The table below analyses debt securities by issuer and measurement classification. The categorisation of debt securities has been revised to include asset-backed securities (ABS) by class of issuer. The main changes are to US central and local government which includes US federal agencies, and financial institutions which now includes US government sponsored agencies and securitisation entities. 2010 data are presented on the revised basis.
Held-for-trading (HFT) 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
Total of which US agencies — 4,896 — — 25,924 — 30,820 28,558 Short positions (HFT) (3,098) (10,661) (19,136) (2,556) (2,854) (754) (39,059) (352)
Total of which US agencies — 6,811 — — 21,686 — 28,497 25,375 Short positions (HFT) (4,200) (10,943) (18,913) (1,844) (3,356) (1,761) (41,017) (1,335)
The Group’s AFS portfolio decreased by £3.8 billion. UK government bonds increased by £5.1 billion, principally in the Group Treasury portfolio.
Gross exposure RMBS: government sponsored or similar 27,549 — 5,884 2 33,435 15,031 — 18,404 — RMBS: prime 1,201 3,487 1,541 484 6,713 1,090 567 4,977 79 RMBS: non-conforming 1,220 2,197 74 — 3,491 717 — 1,402 1,372 RMBS: sub-prime 1,847 427 94 2 2,370 2,183 — 22 165 MBS: covered bond 133 203 8,256 — 8,592 — — 8,592 — CMBS 1,623 1,562 883 1 4,069 2,001 — 862 1,206 CDOs 7,889 72 469 — 8,430 4,455 — 3,885 90 CLOs 5,019 156 1,055 — 6,230 1,294 — 4,734 202 ABS covered bond 21 71 948 4 1,044 — — 1,044 — Other ABS 2,085 1,844 1,746 992 6,667 1,965 17 2,389 2,296 48,587 10,019 20,950 1,485 81,041 28,736 584 46,311 5,410
Risk management: Credit risk continued Balance sheet analysis: Asset-backed securities by product, geography and measurement classification continued
Gross exposure RMBS: government sponsored or similar 24,207 16 6,422 — 30,645 13,840 — 16,805 — RMBS: prime 1,784 3,385 1,118 192 6,479 1,605 1 4,749 124 RMBS: non-conforming 1,249 2,107 92 — 3,448 708 — 1,313 1,427 RMBS: sub-prime 792 365 139 221 1,517 819 — 496 202 MBS: covered bond 138 208 8,525 — 8,871 — — 8,871 — CMBS 3,086 1,451 912 45 5,494 2,646 120 1,409 1,319 CDOs 12,156 128 453 — 12,737 7,951 — 4,687 99 CLOs 6,038 134 879 9 7,060 1,062 — 5,572 426 ABS covered bond — — 1,908 — 1,908 — — 1,908 — Other ABS 3,104 1,144 963 1,705 6,916 1,533 — 2,615 2,768 52,554 8,938 21,411 2,172 85,075 30,164 121 48,425 6,365
Carrying value RMBS: government sponsored or similar 24,390 16 5,958 — 30,364 13,765 — 16,599 — RMBS: prime 1,624 3,000 931 192 5,747 1,384 1 4,249 113 RMBS: non-conforming 1,084 1,959 92 — 3,135 605 — 1,102 1,428 RMBS: sub-prime 638 255 120 205 1,218 681 — 344 193 MBS: covered bond 142 208 7,522 — 7,872 — — 7,872 — CMBS 2,936 1,338 638 38 4,950 2,262 118 1,281 1,289 CDOs 3,135 69 254 — 3,458 1,341 — 2,021 96 CLOs 5,334 102 635 3 6,074 691 — 4,958 425 ABS covered bond — — 1,861 — 1,861 — — 1,861 — Other ABS 2,780 945 754 1,667 6,146 1,259 — 2,228 2,659 42,063 7,892 18,765 2,105 70,825 21,988 119 42,515 6,203
Net exposure RMBS: government sponsored or similar 24,390 16 5,958 — 30,364 13,765 — 16,599 — RMBS: prime 1,523 2,948 596 192 5,259 897 1 4,248 113 RMBS: non-conforming 1,081 1,959 92 — 3,132 602 — 1,102 1,428 RMBS: sub-prime 289 253 112 176 830 305 — 332 193 MBS: covered bond 142 208 7,522 — 7,872 — — 7,872 — CMBS 1,823 1,336 458 38 3,655 1,188 10 1,230 1,227 CDOs 1,085 39 245 — 1,369 743 — 530 96 CLOs 1,387 102 629 1 2,119 673 — 1,021 425 ABS covered bond — — 1,861 — 1,861 — — 1,861 — Other ABS 2,293 748 748 1,659 5,448 690 — 2,220 2,538 34,013 7,609 18,221 2,066 61,909 18,863 11 37,015 6,020
Notes: (1) Fair value through profit or loss. (2) Held-for-trading. (3) Designated as at fair value. (4) Available-for-sale. (5) Loans and receivables.
Risk management: Credit risk continued Balance sheet analysis: Asset-backed securities continued The table below summarises the rating levels of ABS carrying values. Credit ratings are based on those from rating agencies Standard & Poor’s (S&P), Moody’s and Fitch and have been mapped onto the S&P scale.
Key points Carrying value of total ABS decreased by £3.5 billion during 2011. US government sponsored RMBS increased by £3.6 billion, reflecting a move towards G10 governments generally, partially offset by decrease in European exposure. There were reductions across all other portfolios.
CDOs and CLOs decreased by £2.2 billion principally reflecting asset reductions in Non-Core.
Europe RoW Total Government sponsored Covered bond Prime Nonconforming Sub-prime 2011 £m £m £m £m £m £m £m £m £m £m
Derivatives The Group's derivative assets by internal asset quality rating and residual maturity are analysed below. Master netting arrangements in respect of markto -market (mtm) positions and collateral shown below do not result in a net presentation on the Group’s balance sheet under IFRS.
Contract type Notional £bn Assets £m Liabilities £m Notional £bn Assets £m Liabilities £m Notional £bn Assets £m Liabilities £m Interest rate 38,722 422,156 406,709 39,760 311,731 299,209 43,230 323,592 311,415 Exchange rate 4,479 74,492 80,980 4,854 83,253 89,375 3,842 69,283 63,919 Credit derivatives 1,054 26,836 26,743 1,357 26,872 25,344 1,621 41,748 39,127 Equity and commodity 123 6,134 9,551 179 5,221 10,039 188 6,831 9,680 529,618 523,983 427,077 423,967 441,454 424,141
Key points Net exposure, after taking account of position and collateral netting arrangements, declined by 23% despite an increase in derivative carrying values, primarily due to the increased use of netting arrangements.
Interest rate contracts increased due to continued reductions in interest rate yields and the depreciation of sterling against the US dollar. This was partially offset by the appreciation of sterling against the euro.
Exchange rate contracts decreased due to a reduction in trade volumes and the appreciation of sterling against the euro. This was partially offset by the depreciation of sterling against the US dollar.
Credit derivatives remained flat as the increase from the widening of credit spreads and the depreciation of sterling against the US dollar was offset by a reduction in trade volume.
Exchange rate 23,838 8,434 9,766 19,176 13,278 74,492 (57,511) 16,981 Interest rate 3,977 3,197 7,672 102,163 305,147 422,156 (356,325) 65,831 Credit derivatives 135 332 626 15,675 10,068 26,836 (23,980) 2,856 Equity and commodity 542 603 1,128 3,360 501 6,134 (3,810) 2,324 28,492 12,566 19,192 140,374 328,994 529,618 (441,626) 87,992
Cash collateral held against derivative exposures (1) (31,096) Net exposure 65,584 2009 Exchange rate 19,127 5,824 7,603 23,831 11,967 68,352 (47,885) 20,467 Interest rate 8,415 8,380 16,723 111,144 176,799 321,461 (270,791) 50,670 Credit derivatives 201 112 390 19,859 21,186 41,748 (36,411) 5,337 Equity and commodity 1,562 436 1,109 3,057 474 6,638 (3,830) 2,808 29,305 14,752 25,825 157,891 210,426 438,199 (358,917) 79,282
Bought Sold Bought Sold Bought Sold Bought Sold £bn £bn £bn £bn £bn £bn £bn £bn
Client-led trading and residual risk 401.0 390.5 17.0 16.5 386.7 362.5 8.4 6.7 Credit hedging - banking book (1) 15.6 4.7 0.1 0.1 16.3 21.8 — 0.1 Credit hedging - trading book - Rates 21.2 17.1 0.9 1.7 21.9 10.4 (0.9) 0.2 - Credit and mortgage markets 42.9 28.4 2.3 1.7 168.1 172.7 3.5 3.1 - Other 0.9 0.1 — — 0.7 0.1 — — Total excluding APS 481.6 440.8 20.3 20.0 593.7 567.5 11.0 10.1 APS 131.8 — (0.2) — 195.8 — 0.6 —
Client-led trading 371.0 369.4 14.6 14.0 347.5 343.0 5.2 4.4 Credit hedging - banking book 2.2 1.0 — 0.1 1.1 1.0 (0.2) — Credit hedging - trading book - Rates 19.9 16.2 0.9 1.7 21.7 10.3 (0.8) 0.2 - Credit and mortgage markets 4.6 4.0 0.3 0.2 4.4 4.3 0.2 0.3 - Other 0.7 0.1 — — 0.6 0.1 — — 398.4 390.7 15.8 16.0 375.3 358.7 4.4 4.9
Non-Core Residual risk 30.0 21.1 2.4 2.5 39.2 19.5 3.2 2.3 Credit hedging - banking book 13.4 3.7 0.1 — 15.2 20.8 0.2 0.1 Credit hedging - trading book - Rates 1.3 0.9 — — 0.2 0.1 (0.1) — - Credit and mortgage markets 38.3 24.4 2.0 1.5 163.7 168.4 3.3 2.8 - Other 0.2 — — — 0.1 — — — 83.2 50.1 4.5 4.0 218.4 208.8 6.6 5.2
Monoline insurers The table below summarises the Group's exposure to monolines, all of which are in Non-Core.
Gross exposure to monolines 1,888 4,023 6,170 Hedges with financial institutions (71) (71) (531) Credit valuation adjustment (1,198) (2,443) (3,796) Net exposure to monolines 619 1,509 1,843
Credit valuation adjustment at 1 January (2,443) (3,796) (5,988) Credit valuation adjustment at 31 December (1,198) (2,443) (3,796) Decrease in credit valuation adjustment 1,245 1,353 2,192 Net debit relating to realisations, hedges, foreign exchange and other movements (1,878) (844) (3,290) Net credit/(debit) relating to reclassified debt securities 197 (305) (1,468) Net (debit)/credit to income statement (1) (436) 204 (2,566)
The table below summarises monoline exposures by rating. Credit ratings are based on those from rating agencies S&P and Moody's. Where the ratings differ, the lower of the two is taken.
Key points The exposure to monolines declined during the year, primarily due to the restructuring of some our exposures, partially offset by lower prices of underlying reference instruments.
The CVA decreased in line with the reduction in exposure partially offset by the impact of wider credit spreads.
The fair value of these reclassified debt securities at 31 December 2011 was £4,453 million (1 July 2008 - £5,071 million after adjusting for both principal based cash flows and foreign exchange effects between 1 July 2008 and 31 December 2011). As a result of these reclassifications, total cumulative losses of £254 million have not been recognised in the income statement.
Gross exposure to CDPCs 1,896 1,244 1,275 Credit valuation adjustment (1,034) (490) (499) Net exposure to CDPCs 862 754 776
Credit valuation adjustment as a % of gross exposure 55% 39% 39%
The table below details the net income statement effect arising from CDPC exposures. 2011 2010 2009 £m £m £m
Other counterparties The net income statement effect arising from the change in the level of credit valuation adjustments (CVA) for all other counterparties and related trades is shown in the table below.
Key point The CVA held against exposures to other counterparties increased during the year, primarily due to wider credit spreads.
Risk elements in lending, provisions and reserves Risk elements in lending (REIL) comprises impaired loans and accruing loans past due 90 days or more as to principal or interest.
Accruing loans past due 90 days or more - UK 1,192 508 1,700 1,434 939 2,373 2,235 2,235
REIL as a % of gross loans and advances (1) 4.4% 30.1% 8.6% 3.7% 20.8% 7.3% 6.1% 5.4% Closing provision for impairment as a % of total REIL (1) 50% 48% 49% 52% 44% 47% 44% 46%
RBS Insurance and other 3,829 929 — — — — — —
UK Retail 408 108,405 4,620 2,741 4.3 59 1,160 1,135 UK Corporate 72 111,672 3,967 1,732 3.6 44 761 349 Wealth 2,220 16,130 223 66 1.4 30 18 9 Global Transaction Services 3,047 14,437 146 147 1.0 101 8 49 Ulster Bank 2,928 36,858 3,619 1,633 9.8 45 1,161 48 US Retail & Commercial 145 48,516 913 505 1.9 55 483 547 Retail & Commercial 8,820 336,018 13,488 6,824 4.0 51 3,591 2,137 Global Banking & Markets 46,073 75,981 1,719 1,042 2.3 61 146 87 RBS Insurance and other 2,140 601 — — — — — — Core 57,033 412,600 15,207 7,866 3.7 52 3,737 2,224 Non-Core 1,003 108,203 23,391 10,316 21.6 44 5,407 3,818 Group before RFS MI 58,036 520,803 38,598 18,182 7.4 47 9,144 6,042 RFS MI 2 — — — — — 42 — Group 58,038 520,803 38,598 18,182 7.4 47 9,186 6,042 2009 UK Retail 818 102,994 4,641 2,677 4.5 58 1,679 1,150 UK Corporate 91 111,580 2,330 1,271 2.1 55 923 352 Wealth 1,841 13,684 218 55 1.6 25 33 12 Global Transaction Services 1,476 12,670 197 189 1.6 96 39 23 Ulster Bank 2,637 39,707 2,260 962 5.7 43 649 34 US Retail & Commercial 30 48,907 643 478 1.3 74 702 546 Retail & Commercial 6,893 329,542 10,289 5,632 3.1 55 4,025 2,117 Global Banking & Markets 38,788 92,110 1,800 1,289 2.0 72 542 169 RBS Insurance and other 1,893 755 — — — — — — Core 47,574 422,407 12,089 6,921 2.9 57 4,567 2,286 Non-Core 1,360 147,263 22,900 8,252 15.6 36 8,523 4,192 Group before RFS MI 48,934 569,670 34,989 15,173 4.4 43 13,090 6,478 RFS MI 7,879 134,809 3,260 2,110 2.4 65 1,044 461 Group 56,813 704,479 38,249 17,283 5.4 45 14,134 6,939
Movement in REIL The table below details the movement in REIL during the year ended 31 December 2011.
Key points REIL increased by £2.2 billion in the year. REIL at 31 December 2011 excludes £1.5 billion (impaired loans £1.3 billion; accruing loans £0.2 billion) in relation to the UK branch-based businesses being sold to Santander UK plc, of which £1.0 billion was in UK Corporate and £0.5 billion in UK Retail.
Core Non-Core Total Core Non-Core Total RFS MI Total £m £m £m £m £m £m £m £m
Loans, REIL and impairments by sector and geographical region The tables below analyse gross loans and advances (excluding reverse repos and disposal groups), and related REIL, provisions, impairment charges and amounts written-off, by sector and geographical region (by location of lending office).
