory developments for capital and risk management The Basel Committee on Banking Supervision, which meets at the Bank of International Settlements in Switzerland, sets the standards for firm’s weighted risk asset calculations and associated regulatory capital triggers. This Committee published a revised framework, called Basel 2, in June 2004. Full adoption of these new rules is expected by January 2008.
Freehold and long leasehold properties are revalued on a rolling basis, each property being valued at least once every five years. Interim valuations outwith the five year cycle are carried out on properties where there is an indication that its value has changed significantly, given market conditions. Any increase or deficit on revaluation is reflected in the carrying value of premises at that time. Any impairment in the value of premises where there is a clear consumption of economic benefits is charged in full to the profit and loss account. Other impairments of premises are charged to the profit and loss account after eliminating any previous revaluation surplus on the premises. Any profit from the sale of revalued premises is calculated by deducting the revalued amount from the net proceeds. The revaluation of premises at 31 December 2004 resulted in a £56 million increase in property revaluation reserves.
Total capital expenditure on premises, computers and other equipment for the year ended 31 December 2004 was £1,513
Major shareholders Details of major shareholders in the company’s ordinary and preference shares are given on page 117.
At 23 February 2005, the directors of the company had options to purchase a total of 1,800,211 ordinary shares of the company.
As at 31 December 2004, almost all of the company’s US$ denominated preference shares were held by shareholders registered in the US. All other shares were predominantly held by shareholders registered outside the US.
Contents 222 Financial calendar 222 Shareholder enquiries 222 Capital gains tax 223 Analyses of ordinary shareholders 223 Trading market 225 Memorandum and articles of association 225 Taxation for US holders 230 Exchange controls 230 Documents on display 231 Important addresses 231 Principal offices
Dividends Payment dates: *Ordinary shares (2004 Final) 3 June 2005 Ordinary shares (2005 Interim) October 2005 Cumulative preference shares 31 May and 30 December 2005 Non-cumulative dollar preference shares 31 March, 30 June, 30 September and 30 December 2005
Ex-dividend dates: Ordinary shares (2004 Final) 9 March 2005 Cumulative preference shares 4 May 2005
Record dates: Ordinary shares (2004 Final) 11 March 2005 Cumulative preference shares 6 May 2005 * If the necessary approvals are obtained from shareholders at the annual general meeting on 20 April 2005, as an alternative to cash, a scrip dividend election will be offered and shareholders will receive details of this by letter after that date.
ShareGift The company is aware that shareholders who hold a small number of shares may be retaining these shares because dealing costs make it uneconomical to dispose of them. ShareGift, the charity share donation scheme is a free service operated by The Orr Mackintosh Foundation (registered charity 1052686) to enable shareholders to donate unwanted shares to charity.
Should you wish to donate your shares to charity in this way you should contact ShareGift for further information: ShareGift, The Orr Mackintosh Foundation, 46 Grosvenor Street, London W1K 3HN
Capital gains tax For shareholders who held RBS ordinary shares at 31 March 1982, the market value of one ordinary share held was 103p. After adjusting for the 1 March 1985 rights issue, the 1 September 1989 capitalisation issue and the bonus issue of Additional Value Shares on 12 July 2000, the adjusted 31 March 1982 base value of one ordinary share held currently is 46.1p.
Each of the respective ADSs represents the right to receive one corresponding preference share, is evidenced by an American Depositary Receipt (“ADR”) and is listed on the New York Stock Exchange (“NYSE”).
The ADSs, the X-CAPs and the PRO’s are listed on the NYSE.
Taxation for US Holders The following discussion summarises certain US federal and UK tax consequences of the acquisition, ownership and disposition of non-cumulative dollar preference shares, ADSs, X-CAPs or PROs by a beneficial owner that is a citizen or resident of the United States or that otherwise will be subject to US federal income tax on a net income basis in respect of the non-cumulative dollar preference shares, ADSs, X-CAPs or PROs (a “US Holder”). This summary assumes that a US Holder is holding non-cumulative dollar preference shares, ADSs, X-CAPs or PROs, as applicable, as capital assets. This summary does not address the tax consequences to a US Holder (i) that is resident (or, in the case of an individual, ordinarily resident) in the UK for UK tax purposes or (ii) generally, that is a corporation which alone or together with one or more associated companies, controls, directly or indirectly, 10% or more of the voting stock of the company.