- residential mortgages 100,726 2,076 397 2.1 19 0.4 180 25 - personal lending 20,207 2,384 1,925 11.8 81 9.5 645 1,007 - property 55,751 7,880 2,859 14.1 36 5.1 1,413 490 - other 162,220 4,935 3,040 3.0 62 1.9 699 886 Europe - residential mortgages 18,946 2,205 713 11.6 32 3.8 467 10 - personal lending 2,464 209 180 8.5 86 7.3 25 126 - property 16,384 13,073 5,751 79.8 44 35.1 2,296 508 - other 44,862 5,192 3,206 11.6 62 7.1 1,205 289 US
- residential mortgages 702 33 12 4.7 36 1.7 3 — - personal lending 1,511 1 1 0.1 100 0.1 — — - property 850 373 160 43.9 43 18.8 (37) 35 - other 19,623 586 328 3.0 56 1.7 (25) 182 Group before RFS MI 517,865 40,845 19,883 7.9 49 3.8 7,241 4,527 RFS MI — — — — — — (8) — Group 517,865 40,845 19,883 7.9 49 3.8 7,233 4,527
- residential mortgages 101,593 2,062 314 2.0 15 0.3 169 17 - personal lending 23,620 3,083 2,518 13.1 82 10.7 1,046 1,153 - property 65,462 7,986 2,219 12.2 28 3.4 1,546 397 - other 191,934 5,652 3,580 2.9 63 1.9 1,197 704 Europe - residential mortgages 20,094 1,551 301 7.7 19 1.5 221 6 - personal lending 2,870 401 316 14.0 79 11.0 66 24 - property 17,775 10,534 4,199 59.3 40 23.6 2,828 210 - other 53,380 3,950 2,454 7.4 62 4.6 763 1,423 US
- residential mortgages 99,303 2,024 386 2.0 19 0.4 174 24 - personal lending 20,080 2,347 1,895 11.7 81 9.4 657 828 - property 31,141 2,475 568 7.9 23 1.8 379 113 - other 142,464 2,637 1,536 1.9 58 1.1 525 537 Europe - residential mortgages 18,393 2,121 664 11.5 31 3.6 437 10 - personal lending 1,972 143 125 7.3 87 6.3 (8) 22 - property 4,846 1,038 367 21.4 35 7.6 162 11 - other 33,794 2,551 1,891 7.6 74 5.6 928 182 US
Central and local government 6,781 — — — — — — — Finance - banks 57,033 144 126 0.3 88 0.2 (5) 1 - other 46,910 567 402 1.2 71 0.9 191 53 Residential mortgages 140,359 3,999 693 2.8 17 0.5 578 243 Personal lending 33,581 3,131 2,545 9.3 81 7.6 1,157 1,271 Property 42,455 3,287 818 7.7 25 1.9 739 98 Construction 8,680 610 222 7.0 36 2.6 189 38 Manufacturing 25,797 555 266 2.2 48 1.0 119 124 Service industries and business activities - retail, wholesale and repairs 21,974 611 259 2.8 42 1.2 199 103 - transport and storage 15,946 112 40 0.7 36 0.3 40 35 - health, education and recreation 17,456 507 134 2.9 26 0.8 145 64 - hotels and restaurants 8,189 741 236 9.0 32 2.9 165 49 - utilities 7,098 22 3 0.3 14 — 1 — - other 24,464 583 276 2.4 47 1.1 137 98 Agriculture, forestry and fishing 3,758 94 57 2.5 61 1.5 24 5 Finance leases and instalment credit 8,321 244 140 2.9 57 1.7 63 42 Interest accruals 831 — — — — — — — Latent — — 1,649 — — — (5) — 469,633 15,207 7,866 3.2 52 1.7 3,737 2,224 of which: UK
Central and local government 1,383 — — — — — — — Finance - banks 619 1 1 0.2 100 0.2 — — - other 3,229 317 147 9.8 46 4.6 (118) 43 Residential mortgages 5,102 380 180 7.4 47 3.5 300 318 Personal lending 1,556 110 92 7.1 84 5.9 67 351 Property 38,064 17,969 7,861 47.2 44 20.7 3,200 1,004 Construction 2,672 1,102 475 41.2 43 17.8 (39) 101 Manufacturing 4,931 423 283 8.6 67 5.7 121 90 Service industries and business activities - retail, wholesale and repairs 2,339 388 204 16.6 53 8.7 (28) 53 - transport and storage 5,477 264 94 4.8 36 1.7 31 14 - health, education and recreation 1,419 501 245 35.3 49 17.3 134 43 - hotels and restaurants 1,161 485 289 41.8 60 24.9 125 71 - utilities 1,849 66 22 3.6 33 1.2 3 3 - other 3,772 1,308 504 34.7 39 13.4 246 184 Agriculture, forestry and fishing 129 47 27 36.4 57 20.9 8 13 Finance leases and instalment credit 6,059 622 398 10.3 64 6.6 81 102 Interest accruals 116 — — — — — — — Latent — — 647 — — — (293) — 79,877 23,983 11,469 30.0 48 14.4 3,838 2,390 of which: UK
Central and local government 1,671 — — — — — — — Finance - banks 1,003 1 1 0.1 100 0.1 (8) 11 - other 7,651 562 193 7.3 34 2.5 7 88 Residential mortgages 6,142 277 184 4.5 66 3.0 436 426 Personal lending 3,891 413 349 10.6 85 9.0 213 306 Property 47,651 16,297 5,918 34.2 36 12.4 3,943 911 Construction 3,352 1,854 653 55.3 35 19.5 341 108 Manufacturing 6,520 644 237 9.9 37 3.6 (211) 1,423 Service industries and business activities - retail, wholesale and repairs 3,191 546 313 17.1 57 9.8 135 58 - transport and storage 8,195 136 78 1.7 57 1.0 47 4 - health, education and recreation 1,865 548 185 29.4 34 9.9 14 135 - hotels and restaurants 1,492 528 268 35.4 51 18.0 156 57 - utilities 2,110 69 20 3.3 29 0.9 13 7 - other 5,530 855 473 15.5 55 8.6 241 212 Agriculture, forestry and fishing 135 58 29 43.0 50 21.5 7 1 Finance leases and instalment credit 8,529 603 414 7.1 69 4.9 189 71 Interest accruals 278 — — — — — — — Latent — — 1,001 — — — (116) — 109,206 23,391 10,316 21.4 44 9.4 5,407 3,818 of which: UK
For corporate portfolios, given their complexity and nature, the Group relies not only on time-based measures but also on management judgement to identify evidence of impairment. Other factors considered may include: significant financial difficulty of the borrower; a breach of contract; a loan restructuring; a probable bankruptcy; and any observable data indicating a measurable decrease in estimated future cash flows.
Depending on various factors as explained below, the Group uses one of the following three different methods to assess the amount of provision required: individual; collective; and latent.
Collectively assessed provisions: provisions on impaired credits below an agreed threshold are assessed on a portfolio basis to reflect the homogeneous nature of the assets. The Group segments impaired credits in its collectively assessed portfolios according to asset type, such as credit cards, personal loans, mortgages and smaller homogenous wholesale portfolios, such as business or commercial banking. A further distinction is made between those impaired assets in collections and those in recoveries (refer to Problem debt management on page 139 for a discussion of the collections and recoveries functions).
The Group’s methodologies to estimate latent loss provisions reflect: - the probability that the performing customer will default; - historical loss experience, adjusted, where appropriate, given current economic and credit conditions; and - the emergence period, defined as the period between an impairment event occurring and a loan being identified and reported as impaired.
As with collectively assessed impaired portfolios, the Group segments its performing portfolio according to asset type.
Analyses of provisions are set out on page 204 and 205.
The Group reviews its portfolios of available-for-sale financial assets for evidence of impairment, which includes: default or delinquency in interest or principal payments; significant financial difficulty of the issuer or obligor; and it becoming probable that the issuer will enter bankruptcy or other financial reorganisation. However, the disappearance of an active market because an entity’s financial instruments are no longer publicly traded is not evidence of impairment. Furthermore, a downgrade of an entity’s credit rating is not, of itself, evidence of impairment, although it may be evidence of impairment when considered with other available information. A decline in the fair value of a financial asset below its cost or amortised cost is not necessarily evidence of impairment. Determining whether objective evidence of impairment exists requires the exercise of management judgment. The unrecognised losses on the Group’s available-for-sale debt securities are concentrated in its portfolios of mortgage-backed securities. The losses reflect the widening of credit spreads as a result of the reduced market liquidity in these securities and the current uncertain macroeconomic outlook in the US and Europe. The underlying securities remain unimpaired.
Movement in loan impairment provisions The movement in impairment provisions by division is shown in the table below.
At 1 January 2,741 1,732 66 147 1,633 505 6,824 1,042 7,866 10,316 — 18,182 Intra-group transfers — 177 — — — — 177 — 177 (177) — — Transfers to disposal groups (335) (436) — (2) — — (773) — (773) — — (773) Currency translation and other adjustments — 25 3 2 (79) (6) (55) (21) (76) (207) — (283) Disposal of subsidiaries — — — — — — — — — — 8 8 Amounts written-off (823) (653) (11) (79) (124) (371) (2,061) (76) (2,137) (2,390) — (4,527) Recoveries of amounts previously written-off 68 17 — — 1 76 162 5 167 360 — 527 Charged to income statement
Recoveries of amounts previously written-off 128 8 — 1 1 72 210 3 213 198 — 411 Charged to income statement - continuing operations 1,160 761 18 8 1,161 483 3,591 146 3,737 5,407 — 9,144 - discontinued operations — — — — — — — — — — 42 42 Unwind of discount (4) (89) (30) (2) — (70) — (191) (6) (197) (258) — (455)
For the notes relating to this table refer to page 205.
At 1 January 2,086 696 34 43 491 298 3,648 621 4,269 5,182 1,565 11,016 Transfers to disposal groups — — — — — — — (16) (16) (305) (3) (324) Currency translation and other adjustments 67 5 1 128 (109) (34) 58 365 423 (851) (102) (530)
Recoveries of amounts previously written-off 97 20 — 2 1 58 178 11 189 136 74 399 Charged to income statement - continuing operations 1,679 923 33 39 649 702 4,025 542 4,567 8,523 — 13,090 - discontinued operations — — — — — — — — — — 1,044 1,044 Unwind of discount (4) (102) (21) (1) — (36) — (160) (3) (163) (238) (7) (408)
Notes: (1) Global Transaction Services. (2) Retail & Commercial. (3) Global Banking & Markets. (4) Recognised in interest income.
Latent loss (545) (121) 1,184 Collectively assessed 2,591 3,070 3,994 Individually assessed 5,195 6,208 7,878 Customer loans 7,241 9,157 13,056 Bank loans — (13) 34 Securities 1,468 112 809 Charge to income statement 8,709 9,256 13,899
Charge relating to customer loans as a % of gross customer loans (1) 1.5% 1.7% 2.3%
Note: (1) Customer loan impairment charge as a percentage of gross loans and advances to customers including assets of disposal groups and excluding reverse repos.
Key points Impairment provisions, net of £0.8 billion relating to disposal groups, increased by £1.7 billion during 2011.
MI Total Core Non-Core Total Core Non-Core Total £m £m £m £m £m £m £m £m £m £m
Key points The impairment charge, excluding securities, decreased by £1.9 billion or 21% compared with 2010, driven largely by a £1.6 billion reduction in Non-Core, despite continuing challenges in Ulster Bank and corporate real estate portfolios.
The securities impairment in 2011 primarily reflects an impairment charge of £1.3 billion in respect of the Group’s holdings of Greek sovereign bonds and related interest rate hedges.
Available-for-sale debt securities and reserves The table below analyses available-for-sale debt securities and related reserves, gross of tax.
Risk management: Country risk Introduction* Country risk is the risk of material losses arising from significant countryspecific events such as sovereign events (default or restructuring); economic events (contagion of sovereign default to other parts of the economy, cyclical economic shock); political events (transfer or convertibility restrictions and expropriation or nationalisation); and natural disaster or conflict. Such events have the potential to affect elements of the Group’s credit portfolio that are directly or indirectly linked to the country in question and can also give rise to market, liquidity, operational and franchise risk related losses.
External risk environment* 2011 was another year of heightened country risks. However, trends were divergent, with conditions deteriorating among vulnerable eurozone countries facing growth impediments and higher public debt burdens, while many emerging markets continued to enjoy relative stability, seeing net inflows of capital for the full year and lower spreads despite some risk aversion in the second half. In the US, notwithstanding a more challenging political environment and a sovereign downgrade from a rating agency, a deal was secured to increase the sovereign debt ceiling, and yields on government debt remain low.
In May 2011, Portugal’s new government agreed a borrowing programme with the European Union and International Monetary Fund (EU-IMF) after a sharp deterioration in sovereign liquidity. Ireland's performance under its EU-IMF programme was good and the announcement of a bank restructuring deal without defaults on senior debt obligations helped improve market confidence. This was reflected in a compression in bond spreads in the second half of the year.
Emerging markets Emerging markets continued to perform relatively well. In Asia, despite slowing growth, China and India continued to post strong overall expansion, while generally large external savings levels reinforced balance of payments stability. In China specifically, measures to curb house price growth began to have a more noticeable impact, with real estate prices falling in many cities. Efforts are underway to address some bank asset quality concerns linked to rapid lending growth in 2009.
Latin America remained characterised by relative stability owing to balance sheet repair by a number of countries following crises in previous decades. Capital inflows contributed to currency appreciation, but overheating pressures have so far proven contained, including in Brazil where credit growth slowed from high levels.
The framework for the Group’s appetite for country risk is set by the Executive Risk Forum (ERF) in the form of country risk appetite ceilings by sovereign risk grade for both total and medium-term exposure. Authority is delegated to the Group Country Risk Committee to manage exposures within the framework, with escalation where needed to ERF.
Monitoring, management and mitigation* A country watchlist framework is in place to proactively monitor emerging issues and facilitate the development of mitigation strategies.
During 2011, the Group conducted an analysis of its country risk profile. The outcome of this analysis was used to define more specific scenarios to be used as trigger events in stress testing - on an ongoing basis - at both Group and divisional levels. Such risk scenarios include a major balance sheet deleveraging across Europe, a default of a eurozone sovereign, or one or more stressed member states exiting the eurozone and undergoing currency redenomination, with subsequent contagion effects.
Risk appetite setting was strengthened by various measures. In addition to Greece, Ireland and Portugal, the Group brought Italy and Spain under country limit control. Belgium and Japan followed in January 2012, with other advanced countries scheduled for review in this process throughout 2012. Benchmark ratios systematically guide the setting of medium-term country exposure limits.
Further strategic enhancements to portfolio management systems included the introduction of a comprehensive country risk management and reporting application, comprising banking and trading book exposures across the Group on a consistent basis, and taking account of country risk transfers given guarantees, insurance and collateral taken. This system supports analysing and managing the exposures to countries in the eurozone and elsewhere, by tenor bucket, currency type, sector and product type, as well as by individual counterparty names and facilities. In addition, developments in trading book management systems played a role in actual exposure reductions in trading on a number of countries.
Credit default swap (CDS) contracts are used for a number of purposes such as hedging of the credit trading portfolio, management of counterparty credit exposure and the mitigation of wrong-way risk. The Group generally uses CDS contracts to manage exposure on a portfolio rather than specific exposures. This may give rise to maturity mismatches between the underlying exposure and the CDS contract as well as between bought and sold CDS contracts on the same reference entity.
Country risk analysis All the data tables and related definitions in this section are audited.
The following tables show the Group’s exposure by country of incorporation of the counterparty at 31 December 2011. Countries shown are those where the Group’s balance sheet exposure to counterparties incorporated in the country exceeded £1 billion and the country had an external rating of A+ or below from S&P, Moody’s or Fitch at 31 December 2011, as well as selected eurozone countries. The numbers are stated before taking into account the impact of mitigating action, such as collateral, insurance or guarantees that may have been taken to reduce or eliminate exposure to country risk events. Exposures relating to ocean-going vessels are not included due to their multinational nature.
The following definitions apply to the tables and key points on pages 211 to 228: Lending comprises gross loans and advances to: central and local governments; central banks, including cash balances; other banks and financial institutions, incorporating overdraft and other short-term credit lines; corporations, in large part loans and leases; and individuals, comprising mortgages, personal loans and credit card balances. Lending includes impaired loans and loans where an impairment event has taken place, but the impairment provision is recognised.
Debt securities comprise securities classified as available-for-sale (AFS), loans and receivables (LAR), held-for-trading (HFT) and designated as at fair value through profit or loss (DFV). All debt securities other than LAR securities are carried at fair value with LAR debt securities are carried at amortised cost less impairment. HFT debt securities are presented as gross long positions (including DFV securities) and short positions per country. Impairment losses and exchange differences relating to AFS debt securities, together with interest, are recognised in the income statement; other changes in the fair value of AFS securities are reported within AFS reserves, which are presented gross of tax.
Balance sheet exposures comprise lending exposures, debt securities and derivatives, and repo exposures.
The Group primarily transacts CDS contracts with investment-grade global financial institutions who are active participants in the CDS market. These transactions are subject to regular margining. For European peripheral sovereigns, credit protection has been purchased from a number of major European banks, predominantly outside the country of the reference entity. In a few cases where protection was bought from banks in the country of the reference entity, giving rise to wrong-way risk, this risk is mitigated through specific collateralisation. Due to their bespoke nature, exposures relating to CDPCs and related hedges have not been included, as they cannot be meaningfully attributed to a particular country or a reference entity. Exposures to CDPCs are disclosed on page 190.
Turkey - exposures were managed down in most categories, with the non-strategic (mid-market) portfolio significantly reduced in 2011. Nonetheless, Turkey continues to be one of the Group’s key emerging markets. The strategy remains client-centric, with the product offering tailored to selected client segments across large Turkish international corporate clients and financial institutions as well as Turkish subsidiaries of global clients.
Mexico - asset sales and a number of early repayments in the corporate portfolio led to exposure falling £0.8 billion in the year. This decline also reflects the Group’s cautious approach to new business following its decision to close its onshore operation in Mexico.
Group exposure declined in all categories, with notable reductions in lending of £3.4 billion and in off-balance sheet items of £1.4 billion over the year, as a result of currency movements and de-risking in the portfolio.
GBM and Ulster Bank account for the majority of the Group’s exposure to financial institutions. Exposure to the financial sector fell by £1.1 billion during the year, caused by a £0.5 billion reduction in lending, a £0.4 billion reduction in debt securities and smaller reductions in derivatives and repos and in off-balance sheet exposure. The largest category is derivatives and repos where exposure is affected predominantly by market movements and transactions are typically collateralised.
AQ1 AQ2-AQ3 AQ4-AQ9 AQ10 Total Notional Fair value Notional Fair value Notional Fair value Notional Fair value Notional Fair value
The Group’s exposure to the government was negative at 31 December 2011, reflecting net short held-for-trading debt securities.
A sizeable covered bond portfolio of £6.5 billion is the Group’s largest exposure to the Spanish financial sector. The portfolio continued to perform satisfactorily in 2011. Stress analysis conducted to date on these available-for-sale debt securities indicated that this exposure is unlikely to suffer material credit losses. However, the Group continues to monitor the situation closely.
A further £1.9 billion of the Group’s exposure to financial institutions consists of derivatives exposure to Spanish international banks and a few of the large regional banks, the majority of which is collateralised. This increased £0.4 billion in 2011, due partly to market movements.
Lending to banks consists mainly of short-term uncommitted credit lines with the top two international Spanish banks.
Banks 12,904 1,676 487 94 61 10 — — 13,452 1,780 Other financial institutions 10,138 1,550 8 2 219 43 — — 10,365 1,595 Total 23,042 3,226 495 96 280 53 — — 23,817 3,375
Over 2011, the total government debt securities position declined by £2.5 billion to £0.3 billion, reflecting a rebalancing of the trading portfolio.
Banks 2,001 1,345 1 1 — — — — 2,002 1,346 Other financial institutions 1,507 945 63 45 76 47 — — 1,646 1,037 Total 3,508 2,290 64 46 76 47 — — 3,648 2,383
Key points* The Group has reduced its effective exposure to Greece and continues to actively manage its exposure to the country, in line with the de-risking strategy that has been in place since early 2010. Much of the remaining exposure is collateralised or guaranteed.
Due to market movements, the gross derivatives exposure to banks increased by £0.1 billion during the year. The portfolio is largely collateralised.
Key points* In early 2011, RBS closed its local operations in Portugal, leaving the Group with modest overall exposure of £1.4 billion by year-end. The portfolio, now managed out of Spain, is focused on corporate lending and derivatives trading with the largest local banks. Mediumterm activity has ceased with the exception of that carried out under a Credit Support Annex.
Financial institutions A major proportion of the remaining exposures is focused on the top four systemically important financial groups. Exposures generally consist of collateralised trading products.
The largest non-financial corporate exposure is to the energy and transport sectors. The Group’s exposure is concentrated on a few large, highly creditworthy clients.
Other financial institutions 422 — — 494 (47) 195 17 672 1,951 3,045 2,712 2,633 (18) 18 Corporate 7,519 163 44 219 4 44 53 210 633 8,362 20,731 19,076 (382) 372 Personal 162 — — — — — — — — 162 — — — — 20,057 163 44 12,652 (39) 6,770 4,675 14,747 15,266 50,070 29,347 27,815 (302) 283
Banks 7,605 107 88 1 6 — — — 7,699 108 Other financial institutions 14,529 231 308 37 676 81 147 14 15,660 363 Total 22,134 338 396 38 682 81 147 14 23,359 471
Central and local government — — — — — 24 — 24 — 24 — — — — Central banks 25 — — — — — — — — 25 — — — — Other banks 26 — — 30 (1) 45 — 75 499 600 — — — — Other financial institutions 734 — — 99 (3) 32 19 112 1,800 2,646 1,296 1,220 (5) 1
Banks 1,535 93 16 — — — — — 1,551 93 Other financial institutions 2,927 164 10 — 70 7 — — 3,007 171 Total 4,462 257 26 — 70 7 — — 4,558 264
Banks 1,602 97 2 — 12 1 — — 1,616 98 Other financial institutions 866 48 1 — 4 — — — 871 48 Total 2,468 145 3 — 16 1 — — 2,487 146
France - approximately half of the lending to banks is to the top three banks.
Corporate Netherlands - corporate lending fell £1.3 billion over 2011, driven by the manufacturing, natural resources and services sectors. The relatively large contingent liabilities and commitments declined £7.9 billion.
Non-Core lending exposure in Germany was £5.4 billion at 31 December 2011, down £1.1 billion since 31 December 2010. The lending portfolio is mostly in the property (44%) and transport (35%) sectors.
Non-Core lending exposure in the Netherlands was £2.5 billion at 31 December 2011, down £0.7 billion. The portfolio mainly comprises exposures to the property (66%) and technology, media and telecommunications (19%) sectors.
Market risk All the disclosures in this section (pages 229 to 235) are audited, unless indicated otherwise with an asterisk (*).
Market risk arises from changes in interest rates, foreign currency, credit spreads, equity prices and risk related factors such as market volatilities. The Group manages market risk centrally within its trading and nontrading portfolios through a comprehensive market risk management framework. This control framework includes qualitative guidance in the form of comprehensive policy statements, dealing authorities, limits based on, but not limited to, value-at-risk (VaR), stress testing, positions and sensitivity analyses.
The Group also undertakes transactions in financial instruments that are traded over-the-counter (OTC) rather than on a recognised exchange. These instruments range from commoditised transactions in derivative markets, to trades where the specific terms are tailored to meet customer requirements.
Assets and liabilities in the trading book are measured at their fair value. Fair value is the amount at which the instrument could be exchanged in a current transaction. The fair values are determined following IAS 39 guidance, which requires banks to use quoted market prices or, where this is not possible, valuation techniques (models) that make appropriate use of available observable inputs. When marking to market using a model, the valuation methodologies are approved by all stakeholders (trading, finance, market risk, model development and model review) prior to use for profit and loss and risk management purposes. Any profits or losses on the revaluation of positions are recognised in the daily profit and loss.
Organisation structure Independent oversight and support is provided to the business by the Global Head of Market & Insurance Risk, assisted by the Group and business Market Risk teams. The head of each business, assisted by a business market risk management team, is accountable for all market risks associated with its activities. The Global Market Risk Committee reviews and makes recommendations concerning the market risk profile across the Group, including risk appetite, risk policy, models, methodology and market risk development issues. The committee meets monthly and is chaired by the Global Head of Market & Insurance Risk. Attendees include respective business market risk managers and Group Market Risk.
A new product approval process that requires market risk teams to assess and quantify market risk associated with proposed new products.
Risk management: Market risk continued Quantitative risk appetite The Executive Risk Forum (ERF) approves the quantitative market risk appetite for trading and non-trading activities. The Global Head of Market & Insurance Risk, under delegated authority from the ERF, sets and populates a limit framework, which is cascaded down through legal entity, division, business and desk level market risk limits.
A daily report summarises the Group’s market risk exposures against the agreed limits. This daily report is sent to the Head of Restructuring & Risk, Global Head of Market & Insurance Risk, business Chief Risk Officers and appropriate business market risk managers.
The specific market risk metrics that are appropriate for controlling the positions of a desk will be more granular than the Group level limits and tailored to the particular business.
In line with the overall business strategy to reduce risk exposures, the Group’s market risk limits were adjusted down during 2011.
The majority of the Group’s market risk exposure is in the GBM and NonCore divisions and Group Treasury. The Group is also exposed to market risk through interest rate risk on its non-trading activities. There are additional non-trading market risks in the retail and commercial businesses of the Group, principally interest rate risk and foreign exchange risk. These aspects are discussed in more detail in Balance sheet management - Interest rate risk on pages 131 and 132 and structural foreign currency exposures on page 133.
Risk models VaR is a technique that produces estimates of the potential change in the market value of a portfolio over a specified time horizon at a given confidence level. For internal risk management purposes, the Group’s VaR assumes a time horizon of one trading day and a confidence level of 99%. The Group's VaR model is based on a historical simulation model, utilising data from the previous two years.
The VaR model has been approved by the FSA to calculate regulatory capital for the trading book. The approval covers general market risk in interest rate, foreign exchange, equity and specified commodity products and specific risk in interest rate and equity products.
The VaR model is an important market risk measurement and control tool. It is used for determining a significant component of the market risk capital and, as such, it is regularly assessed. The main approach employed is the technique known as back-testing, which counts the number of days when a loss (as defined by the FSA) exceeds the corresponding daily VaR estimate, measured at a 99% confidence level.
A more appropriate time series for the Dutch RMBS portfolio was adopted to better reflect the risk in the portfolio as more granular data became available. In addition, collateralised based discounting has been implemented for the vast majority of the collateralised positions in place of the previous LIBOR-based discounting approach.
Pricing models Pricing models are developed and owned by the front office. Where pricing models are used as the basis of books and records valuations, they are subject to oversight and approval by asset level modelled product review committees (ALMPRCs). These committees prioritise models for independent validation by Group Risk Analytics (GRA) taking into consideration both the materiality of risk booked against the model and an assessment of the degree of model risk (i.e. valuation uncertainty arising from choice of modelling assumptions). The GRA review aims to quantify model risk by comparing model outputs against those of alternative independently developed models, the results of which are used by Market Risk to inform risk limits and by Finance to inform model reserves.
In 2011, the market risk stress testing framework was further developed and enhanced. Reverse stress testing has been implemented, which is designed to assess the plausibility of stressing market risk factors until the loss reaches a given threshold.
Risk management: Market risk continued Risk management: Market risk continued GBM traded revenues* GBM traded revenues*
Note: Note: (1) The effect of any month end adjustments, not attributable to a specific daily market move, is spread evenly over the days of the relevant month. (1) The effect of any month end adjustments, not attributable to a specific daily market move, is spread evenly over the days of the relevant month.
The most frequent result is daily revenue of between £25 million and £30 million with 30 occurrences in 2011, compared with 37 occurrences in 2010.
January February March April May June July August September October November December £m
The extent of diversification benefit depends on the correlation between the assets and risk factors in the portfolio at a particular time. Diversification has an inverse relationship with correlation. The diversification factor is the sum of the VaR on individual risk types less the total portfolio VaR.
The credit spread VaR also decreased due to the adoption of a more appropriate daily time series for sub-prime/subordinated RMBS and as the period of high volatility relating to the 2008/2009 financial crisis dropped out of the VaR calculation.
VaR is not always the most appropriate measure of risk for assets in the banking book and particularly for those in Non-Core, which will diminish over time as the asset inventory is sold down.
Non-Core structured credit portfolio (SCP). These assets are shown separately on a drawn notional and fair value basis by maturity profile and asset class. The risk in this portfolio is managed on both a third party asset and RWA basis.
Also excluded from the non-traded VaR are the loans and receivable products that are managed within the credit risk management framework.
Note: (1) The Group benefits from diversification, which reflects the risk reduction achieved by allocating investments across various financial instrument types, industry counterparties, currencies and regions.
Key points The Group’s total non-trading VaR at 31 December 2011 was significantly lower than at 31 December 2010, due to the exceptional volatility of the 2008/2009 financial crisis dropping out of the twoyear time series data used in the VaR calculation.
Drawn notional Fair value CDOs CLOs MBS (1) Other ABS Total CDOs CLOs MBS (1) Other ABS Total 1-2 years — — — 27 27 — — — 22 22 2-3 years — — 10 196 206 — — 9 182 191 4-5 years — 37 37 95 169 — 34 30 88 152 5-10 years 32 503 270 268 1,073 30 455 184 229 898 >10 years 2,180 442 464 593 3,679 766 371 291 347 1,775 2,212 982 781 1,179 5,154 796 860 514 868 3,038 1-2 years — — — 47 47 — — — 42 42 2-3 years 85 19 44 98 246 81 18 37 91 227 3-4 years — 41 20 205 266 — 37 19 191 247 4-5 years 16 — — — 16 15 — — — 15 5-10 years 98 466 311 437 1,312 87 422 220 384 1,113 >10 years 412 663 584 550 2,209 161 515 397 367 1,440 611 1,189 959 1,337 4,096 344 992 673 1,075 3,084 1-2 years — — — 81 81 — — — 68 68 2-3 years 40 — — 19 59 24 — — 18 42 3-4 years 19 18 42 99 178 16 17 31 76 140 4-5 years 17 47 36 332 432 3 41 29 275 348 5-10 years 107 685 424 521 1,737 90 594 251 394 1,329 >10 years 594 1,114 820 573 3,101 193 896 468 325 1,882 777 1,864 1,322 1,625 5,588 326 1,548 779 1,156 3,809
The overall reduction in collateralised loan obligation (CLO), MBS and other ABS drawn notional is due to the amortisations and paydowns over the year in line with expected amortisation profiles. In addition to this, fair value has declined due to falling market prices.
Risk management continued All the disclosures in this section (pages 236 to 246) are unaudited as indicated with an asterisk (*).
Insurance risk* Insurance risk is the largest inherent risk faced by RBS Insurance. It arises through fluctuations in the timing, frequency and/or severity of insured events, relative to the expectations at the time of underwriting. It can be caused by any of the following core activities: Pricing and underwriting; Claims management; Reserving; and
RBS Insurance has continued to develop its approach to risk management, including enhancing its risk function, to help ensure that insurance risks are better identified, controlled, managed, monitored, reported and mitigated. This is being achieved through the embedding of an enterprise-wide risk management framework, with associated risk appetite and policy frameworks. These are expected to have the following benefits: a consistent and disciplined approach to risk management; a universal view of risk across the business; the ability to influence decision-making and shape behaviours; a reduction in loss events; the improved use and allocation of capital; and enhanced return on risk adjusted capital.
Steps taken in 2010 and 2011 to enhance risk management have resulted in RBS Insurance showing improved results in 2011 relative to 2010, although refocusing the division’s risk appetite has reduced business volumes.
Stress testing and scenario analysis Stress testing and scenario analysis take place on a regular basis to support both the division’s individual capital assessment and the agreed risk appetite. It is also employed prior to the deployment of new products/lines of business.
Key insurance risks are monitored monthly at the Insurance Risk Forum and loss ratio committees, with comprehensive management information being presented regularly (i.e. monthly or quarterly) at the Executive Committee, the Board and the divisional risk and audit committees.
The Group made significant improvements in its operational risk framework during 2011, enhancing its management of operational risks. This is particularly evident in respect of risk appetite, the Group Policy Framework, risk assessment, scenario analysis and statistical modelling for capital requirements. Further development will continue in 2012.
Details of these, and other elements of operational risk management, including developments undertaken and planned, are set out below along with the key processes through which the Group manages operational risk.
Governance, structure and risk appetite Governance and structure Group Operational Risk is an independent function reporting to the Deputy Group Chief Risk Officer. Group Operational Risk is responsible for the design and maintenance of the operational risk policy standards (ORPS).
The ORPS are incorporated in the Group Policy Framework (GPF), they provide the direction for delivering effective operational risk management and are designed to allow the consistent identification, assessment, management, monitoring and reporting of operational risk across the Group.
The Operational Risk Executive Committee which was formed in January 2011, oversees the operational risk framework and profile of the Group in line with the agreed risk appetite. It provides guidance, oversight and advice. It also escalates and reports any issues or areas of concern to the Board Risk Committee and to other senior committees.
Risk appetite The Group’s operational risk appetite statement is agreed by the Group Board. It comprises a number of specific measures of risk, such as: the maximum operational risk losses the Group is prepared to accept. This is expressed as a percentage of the Group’s estimated gross income for the year ahead; or the value of a single extreme but plausible operational impact. These are identified and assessed through the scenario analysis programme (refer to Scenario analysis below).