Subject to applicable limitations that may vary depending upon a holder’s individual circumstances, dividends paid to certain noncorporate US Holders in taxable years beginning before 1 January 2009 will be taxable at a maximum tax rate of 15%. Non-corporate US Holders should consult their own tax advisers to determine whether they are subject to any special rules that limit their ability to be taxed at this favourable rate.
Taxation of capital gains A US Holder that is not resident (or, in the case of an individual, ordinarily resident) in the UK will not normally be liable for UK tax on capital gains realised on the disposition of such holder’s non-cumulative dollar preference share or ADS unless at the time of the disposal, in the case of a corporate US Holder, such US Holder carries on a trade in the UK through a permanent establishment or, in the case of any other US Holder, such US Holder carries on a trade, profession or vocation in the UK through a UK branch or agency and such non-cumulative dollar preference share or ADS is or has been used, held or acquired by or for the purposes of such trade (or profession or vocation), permanent establishment, branch or agency. Special rules apply to individuals who are temporarily not resident or ordinarily resident in the UK.
A US Holder who is liable for both UK and US tax on gain recognised on the disposal of a non-cumulative dollar preference share or ADS will generally be entitled, subject to certain limitations, to credit the UK tax against its US federal income tax liability in respect of such gain.
UK stamp duty and stamp duty reserve tax (“SDRT”) The following is a summary of the UK stamp duty and SDRT consequences of transferring an ADS in registered form (otherwise than to the custodian on cancellation of the ADS) or of transferring a non-cumulative dollar preference share. A transfer of a registered ADS executed and retained in the United States will not give rise to stamp duty and an agreement to transfer a registered ADS will not give rise to SDRT.
Stamp duty or SDRT will normally be payable on or in respect of transfers of non-cumulative dollar preference shares and accordingly any holder who acquires or intends to acquire non-cumulative dollar preference shares is advised to consult its own tax advisers in relation to stamp duty and SDRT.
Payments (including any UK withholding tax, as to which see below) will constitute foreign source dividend income for US federal income tax purposes to the extent paid out of the current or accumulated earnings and profits of the company, as determined for US federal income tax purposes. Payments will not be eligible for the dividends-received deduction allowed to corporate US Holders.
EU Directive on taxation of savings income The European Union has adopted a new directive regarding the taxation of savings income. Subject to a number of important conditions being met, Member States of the European Union will be required from a date not earlier than 1 July 2005 to provide to the tax authorities of other Member States details of payments of interest or other similar income paid by a person to an individual in another Member State, except that Belgium, Luxembourg and Austria will instead impose a withholding system for a transitional period unless during such period they elect otherwise.
Disposal (including redemption) A disposal (including redemption) of X-CAPs by a noncorporate US Holder, will not give rise to any liability to UK taxation on capital gains unless the US Holder carries on a trade (which for this purpose includes a profession or vocation) in the UK through a branch or agency and the X-CAPs are, or have been, held or acquired for the purposes of that trade, branch or agency. The exchange by such US Holder of X-CAPs for preference shares or ADSs pursuant to the company’s exercise of its exchange right will not give rise to a charge to UK tax on capital gains even if such US Holder would be subject to tax on a disposal of such holder’s X-CAPs in accordance with the tax treatment referred to previously.
A transfer of X-CAPs by a US Holder will not give rise to a charge to UK tax on accrued but unpaid interest payments, unless the US Holder is an individual or other non-corporate tax payer and at any time in the relevant year of assessment or accounting period carries on a trade in the UK through a branch or agency to which the X-CAPs are attributable.
Annual tax charges Corporate US Holders of X-CAPs may be subject to annual UK tax charges (or relief) by reference to fluctuations in exchange rates and in respect of profits, gains and losses arising from the X-CAPs, but only if such corporate US Holders carry on a trade, profession or vocation in the UK through a UK permanent establishment to which the X-CAPs are attributable.