Operational risk cycle and key management tools The operational risk cycle comprises four stages: Identification of risks; Assessment or measurement of the scale of risks; Management or control of risks to prevent their recurrence or minimise the potential impact; and
Risk management: Operational risk* continued By assessing extreme but plausible events, scenario analysis is an important component in the operational risk framework, providing senior management with valuable insight into systemic risk that could significantly impact its financial performance if these events were to occur. Using its forward-looking nature, senior management crossexamines various risk topics against a range of circumstances and assumptions.
Consequently, the Group enhanced its approach to assessing the impact of the economic cycle on its operational risk losses in 2011, by specifically assessing the impact of the FSA's published Anchor II scenario, which describes a series of country-specific shocks around the world on: Expected levels of operational risk losses; and
During 2012, additional operational risk scenarios will be run, further broadening the Group's understanding of its exposures to tail risks.
The enhancements have improved risk management by allowing Groupwide analyses of all operational risk issues. In certain cases, this has resulted in global assurance reviews focused on specific areas, helping to identify operational risks to be mitigated.
Event and loss data management Event and loss data management (ELDM) covers the discovery, escalation, capture, investigation, approval and closure, and reporting and analysis of operational risk events and loss data. It also provides for the clear, simple, quick and consistent communication of operational risk events that meet defined threshold criteria to those members of the Group’s senior management and Executives who need to know of these events.
At the start of 2012, the robustness of the historic data migrated into the new repository will be reviewed to confirm its suitability as an input to capital modelling. In addition, the process will be further enhanced to ensure continued compliance with changing regulatory and industry standards regarding the collection of internal loss data.
Insurance The Group purchases insurance to provide the business with financial protection against specific losses and to comply with statutory or contractual requirements. Insurance is used as a risk mitigation tool in controlling the Group’s exposures, providing protection against financial loss once a risk has crystallised.
Control environment certification Control environment certification (CEC) is used by the Group Executive management to review and assess its internal control framework, and provide a self-certification of its current state. It demonstrates that the Group is operating a robust control framework, with mechanisms in place to understand and manage its risks, and to drive action to resolve areas of weakness or concern.
CEC was enhanced during 2011 to improve the quality and depth of certification, and to implement a risk-based approach to the analysis of policy compliance. The enhancements have delivered a greater degree of analysis of the key risk areas for each business and Group policy standard owner. Improved alignment with Group Internal Audit has been delivered through the implementation of a common rating system for the assessment of the control environment, and CEC outcomes are reported at both the divisional risk and audit committees and Group Audit Committee.
Capital model development At the end of 2011, the Group started to develop a statistical modelling capability for operational risk based on the requirements set out under the Basel II advanced measurement approach. The model is a hybrid encompassing internal and external loss data as well as scenarios. Business environment and internal control factors will be utilised when constructing scenarios and allocating capital. Development activities in 2011 focused on building the standalone loss data and scenario components within the model; integration activities, correlation and allocation will continue in 2012. Final model validation is expected to take place during 2012.
Compliance risk* Compliance risk arises from non-compliance with national and international laws, rules and regulations. The Group believes that being a compliant organisation is fundamental to protecting sustainable growth, rebuilding its reputation and maintaining stakeholder confidence.
The regulatory agenda - largely framed by the G20 but with many instances of EU and national initiatives - constitutes the most sweeping set of changes seen in many decades. At 31 December 2011, the Group was managing some 140 major regulatory or legislative policy initiatives; during the year as a whole, it had also reviewed over 300 consultations in its core markets. In addition to these changes, many supervisory authorities also continued to intensify their ongoing level of scrutiny and intervention.
A new Basel Committee framework for identifying an initial list of global systemically important banks (G-SIBs), and applying to these an additional common equity capital requirement, above the Basel III minimum standards, rising from 1% to 2.5% of risk-weighted assets in line with their systemic impact.
Work was initiated in five areas to assess the need for regulatory intervention, and this topic is likely to attract even more attention during 2012, when recommendations for action are expected.
The five areas include: banks’ interactions with shadow banking entities; ways to reduce the susceptibility of money market funds to runs; the regulation of other shadow banking entities on prudential grounds; retention requirements and transparency in securitisation; and the possible regulation of margins and haircuts in securities lending and repos.
Other During 2011, the authorities started to pay more attention to the consistent implementation of G20 and FSB financial reforms, with plans developed to focus more on monitoring and the public reporting of implementation progress. Although a priority, little progress was made during 2011 on developing a global policy framework for over-the-counter derivative reform, so as to help align ongoing activity in this space, particularly in the US and the EU (see below).
Another key area of work was the EU’s “crisis management” legislative package, aimed at dealing with issues similar to those addressed by the FSB work on G-SIFIs. An early 2011 EU Commission consultation included proposals on enhanced supervision and early powers of intervention; recovery and resolution planning; resolution frameworks; resolution funds and debt write-down (but not capital surcharges). Draft legislation to implement these measures was at the time of writing expected to be issued in early 2012, after several postponements.
Market and structural reforms Key developments in this space included: European Markets Infrastructure Regulation (EMIR) - negotiations continued during 2011 on this draft Regulation on OTC derivatives, central counterparties and trade repositories, which represents a major element of the financial crisis regulatory response agenda. Agreement was close to being reached in early 2012.
Markets in Financial Instruments Directive Review (MiFID2) - the EU review of this directive, which sets the framework for investment markets, culminated in the publication of draft legislative text in October 2011.
The Final Report made a number of recommendations, including in relation to: (i) the implementation of a ring-fence of retail banking operations; (ii) increased loss-absorbency (including bail-in, i.e. the ability to write-down debt or convert it into an issuer’s ordinary shares in certain circumstances); and (iii) promotion of competition.
The Group will continue to participate in the debate and to consult with the UK Government on the implementation of the recommendations set out in the Final Report and in the Government’s response.
Retail conduct issues In addition to EU retail initiatives, the UK authorities continued to pursue additional issues during 2011. These included initiatives relating to financial inclusion, where the Government is seeking to widen access to bank accounts; the implementation of the recommendations of the Retail Distribution Review relating to the provision of investment advice; ongoing work on the Mortgage Market Review; the establishment of a Steering Group by HM Treasury to devise a suite of simple financial products; and a review of the insurance products that form part of packaged current accounts.
Supervisory developments In line with that of other regulatory authorities, the FSA’s supervisory scrutiny has intensified in response to the financial crisis and ongoing market stresses. Front-end supervisory resources have been increased and existing tools have been used more frequently and robustly – evidenced, for instance, in terms of the heightened number of information requests, the increased deployment by the FSA of skilled person reports as well as the increased fines charged against the industry. Across the industry fines for 2011 totalled £66.1 million versus £5.3 million in 2007. In addition, the FSA continued to develop new supervisory approaches, notably its Core Prudential Programme for those major financial institutions it oversees, which includes in-depth rolling thematic assessments on governance, business models, risk management, capital and liquidity.
US regulatory developments In the US, activity was dominated by rulemaking following the 2010 Dodd-Frank Act. Although there was some slippage on, for example, derivatives rules, output from the authorities has still been considerable.
Key final rules were issued on a range of issues, including living wills, the Collins Amendment (which floors capital requirements at the level of Basel II advanced approaches), rights for shareholders to have an advisory “say on pay”, and limits on debit card interchange fees. Meanwhile the new Consumer Financial Protection Bureau was established on the Act’s first anniversary on 21 July 2011.
High-profile draft rules that were published included the Volcker Rule (limiting proprietary trading and investments in private equity or hedge funds), the securitisation risk retention rule and rules applicable to Nationally Recognized Statistical Rating Organizations (credit rating agencies).
Against the backdrop of intensified regulatory pressure, Group Regulatory Affairs has managed the increased levels of scrutiny and legislation by increasing the capacity of its team, as well as improving and refining its operating model, tools, systems and processes. Simultaneously, in response to enforcement actions against the Group in 2010 and 2011, Group Compliance initiated and led large-scale remediation and infrastructure changes, driving both the definition and the proactive management of conduct risk.
Group Regulatory Affairs maintains a well-established policy and supporting processes for the identification and management of such changes across the Group. Group Board and Executive Committee oversight is supported by a Prudential Regulatory Developments Executive Steering Group, which was formed in early 2010 to provide a specific focus on a range of key regulatory changes. Communication and coordination were strengthened in 2011 with the formalisation of two Group-wide forums, one focusing on prudential and wholesale market issues, the other on retail conduct issues. In addition, a divisional Heads of Regulatory Developments forum was established, and RBS Americas’ regional governance strengthened.
Other key regulatory policies, specifically ‘Group Relationships with Regulators’ and ‘Political, Legislative and Regulatory Environment’, were reviewed and re-launched. Each incorporates a new risk appetite statement, a benchmarking exercise against the Group's peer banks and, for the latter, an end-to-end review and mapping of the upstream risk management process.
Recovery and resolution planning The Group considers effective resolution regimes, coordination between regulators, and recovery and resolution planning, to be important components of an extensive reform agenda to improve safety and stability within the banking industry. Accordingly, the Group recognises the potential value of Recovery and Resolution Plans (RRPs) as mechanisms for preparing banks to deal with: severe stress events (through a range of developed recovery options in the Recovery Plan); and ensuring authorities will have all the critical information they need to identify and carry out appropriate resolutions in the event of failure (the Resolution Plan).
To ensure effective management of financial stability across jurisdictions, and to avoid duplication and inefficiency for cross-border banks, it is important that the approach, content and role of RRPs are globally consistent across jurisdictions.
Assurance and monitoring Assurance and monitoring activities are essential to ensure that the Group can demonstrate compliance with existing rules and regulations.
Training and awareness Maintaining compliance with existing rules and regulations requires continued investment in professional training, as well as maintaining risk awareness. During 2011, the Group focused on strengthening the capabilities of its compliance risk functions at both Group and divisional level. The Group facilitates extensive compliance training through computer-based Group Policy Learning modules, with each one designed to promote the relevant regulatory Group Policy Standard.
To support the professional development of the Group’s compliance teams, it also has a comprehensive and progressive training programme that is deployed globally. All of the Group’s regulatory staff are actively engaged in compliance e-learning, which incorporates a mandatory ‘essentials’ course, and the RBS Risk Academy, through which all staff are required to complete foundation courses in other risk disciplines, such as operational risk, market risk and retail credit risk. Formal training is supplemented by more informal regulatory familiarisation; this is designed to share knowledge, and support both personal development and technical training across the wider risk community.
An enhanced global whistle-blowing service ‘Right Call’ that allows all employees, irrespective of location, to escalate any concerns outside of their normal line management. Whistle-blowing call volumes have increased since the launch and the new framework is a further positive step to help the Group identify and manage compliance risk.
Reputational risk can arise from actions taken by the Group or a failure to take action, such as failing to assess the environmental, social or ethical impacts of clients or projects to which the Group has provided products or services.
The risk is viewed as material given the central nature of unexpected changes in revenues and costs on the Group’s ability to achieve its strategic objectives.
The trustee is solely responsible for the investment of the Main scheme’s assets which are held separately from the assets of the Group. Significant changes to asset strategy are discussed with the Groups Pension Risk Committee which was established in 2011. The Group and the trustee must agree on the Main scheme funding plan.
In October 2006, the Main scheme was closed to new employees. In November 2009, the Group confirmed that it was making changes to the Main scheme and a number of other defined benefit schemes including the introduction of a limit of 2% per annum (or the annual change in the Consumer Price Index, if lower) to the amount of any salary increase that will count for pensionable purposes.
Risk appetite and investment policy are agreed by the trustee with quantitative and qualitative input from the scheme actuaries and investment advisers. The trustee also consults with the Group to obtain its view on the appropriate level of risk within the pension fund.
Reporting and monitoring The Group maintains an independent review of risk from a sponsor perspective within its pension funds. It achieves this through underlying regular pension risk reporting and monitoring to the Group Board, Group Board Risk Committee and Group Risk Committee on the material pension schemes that the Group has an obligation to support.
Stress testing and modelling Throughout 2011, various pension risk stress testing initiatives were undertaken, focused both on internally defined scenarios and on scenarios undertaken to meet integrated EBA, IMF and FSA stress testing requirements. On an annual basis, the Internal Capital Adequacy Assessment Process is also modelled; this entails assessing changes in pension asset and liability values over a 12-month horizon under various stresses and scenarios.
The assets of the Main scheme, which represent 84% of Group pension plan assets at 31 December 2011, are invested in a diversified portfolio of quoted and private equity, government and corporate fixed interest and index-linked bonds, and other assets including property and hedge funds. The trustee has taken measures to partially mitigate inflation and interest rate risks both by investment in suitable physical assets and by entering into inflation and interest rate swaps. The Main scheme also uses derivatives within its portfolio to manage the allocation to asset classes and to manage risk within asset classes.
Risk management: Pension risk* continued The table below shows the sensitivity of the Main scheme’s assets and liabilities (measured according to IAS 19 ‘Employee Benefits’) to changes in interest rates and equity values at the year end, taking account of the current asset allocation and hedging arrangements.
Asset Protection Scheme* All disclosures in this section (pages 247 to 249) are unaudited and are marked with an asterisk (*).
Key aspects of the Scheme On 22 December 2009, the Group acceded to the Asset Protection Scheme (APS or ‘the Scheme’) with HM Treasury acting on behalf of the UK Government. Under the Scheme, the Group purchased credit protection over a portfolio of specified assets and exposures (“covered assets”) from HM Treasury. The portfolio of covered assets had a par value of approximately £282 billion at 31 December 2008 and the protection is subject to a first loss of £60 billion and covers 90% of subsequent losses net of recoveries. Once through the first loss, when a covered asset has experienced a trigger event, losses and recoveries in respect of that asset are included in the balance receivable under the APS. Receipts from HM Treasury will, over time, amount to 90% of cumulative losses (net of cumulative recoveries) on the portfolio of covered assets less the first loss amount.
Losses are recognised when a covered asset has experienced a trigger event which comprises failure to pay subject to grace periods, bankruptcy and restructuring.
HM Treasury has the right to appoint step-in managers to carry out any oversight, management or additional functions on their behalf, to ensure that the covered assets are managed and administered in compliance with the agreed terms and conditions. This right is exercisable if certain step-in triggers occur. These include: losses on covered assets in total exceed 125% of the first loss amount or losses on an individual covered asset class exceed specified thresholds; a breach of specified obligations in the APS rules or the accession agreement; the Group has failed or is failing to comply with any of the conditions in the APS rules in relation to asset management, monitoring and reporting, and governance and oversight, and such failure is persistent and material or it is evidence of a systematic problem; and material or systematic data deficiencies in the information provided to HM Treasury in accordance with the terms of the APS.
Key points The reduction in covered assets was due to run-off of the portfolio, disposals, early repayments and maturing loans.
The Group continues to take advantage of market conditions and execute sales from a number of its portfolios.
Loans and advances 20,586 18,033 14,240 Debt securities 10,703 11,747 7,816 Derivatives 3,056 2,043 6,834 34,345 31,823 28,890
Original first loss utilisation 38,961 Assets not triggered under modified rules (1) (4,126) Assets triggered under modified rules (2) 997 Expected recoveries (3) (6,272) Revised first loss utilisation 29,560
Notes: (1) Assets that had triggered under the original Scheme rules but were not impaired or defaulted are not triggered under the modified rules. (2) Assets that had not yet triggered under the original Scheme rules but had impaired or defaulted are triggered under the modified rules. (3) For assets which have triggered under both original and modified rules, this amount represents the excess of expected recoveries over cash recoveries received to date.
The table below shows the first loss utilisation under the original and modified rules.
The Group received loss credits of £0.6 billion in 2011 which related to disposals. Cumulative loss credits at 31 December 2011 were £1.8 billion.
The Group continues to expect an average recovery rate of approximately 40% across all portfolios.
Key point The decrease of £36.5 billion in RWAs covered by the Scheme reflects pool movements, assets moving into default and changes in risk parameters.
2011 has been a challenging year for the Group given the continued pressure on financial markets and the Eurozone challenges as well as UK developments such as the recommendations from the Independent Commission on Banking. During 2011, key areas of focus for the Board were: financial performance; strategy; risk; and regulatory developments and reports. The Board was supported by the work of key Board committees.
We conduct an annual evaluation of the effectiveness of the Board and this year’s evaluation was conducted internally, led by the Group Secretary. I also evaluate the individual performance of each of the nonexecutive directors and all directors stand for re-election annually. Further details on performance evaluation are set out on page 260. During 2011, we saw further improvements to the flow of information to the Board both in terms of the quality of papers and the use of new technology to deliver these to directors. The Board continued to focus on strategic priorities and the composition of the Board, including succession planning for senior executives, was kept under review by the Group Nominations Committee.
Diversity The diversity agenda has remained a key priority for RBS in 2011. The Group made a public statement on its website www.rbs.com in September 2011 regarding its aspirations in relation to gender diversity in the boardroom. We expect to meet the aspirational target of 25 per cent female board representation in 2012. In December 2011, the Board approved a formal boardroom diversity policy which aims to promote diversity in the composition of the Board. Under this policy, all Board appointments will be made on the basis of individual competence, skills and expertise measured against identified objective criteria. Further details on the boardroom diversity policy can be found on page 262.
Group Board is the main decision making forum at Group level, setting the strategic direction of the Group and ensuring that the Group manages risk effectively. The Group Board is accountable to shareholders for financial and operational performance.
Group Nominations Committee assists the Group Board in the selection and appointment of directors. It reviews the structure, size and composition of the Group Board, and membership and chairmanship of Group Board committees.
Executive Committee is responsible for managing Group-wide issues and those operational issues that affect the broader Group. It reviews strategic issues and initiatives, monitors financial performance and capital allocations and considers risk strategy, policy and risk management.
Bruce Van Saun (age 54) Date of appointment: 1 October 2009
Over 25 years of financial services experience. From 1997 to 2008 he held a number of senior positions with Bank of New York and later Bank of New York Mellon, most recently as vice-chairman and chief financial officer and before that was responsible for Asset Management and Market Related businesses. Prior to that he held senior positions with Deutsche Bank, Wasserstein Perella Group and Kidder Peabody & Co. He has served on several corporate boards as a non-executive director and has been active in numerous community organisations.
External appointments Chairman of Creative Scotland Member and vice-chairman of the Board of Governors of The Royal Conservatoire of Scotland President of the Cockburn Association
External appointments Member of the Advisory Board of City National Bank Non-executive director of Unisys Corporation Chair of the Governing Board of Women’s Initiative for Self Employment
Has worked for a variety of financial institutions starting with Peat Marwick (now KPMG) and then Goldman Sachs, ultimately as controller of the global firm. He was chief financial officer of the investment bank of NationsBank (now Bank of America) before joining Paine Webber and then Deutsche Bank where he became chief financial officer in 2006. After retiring in 2008 he served as senior adviser to Ernst & Young working with the firm’s financial services partners in the UK, Europe, the Middle East and Africa.
Penny Hughes, CBE (age 52) Date of appointment: 1 January 2010
Previously a director and chairman of the Remuneration Committee of Skandinaviska Enskilda Banken AB and a non-executive director of Home Retail Group plc and chairman of its Remuneration Committee. She spent the majority of her executive career at Coca-Cola where she held a number of leadership positions, latterly as President, Coca-Cola Great Britain and Ireland. Former non-executive directorships include Vodafone Group plc, Reuters Group PLC and The Gap Inc.
Independent non-executive directors Arthur ‘Art’ Ryan (age 69) Date of appointment: 1 October 2008
External appointments Non-executive director of Regeneron Pharmaceuticals Inc. Active member of numerous community boards
Wide-ranging experience of financial services and risk management, including previous responsibility for Aviva’s continental European and International life and long-term savings businesses. He held a number of senior executive positions during his career at Aviva including his role as group finance director until January 2010. President Elect of the Institute and Faculty of Actuaries and Fellow of the Association of Certified Public Accountants.
Stephen Hester, Group Chief Executive Bruce Van Saun, Group Finance Director For biographies see page 253
Nathan Bostock (age 51) Head of Restructuring & Risk Nathan Bostock joined the RBS Group in June 2009. He is Head of Restructuring and Risk with responsibility for Risk Management, Legal & Regulatory Affairs, Global Restructuring Group and the Asset Protection Scheme. Before joining RBS, Nathan spent eight years with Abbey National plc in several roles and was latterly the chief financial officer and main board director responsible for Products & Marketing, HR, Insurance and Cards. Before joining Abbey in 2001, Nathan spent ten years with RBS in a number of roles, including Chief Operating Officer of Treasury and Capital Markets and Group Risk Director. A Chartered Accountant, Nathan worked with Coopers & Lybrand, before starting his career in banking. He spent seven years in Chase Manhattan Bank in a variety of areas and functions. He also holds a BSc (Hons) in Mathematics.
Brian Hartzer (age 45) Chief Executive, UK Retail, Wealth and Ulster Bank Brian Hartzer has been the Chief Executive Officer for Retail, Wealth and Ulster Bank since August 2009. He joined RBS from ANZ in Australia, where he was chief executive officer Australia, as well as global segment lead for retail and wealth. Brian joined ANZ in 1999 as managing director, consumer finance, and later ran ANZ’s personal banking division. Prior to joining ANZ, Brian spent ten years as a financial services consultant in
New York, San Francisco, and Melbourne. Brian is a graduate of Princeton University and holds joint US and Australian citizenship. Brian will leave the RBS Group in summer 2012.
John Hourican (age 41) Chief Executive, Markets & International Banking John Hourican was appointed Chief Executive, Markets & International Banking in January 2012 having served as Chief Executive of its predecessor, Global Banking & Markets, since October 2008. Prior to this John held a variety of positions across the RBS Group, including Chief Financial Officer of ABN AMRO Group, Head of Leveraged Finance and Chief Operating Officer of Global Banking & Markets. John received a degree in Economics and Sociology from the National University of Ireland and received a Postgraduate Diploma in Accounting from Dublin City University before starting his career at Price Waterhouse, where he worked in Dublin, London and Hong Kong. He is a fellow of the Institute of Chartered Accountants in Ireland.
It comprises members of the Executive Committee plus a number of other senior executives. Full details of membership of the Management Committee can be found on the Group’s website www.rbs.com.
The names and biographical details of the members of the Board are shown on pages 253 to 256.
The Board is aware of the other commitments of its directors and is satisfied that all directors allocate sufficient time to enable them to discharge their responsibilities effectively.
The non-executive directors combine broad business and commercial experience with independent and objective judgement. The nonexecutive directors provide independent challenge to the executive directors and leadership team. The balance between non-executive and executive directors enables the Board to provide clear and effective leadership and maintain the highest standards of integrity across the Group’s business activities.
Notes: (1) Joined the Board on 1 August 2011. (2) Joined the Board on 1 September 2011. (3) Retired from the Board on 5 August 2011.
At each Board meeting, the Chairman provided a verbal update and the Group Chief Executive provided a written report on business activities.
The terms of reference of the undernoted committees are available on the Group’s website www.rbs.com and copies are available on request.
The Board Committees are discussed in their individual reports: Group Audit Committee - pages 263 to 267 Board Risk Committee - pages 268 to 271 Group Remuneration Committee - pages 272 to 293
Information, induction and professional development All directors receive accurate, timely and clear information on all relevant matters. All directors also have access to the advice and services of the Group Secretary who is responsible to the Board for ensuring that Board procedures are followed and for advising on all governance matters. In addition, all directors are able, if necessary, to obtain independent professional advice at the company’s expense.
In line with the recommendations of the Walker Review of Governance in Banks and Financial Institutions (the Walker Review) and the Code, the Group Secretary has reviewed the induction programme for new directors. Each new director receives a formal induction on joining the Board, including visits to the Group’s major divisions and meetings with directors and senior management and key stakeholders. The induction is tailored to the director’s specific requirements.
Business visits are also arranged as part of the Group Audit Committee and Board Risk Committee schedule and all non-executive directors are invited to attend. During 2011, visits were made to Group Internal Audit, RBS N.V., Restructuring and Risk and RBS Insurance.
Performance evaluation In accordance with the Code, an external evaluation of the Board takes place every three years with the last externally facilitated evaluation having taken place in 2009.
The 2010 evaluation was conducted internally and a number of initiatives were implemented aimed at improving the overall performance and effectiveness of the Board. These included further improvements to the flow of information to the Board, both in terms of the quality of papers and the use of new technology to deliver these to directors. The 2011 evaluation concluded that the recommendations from the 2010 evaluation had been implemented in full.
Performance evaluation process The directors agreed that the 2011 evaluation of the Board and its key Board Committees be conducted internally, led by the Group Secretary. The Group Secretary undertook a formal and rigorous evaluation by: circulating a detailed framework of questions to all directors and regular meeting attendees; collating the responses and conducting structured individual meetings with each director and regular meeting attendees; discussing the outcomes and recommendations with the Chairman; and agreeing the recommendations and outcomes with the Board and Board Committee members.
The evaluation concluded that the Board is strong, operating effectively and meeting its objectives. Headed by an excellent Chairman, the Board is currently viewed as an appropriate size, although Board composition should be kept under continual review. Meetings are of an appropriate length and frequency with sufficient opportunity for debate and discussion, although it was suggested the Board continue to make use of evening and lunch slots to facilitate further debate and discussion on key areas such as strategy and risk management.
A summary of the objectives and actions proposed to be taken to address the objectives arising from the 2011 performance evaluation is set out below: Key themes Proposed action
Individual director and Chairman effectiveness reviews Within the performance evaluation questionnaires, directors were asked to provide feedback on their fellow directors. This feedback was shared with each director by the Chairman, who met with each director individually to discuss their own performance and ongoing professional development. Separately, the Senior Independent Director canvassed the views of the executive directors and met with the non-executive directors as a group, without the Chairman present, to consider the Chairman’s performance. Feedback was sought on governance and stewardship of the Group, relationships with key external and internal stakeholders, execution of the Group’s Strategic Plan and delivery of value and return to shareholders. The Senior Independent Director also canvassed views from United Kingdom Financial Investments Limited (UKFI), the FSA and the Asset Protection Agency. The results of the Chairman effectiveness review were then shared with the Chairman who agreed to consider the points raised and provide separate responses in due course.
Group Nominations Committee Role of the Group Nominations Committee The Group Nominations Committee is responsible for: reviewing the structure, size and composition of the Board and making recommendations to the Board on any appropriate changes; assisting the Board in the formal selection and appointment of directors (executive and non-executive) having regard to the overall balance of skills, knowledge, experience and diversity on the Board; reviewing membership and chairmanship of Group Board Committees; considering succession planning for the Chairman and the executive and non-executive directors, taking into account the skills and expertise which will be needed on the Board in the future. No director is involved in decisions regarding his or her own succession; and making recommendations to the Board concerning the re-election by shareholders of directors under the provisions of the Code. In so doing, they will have due regard to their performance and ability to continue to contribute to the Board in light of the knowledge, skills and experience required and the need for progressive refreshing of the Board.
The terms of reference of the Group Nominations Committee are available on the Group’s website www.rbs.com.
The Group Nominations Committee engages with external consultants, considers potential candidates and recommends appointments of new directors to the Board.
Philip Hampton (Chairman) 5/5 Sandy Crombie 5/5 Penny Hughes 4/5 Joe MacHale 5/5 John McFarlane 5/5 Brendan Nelson 5/5 Art Ryan 5/5 Philip Scott 5/5
Board and Committee membership When considering the appointment of Alison Davis, Baroness Noakes and Tony Di Iorio, and the retirement of Colin Buchan, the Group Nominations Committee also reviewed the membership of the Group Board Committees. Based on the expertise of the incoming nonexecutive directors, the Group Nominations Committee agreed to strengthen the Group Board Committees with additional members.
Succession planning The Group Nominations Committee considers succession planning on an ongoing basis. The Board considered talent and succession planning for the Group Chief Executive and each member of the Executive Committee at a meeting in June 2011. The meeting concluded that the executive team was extremely strong and the Board should continue to monitor the position as industry developments progress.
Group Sustainability Committee The Group Sustainability Committee (GSC) is chaired by the Senior Independent Director and meets quarterly. The GSC is responsible for reviewing the Group’s overall sustainability strategy, values and policies and aligning the Group’s approach to ethical, social and environmental issues. All key business areas are represented on the GSC and it is attended by the Group Chairman. For more information on the governance framework which supports the GSC see page 30. Further details of the Group’s sustainability policies are available on the Group’s website www.rbs.com/sustainability and in the Annual Sustainability Report.
the Chair of the Group Remuneration Committee consults extensively with institutional shareholders in respect of the Group’s remuneration policy.
Throughout the year, the Chairman, Group Chief Executive, Group Finance Director and Chair of the Group Remuneration Committee communicate shareholder feedback to the Board and the directors receive independent analyst notes and reports reviewing share price movements and the Group’s performance against the sector. Detailed market and shareholder feedback is also provided to the Board after major public announcements such as results announcements. The arrangements used to ensure that directors develop an understanding of the views of major shareholders are considered as part of the annual Board evaluation.
2011 has been a difficult year for the industry and for the Group and the Committee has concentrated its efforts on key emerging issues. In particular, it has considered and, where appropriate, made recommendations to the Group Board in respect of: the continued market turmoil and its effect on the Group’s businesses, in particular the GBM division; the ongoing Eurozone crisis and impairment of the Group’s sovereign debt exposure; impairment charges in the UK Corporate and Ulster Bank divisions; Payment Protection Insurance (PPI) provision; the implications, including the capital, risk and control assumptions and dependencies of the proposed structured transfer of the assets and liabilities of RBS N.V. to RBS plc; the adequacy of internal change processes and controls; the activity, performance and findings of Internal and External Audit; and the quality and transparency of disclosures contained in external financial statements.
Report of the Group Audit Committee The role and responsibilities of the Group Audit Committee The Group Audit Committee’s primary responsibilities, as set out in its terms of reference, are to assist the Board in discharging its responsibilities in respect of: financial reporting and policy; systems of internal control; processes for Internal and External Audit and oversight of the Group’s relationship with its regulators. The terms of reference of the Group Audit Committee are reviewed annually by the Group Audit Committee and approved by the Board. They are available on the Group’s website www.rbs.com.
The annual programme of joint visits by the Group Audit and Board Risk Committees to the Group's business divisions and control functions continued in 2011. The object of the programme is to promote the Committees’ understanding of the Group; invitations to attend are extended to all non-executive directors. The programme of visits is considered annually. The Group Audit Committee and the Board Risk Committee undertook four visits - to Group Internal Audit, RBS N.V., Restructuring and Risk and RBS Insurance - during 2011.
Membership of the Group Audit Committee The Group Audit Committee comprises at least three independent nonexecutive directors. The Chairman and members of the Committee, together with their attendance at meetings, are shown below.
Brendan Nelson (chairman) Independent 7/7 Tony Di Iorio (1) Independent 2/2 Baroness Noakes (2) Independent 3/3 Philip Scott Independent 7/7
Notes: (1) Joined the Committee on 1 September 2011. (2) Joined the Committee on 1 August 2011. (3) Retired from the Committee on 5 August 2011.
Brendan Nelson, Tony Di Iorio and Philip Scott are also members of the Board Risk Committee facilitating the effective governance of finance and risk issues and the alignment of agendas. The Group Audit and Board Risk Committees also have strong links with the Group Remuneration Committee ensuring that levels of compensation reflect relevant finance and risk considerations.
Principal activity of the Group Audit Committee during 2011 Financial reporting During 2011, the Group Audit Committee received regular updates on accounting issues and developments from both the Group Chief Accountant and from the External Auditors who presented for approval their audit plan, their audit fee proposal and engagement letter, as well as confirmation of their independence and a comprehensive report of all non-audit fees.
The Group Audit Committee focused on a number of salient judgments and reporting issues in the preparation of the 2011 accounts, including: valuation methodologies and assumptions for financial instruments carried at fair value including the Group's credit market exposures; disclosures, including those in relation to forbearance and sovereign debt; impairment losses in the Group's loans and advances and availablefor -sale securities; with particular emphasis on Eurozone issues, sovereign debt exposures, Ulster Bank and UK Corporate impairment; PPI provision; actuarial assumptions for the Group Pension Fund and the Group’s general insurance claims reserves; impairment of goodwill; and the Group’s tax position, including the recognition of deferred tax assets.