Stamp duty and SDRT No UK stamp duty is payable on the transfer by delivery or redemption of bearer X-CAPs, whether in definitive form or in the form of one or more global X-CAPs. No SDRT is payable on any agreement to transfer bearer X-CAPs provided that the agreement is not made in contemplation of, or as part of an arrangement for, a takeover of the company.
A US Holder will, upon the sale, exchange or redemption of a PRO, generally recognise capital gain or loss for US federal income tax purposes in an amount equal to the difference between the amount realised (excluding any amount in respect of mandatory interest and any Missed Payments which are to be satisfied on a Missed Payment Satisfaction Date, which would be treated as ordinary income and the US Holder’s tax basis in the PRO (assuming, in the case of a redemption, that such US Holder does not own, and is not deemed to own, any ordinary shares of the company). A US Holder who is liable for both UK and US tax on a gain recognised on the disposal of PROs will generally be entitled, subject to certain limitations, to credit the UK tax against its US federal income tax liability in respect of such gain.
Any paying agent or other person by or through whom interest is paid to, or by whom interest is received on behalf of, an individual, may be required to provide information in relation to the payment and the individual concerned to the UK Inland Revenue. The Inland Revenue may communicate this information to the tax authorities of other jurisdictions.
The UK Inland Revenue confirmed at around the time of the issue of the PROs that interest payments would not be treated as distributions for UK tax purposes by reason of (i) the fact that interest may be deferred under the terms of issue or (ii) the undated nature of the PROs, provided that at the time an interest payment is made, the PROs are not held by a company which is ‘associated’ with the company or by a ‘funded company’. A company will be associated with the company if, broadly speaking, it is part of the same group as the company. A company will be a ‘funded company’ for these purposes if there are arrangements involving that company being put in funds (directly or indirectly) by the company, or an entity associated with the company. In this respect, the Inland Revenue has confirmed that a company holding an interest in the PROs which incidentally has banking facilities with any company associated with the company will not be a ‘funded company’ by virtue of such facilities.
Disposal (including redemption) A disposal (including redemption) of PROs by a non-corporate US Holder, will not give rise to any liability to UK taxation on capital gains unless the US Holder carries on a trade (which for this purpose includes a profession or a vocation) in the UK through a branch or agency and the PROs are, or have been, held or acquired for the purposes of that trade, branch or agency.
Annual tax charges Corporate US Holders of PROs may be subject to annual UK tax charges (or relief) by reference to fluctuations in exchange rates and in respect of profits, gains and losses arising from the PROs, but only if such corporate US Holders carry on a trade, profession or vocation in the UK through a UK permanent establishment to which the PROs are attributable.
Inheritance tax In relation to PROs held through DTC (or any other clearing system), the UK inheritance tax position is not free from doubt in respect of a lifetime transfer, or death of, a US Holder who is not domiciled nor deemed to be domiciled in the UK for inheritance tax purposes; the UK Inland Revenue are known to consider that the situs of securities held in this manner is not necessarily determined by the place where the securities are registered. In appropriate circumstances, there may be a charge to UK inheritance tax as a result of a lifetime transfer at less than fair market value by, or on the death of, such US Holder. However, exemption from, or a reduction of, any such UK tax liability may be available under the Estate Tax Treaty. US Holders should consult their professional advisers in relation to such potential liability.
Exchange controls The company has been advised that there are currently no UK laws, decrees or regulations which would prevent the remittance of dividends or other payments to non-UK resident holders of the company’s non-cumulative dollar preference shares.
Documents on display Documents concerning the company may be inspected at 36 St Andrew Square, Edinburgh, EH2 2YB (telephone 0131
Principal offices The company 42 St Andrew Square Edinburgh EH2 2YE
Citizens Citizens Financial Group, Inc. One Citizens Plaza Providence Rhode Island 02903 USA
RBS Insurance Direct Line House 3 Edridge Road Croydon Surrey CR9 1AG Churchill Court West Moreland Road Bromley BR1 1DP
NatWest Offshore 23/25 Broad Street St Helier Jersey Channel Islands JE4 8QG
The registered office of the company is 36 St Andrew Square Edinburgh EH2 2YB (telephone 0131 556 8555).