The Committee sought to understand and to challenge in a robust manner management’s accounting judgments and estimates. It reviewed the conclusions of the External Auditors and, where applicable, other experts and satisfied itself that disclosures in the financial statements about these judgements and estimates are transparent and appropriate.
Internal Control In 2011, the Group Audit Committee tracked progress in the development and implementation of the new Group Policy Framework across the Group and will continue to monitor progress in embedding the framework throughout 2012. It will review the results of assurance activity in respect of the new framework in the latter half of the year.
The Group Audit Committee reviewed the control framework in place to ensure that it is operating effectively and specifically reviewed progress against its plan for a number of large strategic initiatives such as the Finance and Risk Transformation Programme. It also tracked progress in relation to mandatory and remedial projects including the Group’s AntiMoney Laundering Programme and the progress of the Group’s US regulatory initiatives.
The Committee received reports and considered the Group’s compliance with the requirements of the Sarbanes-Oxley Act of 2002. It was regularly advised of: whistle-blowing events which occurred within the Group; complaints raised with members of the Group’s executive team; and significant internal investigations undertaken within the Group.
Internal audit The Group Audit Committee oversees the work of Group Internal Audit, and receives a quarterly report from the Head of Group Internal Audit. This report rates the quality of the control environment of all the Group’s divisions and of management’s level of awareness on these matters. It offers the Group Audit Committee oversight of Group Internal Audit’s work, and allows the Group Audit Committee to monitor the level of internal control within the Group by reporting on areas where improvements are required to the control environment.
External audit Deloitte LLP have been the company’s auditors since March 2000. There are no contractual obligations restricting the company's choice of external auditor.
During 2011, the External Auditors provided the Group Audit Committee with reports summarising their main observations and conclusions arising from their year end audit, their half year review and their work in connection with the first and third quarters and their recommendations for enhancements to the Group’s reporting and controls. Deloitte also presented for approval to the Committee their audit plan, their audit fee proposal and engagement letter, as well as confirmation of their independence and a comprehensive report of all non-audit fees.
The Group Audit Committee is responsible for making recommendations to the Board in relation to the appointment, re-appointment and removal of the External Auditors. In order to make a recommendation to the Board, the Group Audit Committee considers and discusses the performance of the External Auditor in the previous year, taking account of the outcomes of the annual evaluation carried out. The Board submits the Group Audit Committee's recommendations to shareholders for their approval at the Annual General Meeting. The Board has endorsed the Group Audit Committee's recommendation that shareholders be requested to approve the reappointment of Deloitte LLP as External Auditors at the Annual General Meeting in 2012. The Group Audit Committee has considered the proposals for reform of the audit market as published by the EU Commission. It will continue to monitor developments in this regard including the potential implications for External Auditor appointment in the UK.
Audit and non-audit services The Group Audit Committee has adopted a policy on the engagement of the External Auditors to supply audit and non-audit services, which takes into account relevant legislation regarding the provision of such services by an external audit firm.
Provision of advice, best-practice options and support to management on a number of projects (four engagements)
The External Auditor was appointed in relation to these engagements because it was the market leader in the subject matter or because the external audit team included personnel who were uniquely positioned, experienced and qualified to provide the necessary advice.
A full tender process was undertaken in relation to two engagements and the External Auditor was appointed following presentation of a thorough proposal and a willingness to leverage existing knowledge to ensure a competitive price proposition.
Following a tender process in the other instance the External Auditor was judged to be the best firm to employ and was agreed by the co-sponsors to the engagement.
Information on fees paid in respect of audit and non-audit services carried out by the External Auditors is detailed in Note 5 on the Group’s consolidated accounts.
Group’s relationship with its regulators The Group Audit Committee has a responsibility to monitor the Group’s relationship with the Financial Services Authority (FSA) and other regulatory bodies. During 2011, it received regular reports on the Group’s relationship with all its regulators and significant developments or changes to those interactions. It receives reports on regulatory actions and investigations. Over the course of the year the chairmen of the Group’s Senior Board Committees met with the FSA on an individual basis and also participated in certain Regulatory College meetings with the Group’s primary regulators. The non-executive directors also collectively participated in meetings with the FSA on two occasions and the FSA were invited to attend certain discussions of the Board.
The non-executive directors closely monitor the Group’s relationship with its international regulators and during 2011 significant time has been dedicated in particular to understanding the regulatory requirements in the US and the implications on the Group’s US operations and structure.
Performance evaluation An external review evaluating the effectiveness of the Group Audit Committee takes place every three to five years, with internal reviews by the Board in intervening years. An internal review took place during 2011 covering the role of the Committee; its composition, meetings and processes, performance and reporting, policy and procedures; induction and continuing professional development; communication; and divisional committees. Overall the review concluded that the Committee continued to operate effectively.
Brendan Nelson, Chairman of the Group Audit Committee 22 February 2012
I am pleased to bring you this report on the activity of the Board Risk Committee during 2011.
The Board Risk Committee was created in January 2010 following the recommendations set out in the Walker Review and it is therefore a relatively new committee to the Group. Notwithstanding the challenges presented by external market forces, it was important that the Committee, during its second year of operation, continued to fully refine and enhance its approach to risk oversight and its interaction with other senior Board Committees. I am pleased to report that during 2011 the Committee has made progress in the following areas: further development of a risk appetite framework and methodology; development of a new conduct risk appetite framework; enhancement of the Group Policy Framework. This has been a major project for the Group in 2011 and the Board Risk Committee has provided oversight of the project which has now completed its critical initial phase; interaction with the Group Remuneration Committee. Penny Hughes, Chair of the Group Remuneration Committee, and I sponsored a project in 2011 to review and improve interaction between both committees. This has led to clarification of responsibilities, improved planning and the identification of additional trigger points outwith pay cycles where risk should be taken into consideration; improvement of reporting standards; promotion of a risk awareness culture; and oversight of the enhancement of the risk governance framework that supports the Committee at an executive level.
The activity of the Committee is set out more fully in the Report of the Board Risk Committee below. However, while progress has been made, the work of the Committee is in no way complete and these risk areas will remain a key area of focus and refinement in 2012. The risk appetite framework must be fully embedded across divisions and the Committee recognises that development of an economic capital model must be prioritised in 2012. Furthermore, the difficulties being experienced in Europe and the US will necessitate a continued focus on market and sovereign risk in the year ahead.
It is not yet possible to determine the impact of the recommendations contained within the Report of the Independent Commission on Banking. The recommendations are complex and it will take time to fully consider what they mean for the Group and any corresponding strategic and organisational change. The Board Risk Committee will monitor developments and will fully consider the risk implications of any decision in this regard.
Philip Scott Chairman of the Board Risk Committee 22 February 2012
Meetings and visits The Board Risk Committee held six scheduled meetings and three additional ad hoc meetings in 2011. Meetings are held alongside Group Audit Committee meetings to ensure that the work of the two Committees is coordinated and consistent. Board Risk Committee meetings are attended by relevant executive directors, risk management and finance executives and the internal auditors. External advice may be sought by the Board Risk Committee where considered appropriate. During 2011, the members of Board Risk Committee in conjunction with the members of the Group Audit Committee took part in an annual programme of visits to the Group's business divisions and control functions. Details about the programme of visits is set out in the Report of the Group Audit Committee on page 264.
Notes: (1) Joined the Committee on 1 September 2011. (2) Retired from the Committee on 5 August 2011.
The Board Risk Committee has assumed responsibility on behalf of the Group Board for considering key areas of risk in a deeper level of granularity. In particular, during 2011 it has played an important governance role in the oversight and remediation of regulatory issues in the RBS Americas region. Brendan Nelson has personally provided oversight of the Executive Steering Group established with responsibility for remediation of known issues in the region and the Committee receives regular reports on progress.
In response to market events, the Committee has reviewed its controls for potential weaknesses from a rogue trading perspective. This review identified that most controls were effective and the Committee will oversee the remedial work that is underway to resolve all potential weaknesses identified.
The Committee has also considered the risks inherent within large strategic transactions such as the proposed transfers of a substantial part of the business activities of RBS N.V. to the Royal Bank.
The Committee reviewed the capital and liquidity position of the Group regularly during 2011 in light of external conditions and has reviewed the output of stress tests, including the Group results under the EU wide stress testing exercise of the European Banking Authority, the results of which were published in July 2011. It has considered and made recommendations to the Group Board in relation to the Individual Liquidity Adequacy Assessment and the Individual Capital Adequacy Assessment required by the FSA.
Regulatory risk has featured highly on the agenda of the Committee. The members have received reports on the status of ongoing regulatory investigations and have considered individual remuneration impacts (if any), as those investigations progress. Regulatory developments have been monitored and the regulatory risks associated with the sale of complex products to certain customers have been considered. Operational risks inherent in the Groups processes have also been considered and the Committee has specifically considered continuity and data control.
As set out in the Group Audit Committee report on page 265 a framework of Divisional Risk and Audit Committees are responsible for reviewing the business of each division and reporting to the Group Audit Committee and Board Risk Committee. The risk agenda of these committees continues to evolve alongside the Board Risk Committee agenda. In 2011, a quarterly risk assessment process was introduced to raise awareness and understanding of risk appetite at divisional level. While this assessment has had some success, risk reporting at a divisional level has been further refined and aligned with regulatory process. A new Material Risk Assessment process will be implemented within the divisions in 2012 and will be overseen by the Divisional Risk and Audit Committees. This will streamline reporting and standardise structure across the divisions. Progress will be closely monitored by the Board Risk Committee in 2012.
While some progress has been made, significant work is still required to fully develop an operational economic capital model for the Group. This will be an area of focus for the Committee over the coming year.
During 2011, the risk governance model has been extensively reviewed and streamlined at executive level. The role of the Executive Risk Forum has been clarified. The Executive Risk Forum has responsibility for consideration of strategic risk and policy issues in advance of the Board Risk Committee and aims to provide an effective filter of the key risks for the consideration of the Board Risk Committee.
Risk architecture The Committee has sought continually to drive improvements to reporting standards and has implemented new guidance for the presentation of papers for the consideration of the Committee. It has held separate discussions to refine and enhance the quality of the key risk report and metrics and following those discussions a revised risk report will be operational in 2012. Work is ongoing to develop risk reporting at entity level (in addition to reporting at a Group and divisional level).
Remuneration The Board Risk Committee has continued to strengthen its relationship with the Group Remuneration Committee with the aim of ensuring that risk is adequately reflected in objectives and compensation arrangements and decisions. Significant improvements have been made in 2011 including clarification of responsibilities, improved planning and the identification of additional trigger points outwith pay cycles where risk should be taken into consideration. This improved interaction has led to a number of additional meetings of the Board Risk Committee specifically to consider the risk implications of remuneration decisions.
Performance evaluation An internal review of the effectiveness of the Board Risk Committee during 2011 was conducted. Amongst the areas reviewed were the role of the Committee, composition, meetings and processes, performance and reporting, policy and procedures, divisional committees, induction and continuing professional development and communication. The Committee has considered and discussed the report on the outcomes of the evaluation and is satisfied with the way in which the evaluation has been conducted, the conclusions and the recommendations for action. The outcomes of the evaluation have been reported to the Board, and during 2012, the Committee will place focus on driving improvements to: the structure of the agendas to ensure the Committee is focused on consideration of the key issues - while recognising the remit of the Committee is extremely onerous; Divisional Risk and Audit Committees: implementing the changes to the risk assessment process and reporting; enhance the bench strength of the Risk Management function; and the Committee’s interaction with the Executive Risk Forum.
Remuneration in banks continues to be an important and sensitive topic and this is particularly true at RBS. And so it has been another eventful and challenging year for the Group Remuneration Committee.
It is worth reiterating that since 2008, there has been a complete change of the executive leadership team at RBS. Those who were responsible for the problems of the past have been replaced by a team charged with fixing them. On pay, we operate with a strong sense of restraint but it's important that our people believe that they'll be treated fairly and competitively. We consider that this is in the best interests of our shareholders and customers. We aim to set pay and incentives based on performance and market conditions, appropriate to the different markets in which our people operate, the objectives we set them and results we get from them, and a desire to minimise costs where consistent with our wider goals. We are a commercially run bank and that principle must apply to how we pay all of our employees. Overall, our pay is towards the lower end of market norms in aggregate.
We have been very clear over recent years that pay for performance, not failure, is at the heart of our remuneration policy. Under the leadership of the current executive directors, RBS has made significant progress in exceptionally difficult circumstances. In recognition of this, the Board believed, and still believe, that the award to its Group Chief Executive was justified in the context of the market and appropriate based on achievement against the performance objectives that had been set (see page 282 for further details). The Board’s decision was well-balanced and took into account all the circumstances, including the fall in share price over 2011, which was mirrored in most other banks. The award was offered on terms that are arguably amongst the most reformed in our industry and endorsed at the 2011 AGM by over 99% of our shareholders. The award would have been delivered entirely in shares, been deferred and subject to clawback.
Stephen Hester subsequently decided to waive his bonus because the attention it received had become a damaging distraction for him and the Group. Since this announcement, many of our major shareholders have expressed overwhelming support for all members of our leadership team and are supportive of the Group Remuneration Committee’s efforts to ensure that these individuals are fairly rewarded as they continue to lead the turnaround of the Group. There is significant concern that the alternative - attempting to operate on a less-than-commercial basis - would be value destructive if RBS becomes an unattractive place to work.
There has been a 43% reduction at Group level in variable compensation. Details of our variable compensation can be found in Note 3 on the consolidated accounts on page 332.
The Committee recognises the importance of driving cultural change, not just through pay, but in the wider sense. As Group Remuneration Committee Chair, I am actively involved in the Group’s initiatives relating to diversity, graduate recruitment and management development. I’m impressed by the quality and depth of these initiatives around the Group, many of which have received award-winning recognition.
Our restrained approach to pay is not without risk. Employees at all levels of RBS have choices about where they work. If we allow a sizeable gap to open up between how we pay and how others pay, then it will affect our ability to attract and retain good, well-motivated people to work here. We do not believe that this would be in the interests of our shareholders, our customers, or the taxpayer.
We believe we are getting the balance right in difficult circumstances. Under the leadership of Stephen Hester and his team, RBS is a challenging but inspiring place to work. Employee engagement continues to improve, which demonstrates the pride our people have in helping to fix and recover from one of the biggest failures in corporate history. Whilst the road to recovery is proving more challenging than probably any of us envisaged, our people are working hard to help return the Group to financial strength and the Group Remuneration Committee remains committed to helping create an environment in which they can meet their ambitions.
The terms of reference of the Group Remuneration Committee are available on the Group’s website www.rbs.com and these are reviewed annually by the Committee and approved by the Group Board.
Penny Hughes (chair) 9/9 Sandy Crombie 9/9 Alison Davis (1) 4/4 John McFarlane (2) 9/9
Enhanced governance The Group Remuneration Committee has taken a number of steps during 2011 to enhance its governance arrangements: Alison Davis was appointed as an additional member to bring further financial experience and fresh expertise; private sessions are held at each Committee meeting with only the Group Chairman and non-executive directors present; a strategy session is carried out to ensure agendas focus on key issues in relation to remuneration; reporting between the Committee and the Group Board has been improved so that all directors are fully informed and able to discuss the approach being taken; and greater focus was placed on international regulatory compliance as requirements emerge across the territories in which we operate.
First quarter new arrangements for the executive directors. Following extensive shareholder consultation and consideration by the Committee, Share Bank arrangements and new long term incentive plans (LTIP) performance measures were introduced; remuneration arrangements and year-end performance reports for members of the Executive Committee, Management Committee and annual performance objectives for 2011 and also LTIP performance objectives; remuneration arrangements and year-end performance reports for APS In-Scope employees and Code Staff; new process for divisional bonus pools implemented with advice from the Board Risk Committee on risk performance; progress against unvested LTIP performance measures; approval of the Group and divisional bonus pools; and approval of Directors’ remuneration report.
Second quarter key business and strategic priorities; presentations from Non-Core, RBS Insurance and GBM; project to enhance risk input into remuneration; and formal remuneration strategy session - compensation structure and priorities for the forthcoming year were agreed.
Fourth quarter review of risk-adjusted performance across the Group and divisions; preliminary bonus pools discussions for Group and divisions; enhanced process for review of risk trigger events for clawback and bonus reduction; content for shareholder consultations undertaken in December 2011 and January 2012; and report from the project to enhance risk input into remuneration with recommendations for actions.
PricewaterhouseCoopers LLP (PwC) were appointed as the Committee’s remuneration advisers on 14 September 2010, and their appointment was reconfirmed by the Committee in June 2011 after an annual review of the quality of the advice received and fees charged. PwC are signatories to the voluntary code of conduct in relation to remuneration consulting in the UK.
Performance evaluation process An internal review of the effectiveness of the Group Remuneration Committee was conducted by the Group Secretary during 2011. The evaluation was based on detailed questionnaires and individual meetings with each member and attendee. Amongst the areas reviewed were the role of the Committee, composition, meetings and processes, continuing professional development and communication. Generally, the Committee was considered to be effective and meeting its objectives, with members willing to spend the time necessary to discharge their responsibilities. The evaluation respondents agreed that the Committee was the right size, with an appropriate composition and was headed by a committed Chair. The respondents were also impressed by the level of work undertaken outside of the meetings, particularly by the Chair.
A number of actions arose from the evaluation relating to the further improvement of the meeting arrangements, including: improved performance from the Committee’s internal and external resources; further improvement on length and clarity of materials provided to the Committee; and monitoring of the new processes for risk input into remuneration and processes for reporting and escalation of trigger events which may lead to clawback or bonus reduction.
The Committee has considered and discussed the report on the outcomes of the evaluation and is satisfied with the way in which the evaluation was conducted, the conclusions and the recommendations for actions. The outcomes of the evaluation have been reported to the Group Board and the actions are being progressed.
Regular updates on key developments including the FSA Code, Government consultations, guidelines from shareholders and investor bodies.
The Committee has appointed independent external advisers who attend private sessions of the Committee without executives present.
Extensive shareholder consultation and reporting to the Committee so that members are aware of shareholder views. (More details on the consultation process is given on the next page).
Shareholder consultation and its impact on remuneration policy In late 2011 and early 2012, an extensive consultation was undertaken with institutional shareholders and other stakeholders on the Group’s remuneration approach. Investors recognised the difficult challenge faced by the Group Remuneration Committee in balancing the need to pay competitively to support business goals but at the same time being mindful of the wider economic environment and the need to show restraint.
The shareholders gave a clear message that increases to base pay and pension contributions for executive directors were not appropriate. However, the overall shape of executive remuneration structure received widespread support. Shareholders recognised the need for retention of the current executive team and the potentially destructive effect that any break up would have on rebuilding the Group.
This consultation included UKFI and as with other shareholders, the Committee received their input. However, in line with the Group’s mandate to operate commercially, the Committee did not receive formal direction from UK Government.
The consultation process involved one-to-one meetings, a roundtable session hosted by the Association of British Insurers and National Association of Pension Funds and a number of follow-up letters and meetings.
Topics discussed with investors included both Group-wide and executive directors’ pay positioning, scale and design of incentive structures, risk alignment of remuneration, deferral, clawback and remuneration disclosures.
There was also concern over falling share prices across the industry. Some shareholders proposed that LTIP award levels to employees should be scaled back given the fall in the share price over 2011. The Committee recognises the impact that the fall in share price has had both on shareholders and employees. The share awards that were made to employees at the beginning of 2011, under bonus deferral or the long term incentive plan, have fallen in value. This is clear alignment with the value reduction that shareholders have experienced. It is also true in the case of prior year unvested and vested but retained awards.
The support received by shareholders during the consultation period has been greatly encouraging. Shareholders have played a key role in developing remuneration practices that support the long term goals of the business.
Risk and regulatory environment FSA Remuneration Code compliance The Group has been fully compliant throughout 2011, in practice and in spirit, with all aspects of the FSA Remuneration Code.
During 2011, a project was undertaken, co-sponsored by the Chairs of the Group Remuneration Committee and Board Risk Committee, to identify and implement further areas of improvement in risk/remuneration alignment. The project focussed on three workstreams: robust governance (clarify and enhance respective roles of the Group Remuneration Committee and Board Risk Committee and the interaction between them); pay-for-performance (risk input into objectives and performance reviews and enhanced clawback process); and control function input and risk adjusted performance measures.
How do we apply this in practice? The assessment undertaken by the risk function and Board Risk Committee confirmed that, for some divisions, a number of risk-related events needed to be taken account of when determining bonus pools, including regulatory, compliance and credit and market risk issues.
The enhanced process for individual accountability review assessments (which consider material risk management, control and general policy breach failures, accountability for those events and appropriate action against individuals) is operated across divisions and functions. RBS Risk Management has concluded that the accountability review assessments approach is robust and complete from a perspective of all known material events having been considered.
Pay for performance The Group Remuneration Committee’s formal process for determining bonus pools is outlined in the diagram below. This process is designed to ensure that financial, risk and non-financial performance measures are all taken in to account in an integrated and structured way with appropriate reference being made to the business plan and capital adequacy.
Risk is taken into account in the performance assessment through a thorough risk analysis carried out by RBS Risk Management to a preagreed framework approved by the Group Remuneration and Board Risk Committees. Performance assessments may be adjusted in situations where risk performance is outside risk appetite or strategic plans. Nonfinancial factors such as turnover, succession issues, customer issues, market environment and franchise development are then taken into account in developing a final bonus proposal. Bonus proposals are reviewed in the context of key compensation framework ratios including: compensation to revenues, compensation to pre-compensation profit and bonus to pre-bonus profit. These ratios help to ensure appropriate sharing of value between employees and shareholders. Finally bonus proposals are reviewed against our capital adequacy framework to ensure that regulatory requirements are met.
The annual incentive pool is based on a balanced scorecard of measures including financial performance, risk, people and customer measures. Capital adequacy and the impact of incentive awards on the balance sheet are also taken into account.
Allocation from the pool depends on divisional, functional and individual performance. Individual performance assessment is supported by a structured performance management framework.
LTIP To encourage the creation of value over the long term and to further align the rewards of the participants with the returns to shareholders, the Group provides certain employees in senior roles with long-term incentive awards. Awards are structured as performance-vesting shares. Vesting will be based partly on divisional or functional performance and partly on performance across the Group. All awards are subject to clawback.
Employees in certain countries are eligible to participate in share plans which are not subject to performance conditions.
Executive directors In determining directors’ remuneration, the Group Remuneration Committee takes into account pay and employment conditions of employees of the company. It does so by reference to annual market data against an assessment of the competitiveness of the current base salary ranges or benchmarks and actual salaries in payment. Any salary increases awarded to executive directors are also considered in the context of salary increases for the wider employee population. A summary of executive directors’ remuneration for 2011 and 2012 is set out below: Policy 2011 arrangements 2012 arrangements
The shares will vest in two equal tranches on the first and second anniversaries of the date of grant. Prior to vesting, shares will be subject to clawback and shares must be held for a further six months post vesting.
Incentives will be awarded entirely in shares which will vest in two equal tranches on the first and second anniversaries of the date of grant. Prior to vesting, shares will be subject to clawback and shares must be held for a further six months post vesting.
The awards will vest in 2014 in an amount based on the achievement of performance conditions (see description on page 284). These will each have the ability to deliver a number of shares worth up to 100% of salary; however, the number of shares that vest will be subject to an overall cap in value of 375% of salary (based on salary and share price at the time the award was made).
The awards will vest in 2015 in an amount based on the achievement of performance conditions (see description on page 287). These will each have the ability to deliver a number of shares worth up to 100% of salary; however, the number of shares that vest will be subject to an overall cap in value of 300% of salary (based on salary and share price at the time the award was made). The notional value of these awards would be 45% of face value, which is 135% of salary.
Shareholding guidelines The Group operates shareholding guidelines for executive directors. The target shareholding level for the Group Chief Executive is 200% of gross annual salary and 100% of gross annual salary for executive directors. A period of five years is allowed in which to build up shareholdings to meet the guideline levels.
The data shows that Stephen Hester is likely to receive just 10% of the maximum value of his incentives awarded over the last three years, and around 29% of his maximum total compensation. This is despite the majority of financial and non-financial targets for RBS having been met when measured over the three year period since 2009. In comparison, levels of pay-out at RBS are expected to be at least one-third lower than recent levels of pay-out in the FTSE-30 and less than half recent payouts in the international banking sector.
Av er ag e A nn ua lT ot al C om pe ns at io n (£
Stephen Hester Stephen Hester’s performance is measured against a number of strategic and business objectives. In the course of 2011 the Group’s priority has been to strengthen its balance sheet and reduce risk as it works through the restructuring plan, and this is reflected in good progress on the key risk measures set out in 2009. Targets for capital, short-term wholesale funding, liquidity reserves and leverage have all been met ahead of schedule, while the Group loan:deposit ratio improved further.
ROE, profitability, costs, core tier 1 ratio, funding and risk profile, lending commitments, EU mandated disposals.
All risk reduction and control measures were exceeded. This includes Group loan:deposit ratio (LDR) improved to 108%, with Core loan:deposit ratio ahead of target at 94%. Leverage was stable at 16.9x. Performance against agreed APS objectives was satisfactory and significantly improved compared with prior year.
Relationships with shareholders and other external stakeholders. Customer satisfaction and Treating Customers Fairly (TCF) measures.
Strategic progress Monitoring/improvement of Group and Divisional Strategic Plans. Work with Group Chief Executive on Group Strategy/M&A and APS compliance requirements.
Strong stewardship over the financial risk and control environment, viewed as a strong risk partner by risk function. Effective management against FSA liquidity metrics. Balance sheet substantiation programme completed. Mobilisation of the FiRST programme, to enhance risk and finance data quality.
Executive directors long-term incentive plan (LTIP) awards The following tables provide a current assessment of executive directors' performance against LTIP awards granted in previous years. The Group Remuneration Committee does not believe that these outcomes are reflective of the executive directors' performance over the period 2009 to 2011. As highlighted in the opening letter to this remuneration report, very significant progress has been made across the Group’s strategic plan targets since 2009, resulting in a significantly safer, more resilient and sustainable bank. However, this is not being reflected in the LTIP outcomes. In 2009 and 2010, LTIPs were linked entirely to share price and economic profit targets. In line with the whole sector, and exacerbated by its legacy portfolio, RBS's performance against these metrics has been heavily impacted by the economic and regulatory environment.
The table below summarises the assessment of the first year of a three year performance period. Each measure has the ability to deliver a number of shares worth up to 100% of salary; however, the number of shares that vest will be subject to an overall cap in value of 375% of salary. Awards are due to vest in 2014. An assessment of performance of each relevant element is provided by the control functions and an external firm assesses relative Total Shareholder Return (TSR) performance. The Group Remuneration Committee determines overall vesting based on these assessments including consideration of the drivers of performance and the context against which it was delivered. The assessment is analytical and if any discretion is used, it would be explained. This award is due to be assessed in March 2014 to determine the level of vesting. The table below represents an early indication only.
Maximum: 100% vesting if the Group’s TSR is at the upper quartile of the companies in the comparator group.
Good progress on brand franchises (e.g., ‘Helpful Banking’ in UK), sustainability and employee engagement measures. Further work needed on cost:income ratio.
Maximum vesting of the Economic Profit measure will be triggered by early delivery of Core Business profitability, well ahead of the range implied by the published Strategic Plan targets and also in excess of the cost of capital.
Continued difficult economic conditions in a number of our key markets mean that based on performance to date, the threshold targets have not yet been met.
Based on share price performance to date, the threshold targets have not yet been met.
In 2009, executive directors received long-term incentives under two plans, the Medium Term Performance Plan (MPP) and Executive Share Option Plan (ESOP). These awards are due to be formally assessed in June 2012. It is currently anticipated that, based on performance to date, the threshold targets would not be met and there would be nil vesting under any of the elements of these awards.
Based on share price performance to date, the threshold targets would not be met and there would be no vesting under this element of the award.
Note: The TSR calculations were provided by PwC based on TSR calculations up to and including 3 January 2012.
Total shareholder return - one year Financial shares outperformed the market for most of the first half of the year. However, focus shifted to the fiscal positions of peripheral Eurozone economies, particularly Greece and Italy, in the summer. This prompted investor concerns about the implications for banks exposed to these countries and caused stresses in European bank funding markets. The RBS share price was impacted broadly in line with other domestic UK banks and European peers, underperforming the market in the second half. Accompanying this was a reduction in the consensus outlook for bank earnings, driven by a weaker outlook for growth in the global economy.
Since that date to 22 February 2012, the day before the Group’s 2011 results announcement, the Group’s share price has risen 265% which compares to 164% and 145% respectively for the FTSE banks index and the FTSE 100 index as a whole.
Setting performance for 2012 The executive directors’ annual performance objectives are approved by the Group Remuneration Committee. The risk objectives are reviewed by the Board Risk Committee.
Ensure statutory, regulatory and management reporting is compliant with all external and internal standards. Continue to improve ‘best in class’ external reporting. Provide strong CFO role to the business through strategic planning, budgeting, forecasting and reporting. Ensure a robust capital and funding planning framework. Drive efficiency. Successful completion of EU mandated disposals.
Current Cost of Equity is 12%, which is subject to review at least annually.
Relative Total Shareholder Return (TSR) (25%) The relative TSR measure provides a direct connection between executive directors’ awards and relative performance delivered to shareholders. The measure compares the Group's performance against a group of comparator banks from the UK and overseas, weighted towards those companies most similar to the Group. Performance is measured over a three year performance period. The Remuneration Committee reviewed the weightings within the TSR peer group, and made a small number of adjustments to reflect emerging regulatory influences, the future geographic and business focus of RBS, and consequent future relevance of peer companies. This has resulted in reducing the weightings of a small number of banks in the peer group for 2012 LTIP awards.
Strategic Scorecard (25%) The balanced Strategic Scorecard rewards management for delivering a robust basis for future growth in terms of the strength of our franchise, efficiency, reputation, and the strength and engagement of employees.
Service contracts The company's policy in relation to the duration of contracts with directors is that executive directors' contracts generally continue until termination by either party, subject to the required notice, or until retirement. The notice period under the service contracts of executive directors will not normally exceed twelve months. In relation to newly recruited executive directors, subject to the prior approval of the Group Remuneration Committee, the notice period may be extended beyond twelve months if there is a clear case for this. Where a longer period of notice is initially approved on appointment, it will normally be structured such that it will automatically reduce to twelve months in due course. All new service contracts for executive directors are subject to approval by the Group Remuneration Committee. Those contracts normally include standard clauses covering the performance review process, the company's normal disciplinary procedure, and terms for dismissal in the event of failure to perform or in situations involving actions in breach of the Group's policies and standards. Any compensation payment made in connection with the departure of an executive director will be subject to approval by the Group Remuneration Committee, having regard to the terms of the service contract and the reasons for termination.
Letter of engagement The non-executive directors do not have service contracts or notice periods although they have letters of engagement reflecting their responsibilities and commitments.
Time commitments Letters of engagement make clear to non-executive directors the time commitment they are expected to give to their Board duties. Since 2010, non-executive directors letters of engagement specifically state that their time commitment should be in line with the Walker Review of corporate governance of banks and other financial institutions in respect of their general Board duties. Additional time will be spent as necessary in respect of Committee duties, including in particular any Committees which they chair.
Chairman’s fee £750,000 Senior Independent Director (composite fee) £150,000 Chairman of Group Audit Committee, Board Risk Committee or Group Remuneration Committee (composite fee) £150,000 Non-executive director Group Board fee £72,500 Membership of Group Audit Committee, Board Risk Committee or Group Remuneration Committee fee £25,000 Membership of Nominations Committee fee £5,500
Remuneration in detail The tables and explanatory notes on pages 291 to 293 detail the remuneration of each director for the year ended 31 December 2011 and have been audited by the company's auditors, Deloitte LLP.
Notes: (1) Stephen Hester waived his award of 3.6 million shares which was approved by the Group Board and which was due to be awarded in March 2012. Bruce Van Saun will receive an award of 3.0 million shares in respect of 2011 performance, which will be delivered into Share Bank in March 2012 and will vest in March 2013 and 2014. For subsequent reporting years, the 3.0 million shares awarded to Bruce Van Saun will be detailed in the Deferred Awards table (see page 292). Further details of the performance assessment of the executive directors in 2011 is outlined on pages 282 and 283. Amounts disclosed as performance bonus under the remuneration table in the 2010 Report & Accounts represent the cash value that was subsequently converted to shares at the date of award in March 2011. The awards are shown as deferred awards granted in 2011 as set out on page 292.
(2) Bruce Van Saun is director of ConvergEx Holdings LLC and retains the fee paid to him in this respect. For 2011, he received a fee of $75,000.
Non-executive directors Sandy Crombie 150 — 150 150 Alison Davis (1) 30 13 43 —
Penny Hughes (3) 150 — 150 130 Joe MacHale (4) 73 60 133 141 John McFarlane 73 30 103 103 Brendan Nelson (5) 150 — 150 111 Baroness Noakes (6) 30 13 43 —
Notes: (1) Appointed on 1 August 2011. (2) Appointed on 1 September 2011. (3) Fee has not increased in 2011. Lower fee in 2010 reflects appointment as Chair of Group Remuneration Committee with effect from 1 June 2010. (4) Board Committee fee includes membership of the Asset Protection Scheme Senior Oversight Committee. (5) Fee has not increased in 2011. Lower fee in 2010 reflects appointment to the Board from 1 April 2010 and as Chairman of the Group Audit Committee from 28 April 2010. (6) Appointed on 1 August 2011. (7) Retired from the Board with effect from 5 August 2011.
Notes: (1) In February 2010, Stephen Hester agreed to waive his deferred award in respect of the 2009 performance year. (2) The awards granted on 7 March 2011 relate to an allocation of shares under the Share Bank arrangements for annual incentives in respect of the 2010 performance year. The allocation was made as a conditional right to acquire ordinary shares under The RBS 2010 Deferral Plan. The Awards are due to vest in two equal tranches on 7 March 2012 and 7 March 2013 and any vested shares are subject to a further six month retention post-vesting. Mr Hester has voluntarily agreed to a total retention period of 12 months post-vesting. Clawback provisions will apply prior to vesting of the shares.
(3) The Award was granted in March 2010 and relates to an allocation of shares in respect of annual incentives for the 2009 performance year.
Share options The ESOP was approved by shareholders in April 2007. No further awards will be made under the ESOP as it has been replaced by the LTIP. Performance conditions applying to the outstanding awards are shown on page 285.
No options had their terms and conditions varied during the year ended 31 December 2011. No payment is required on the award of an option. The plan was amended in 2009 to introduce a clawback provision for grants made in 2009. In respect of the grant of options in 2009, the performance conditions for executive directors are based on a combination of relative and absolute TSR measures.
Medium-Term Performance Plan (MPP) The MPP was approved by shareholders in April 2001. No further awards will be made under the MPP as it has been replaced by the LTIP. No variation was made to any of the terms of the plan during the year. In respect of the 2009 awards, the performance conditions for executive directors are based on a combination of relative and absolute TSR measures. Performance conditions applying to the outstanding awards are shown on page 285.
Restricted Share Award No variation was made to any of the terms of the plan during the year and no awards were granted under the Restricted Share plan in 2011.
Performance conditions for outstanding share awards made in prior years Summaries of the performance targets and current assessment of performance can be found on pages 284 and 285.
The 2011 LTIP measures are similar to those adopted for 2012 awards as set out on page 287, although there are some differences in terms of the individual components within the four headings. Full details of the 2011 LTIP measures are set out on page 251 of the 2010 Report & Accounts which can be found on www.rbs.com.
Shareholder dilution During the ten year period to 31 December 2011, awards were made that could require new issue shares under the company's share plans represented 3.7% of the company's issued ordinary share capital (including the B share capital), leaving an available dilution headroom of 6.3%. The company meets its employee share plan obligations through a combination of new issue shares and market purchase shares.
Directors’ pension arrangements Executive directors receive a cash allowance in place of pension benefits or have amounts credited to a defined contribution pension arrangement: Cash allowances in place of pension Stephen Hester 420 420 Amounts credited to defined contribution arrangements Bruce Van Saun (1) 403 321
Penny Hughes Chair of the Group Remuneration Committee 22 February 2012
Deferred variable remuneration (shares subject to retention) — 840 585 750 525 249 270 255 — 65 Long Term Incentive Awards vested during 2011 — — — 26 — — 15 — — 7
Long Term Incentive Awards (subject to future performance) (1) 1,620 1,013 991 — 1,125 675 675 675 — 270
No sign-on or severance awards have been made during 2011 to any of the above individuals.
Note: (1) The Long Term Incentive Award (subject to future performance) is made following the end of the relevant financial year. The amounts shown reflects an approximate notional value, verified by external advisors. The actual value of the award which will vest in 2015 will be dependent on actual performance and share price.
During the three years covered by the LTIP award, GBM accomplished its restructuring goals and contributed £10.7 billion of operating profit to RBS (a cumulative ROE of 18%, good by industry comparison and good in absolute terms). This performance was ahead of targets and a key ingredient in financing the risk clean up across the whole of RBS accomplished during that time. Without these profits the RBS recapitalisation would have been insufficient.
PwC provided independent analysis and advice to help the Group Remuneration Committee as it made its judgement on the appropriate level of achievement against the performance conditions. The Committee also obtained independent legal advice on the operation of the performance conditions. The Group Remuneration Committee determined that the majority of targets laid down for the period had been met and in important areas exceeded. Some shortcomings were acknowledged relating primarily to lower GBM profitability in 2011 and the closure of cash equities (4% of GBM 2011 income) where targets had not been realised, hence the 27% reduction in vested award value.
FSA Remuneration Disclosure The undernoted disclosures are in accordance with the FSA’s Handbook for banks, building societies and investment firms (BIPRU) 11.5.18 (6) and (7).
Variable remuneration (cash) 0.3 0.3 Variable remuneration (shares subject to retention) 14.4 21.6 Deferred remuneration (bonds) 30.3 48.2 Deferred remuneration (shares) 15.7 25.8 2% of total variable remuneration was subject to a guaranteed commitment made on recruitment to secure the employment of key individuals.
Throughout the year ended 31 December 2011, the company has complied with all of the provisions of the UK Corporate Governance Code issued by the Financial Reporting Council in May 2010 (the “Code”) except in relation to the provision (D.2.2) that the Group Remuneration Committee should have delegated responsibility for setting remuneration for the Chairman and executive directors. The company considers that this is a matter which should rightly be reserved for the Board. No director is involved in decisions regarding his or her own remuneration. Information on how the company has applied the main principles of the Code can be found in the Corporate governance report on pages 252 to 295. A copy of the Code can be found at www.frc.org.uk/corporate.
The company has also implemented the recommendations arising from the Walker Review.
Internal control The Board of directors is responsible for the Group’s system of internal control that is designed to facilitate effective and efficient operations and to ensure the quality of internal and external reporting and compliance with applicable laws and regulations. In devising internal controls, the Group has regard to the nature and extent of the risk, the likelihood of it crystallising and the cost of controls. A system of internal control is designed to manage, but not eliminate, the risk of failure to achieve business objectives and can only provide reasonable, and not absolute, assurance against the risk of material misstatement, fraud or losses.
The Group’s independent auditors present to the Group Audit Committee reports that include details of any significant internal control matters which they have identified. The system of internal controls of the authorised institutions and other regulated entities in the Group is also subject to regulatory oversight in the UK and overseas. Additional details of the Group’s regulatory oversight are given in the Supervision and Regulatory developments and reviews sections on pages 443 and 444.
The Group assessed the effectiveness of its internal control over financial reporting as of 31 December 2011 based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in ‘Internal Control - Integrated Framework'.
Management's report on the Group's internal control over financial reporting will be filed with the Securities and Exchange Commission at the same time as the Annual Report on Form 20-F.
The New York Stock Exchange As a foreign issuer with American Depositary Shares representing ordinary shares, preference shares and debt securities listed on the New York Stock Exchange (the “NYSE”), the company must disclose any significant ways in which its corporate governance practices differ from those followed by US companies under the NYSE corporate governance listing standards. In addition, the company must comply fully with the provisions of the listing standards that relate to the composition, responsibilities and operation of Audit Committees. These provisions incorporate the relevant rules concerning audit committees of the Exchange Act.
As stated at the start of this Compliance report, in the case of the company, the Group Board, rather than the Group Remuneration Committee, reserves the authority to make the final determination of the remuneration of the Group Chief Executive.
The directors present their report together with the audited accounts for the year ended 31 December 2011.
Group structure The company is a holding company owning the entire issued ordinary share capital of The Royal Bank of Scotland plc, the principal direct operating subsidiary undertaking of the company. The Group comprises the company and all its subsidiary and associated undertakings, including the Royal Bank and NatWest. Details of the principal subsidiary undertakings of the company are shown in Note 8 on page 427.
Results and dividends The loss attributable to the ordinary and B shareholders of the company for the year ended 31 December 2011 amounted to £1,997 million compared with a loss of £1,125 million for the year ended 31 December 2010, as set out in the consolidated income statement on page 307.
Risk factors The Group’s future performance and results could be materially different from expected results depending on the outcome of certain potential risks and uncertainties. Certain risk factors the Group faces are summarised on page 39. Fuller details of these and other risk factors are set out on pages 451 to 464.
The Group’s approach to risk management, including its financial risk management objectives and policies and information on the Group’s exposure to price, credit, liquidity and cash flow risk, is discussed in the Risk and balance sheet management section of the Business review on pages 100 to 249.
Financial performance A review of the Group's performance during the year ended 31 December 2011, including details of each division, and the Group's financial position as at that date is contained in the Business review on pages 40 to 95.
Approximately 98% of the issued share capital of RFS Holdings B.V. is held by the Group.
Business divestments To comply with EC State Aid requirements the Group agreed a series of restructuring measures to be implemented over a four year period from December 2009. This supplements the measures in the strategic plan previously announced by the Group. These include divesting RBS Insurance, 80.01% of Global Merchant Services (largely completed in 2010) and substantially all of RBS Sempra Commodities JV business (completed in 2010), as well as divesting the RBS branch-based business in England and Wales and the NatWest branches in Scotland, along with the Direct SME customers across the UK.
Employee learning and development The Group maintains a strong commitment to providing all its employees with the opportunity to grow through learning and development, which in turn helps to achieve business objectives and drive excellent customer service. Employee Volunteering schemes make it easy for individuals and teams to give something back to their communities and make a real difference.
Diversity and inclusion During 2011, the Group executive renewed its commitment to make workplace policies, processes and experiences inclusive for staff, customers and stakeholders.
Inclusion is built into the recruitment process, positive action programmes developing talent, flexible working policies and support for ill-health and disability-related absence. The Group continues to support disabled people ensuring they have equal opportunities to recruitment, employment, promotion and training.
The Group supports employee led networks such as Focused Women and Rainbow who support personal and career development through networking and training events.
This approach to inclusion extends to the marketplace with the RBS Women in Business Ambassadors who support and guide more and more women to take the step of starting their own business.
Further details on the Board diversity policy can be found on page 262 .
Safety, health and wellbeing Ensuring the safety, health and wellbeing of employees and customers is an important responsibility for the Group.
A wide range of health benefits and services are in place to help employees maintain good physical and psychological health, and support them if they do become unwell. A number of these services have been enhanced and promoted in response to the impact of the economic environment.
Sustainability Sustainability is central to the way the Group is managed. Sustainability is not just about the many responsibilities and obligations that the Group has in a legal sense, but about specific issues that need to be addressed to ensure that the Group is a healthy and respected business operating on a sustainable basis. There is a clear governance structure for Group Sustainability that oversees and aligns the Group's approach to the range of ethical, social and environmental issues which confront the business on a daily basis. For more information on the governance structure, see page 30.
Going concern The Group’s business activities and financial position, the factors likely to affect its future development and performance and its objectives and policies in managing the financial risks to which it is exposed and its capital are discussed in the Business review. The risk factors which could materially affect the Group’s future results are set out on pages 451 to 464. The Group’s regulatory capital resources and significant developments in 2011 and anticipated future developments are detailed on pages 110 to 115. The liquidity and funding section on pages 116 to 130, describes the Group’s funding and liquidity profile, including changes in key metrics, the build up of liquidity reserves and the outlook for 2012.
BBA disclosure code In September 2010, the British Bankers’ Association published its Code for Financial Reporting Disclosure. The code sets out five disclosure principles together with supporting guidance. The principles are that the Group and other major UK banks will provide high quality, meaningful and decision-useful disclosures; review and enhance their financial instrument disclosures for key areas of interest to market participants; assess the applicability and relevance of good practice recommendations to their disclosures acknowledging the importance of such guidance; seek to enhance the comparability of financial statement disclosures across the UK banking sector; and clearly differentiate in their annual reports between information that is audited and information that is unaudited. The Group’s 2011 financial statements have been prepared in compliance with the code’s principles.
Share capital Details of the ordinary and preference share capital at 31 December 2011 and movements during the year are shown in Note 27 on the consolidated accounts.
The rules governing the powers of directors, including in relation to issuing or buying back shares and their appointment are set out in the company’s Articles of Association. It will be proposed at the 2012 Annual General Meeting that the directors be granted authorities to allot shares under the Companies Act 2006. The company’s Articles of Association may only be amended by a special resolution at a general meeting of shareholders.
The rights and obligations of holders of non-cumulative preference shares are set out in Note 27 on the consolidated accounts.
All directors of the company stand for re-election annually and, with the exception of John McFarlane, all directors will stand for election or reelection by shareholders at the Annual General Meeting in 2012.
Directors’ interests The interests of the directors in the shares of the company at 31 December 2011 are shown on page 303. None of the directors held an interest in the loan capital of the company or in the shares or loan capital of any of the subsidiary undertakings of the company, during the period from 1 January 2011 to 22 February 2012.
Post balance sheet events There have been no significant events between the year end and the date of approval of these accounts which would require a change to or disclosure in the accounts.
Charitable contributions In 2011, the Group’s overall community contribution was £72.0 million (2010 - £56.1 million). The total amount given for charitable purposes by the company and its subsidiary undertakings during the year ended 31 December 2011 was £39.1 million (2010 - £29.6 million).
Auditors The auditors, Deloitte LLP, have indicated their willingness to continue in office. A resolution to re-appoint Deloitte LLP as the company’s auditors will be proposed at the forthcoming Annual General Meeting.
The Royal Bank of Scotland Group plc is registered in Scotland No. SC45551
Non-executive directors Sandy Crombie 200,000 200,000 40,360 Alison Davis — 200,000 40,360 Tony Di lorio (2) — 300,000 60,540
Notes: (1) Value is based on the share price at 30 December 2011 (the last working day of 2011), which was 20.18p. During the year ended 31 December 2011, the share price ranged from 17.34p to 49.0p. (2) Mr Di Iorio holds his interests in the company’s shares in the form of American Depository Receipts (ADRs). Each ADR represents 20 ordinary shares of £0.25 each in the company. Mr Di Iorio holds 15,000 ADRs representing 300,000 ordinary shares.
As at 22 February 2012, there were no changes to the directors' interests in shares shown in the table above.
The directors are responsible for the preparation of the Annual Report and Accounts.
(excluding insurance net premium income) 328 3 Operating expenses 329 5 Auditor’s remuneration 337 7 Profit attributable to preference shareholders and paid-in equity holders 339 8 Ordinary dividends 339 9 Earnings per ordinary and B share 339 10 Financial instruments – classification 340 11 Financial instruments – valuation 345 12 Financial instruments – maturity analysis 362 13 Financial assets – impairments 364 15 Debt securities 368 16 Equity shares 369 17 Intangible assets 370 18 Property, plant and equipment 373 19 Prepayments, accrued income and other assets 375 20 Discontinued operations and assets and liabilities of disposal groups 375 21 Short positions 377 22 Accruals, deferred income and other liabilities 377 23 Deferred tax 378 24 Insurance business 379 25 Subordinated liabilities 383 26 Non-controlling interests 390 27 Share capital 391 28 Other equity 393 30 Securitisations and asset transfers 396 31 Capital resources 398 32 Memorandum items 400 33 Net cash inflow/(outflow) from operating activities 409 34 Analysis of the net investment in business interests and intangible assets 409 35 Interest received and paid 410 36 Analysis of changes in financing during the year 410 37 Analysis of cash and cash equivalents 410 38 Segmental analysis 411 39 Directors’ and key management remuneration 417 40 Transactions with directors and key management 417 41 Related parties 417 42 Post balance sheet events 419 420 Parent company financial statements and notes
Our responsibility is to audit and express an opinion on the financial statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board's Ethical Standards for Auditors.
Scope of the audit of the financial statements An audit involves obtaining evidence about the amounts and disclosures in the financial statements sufficient to give reasonable assurance that the financial statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of; the reasonableness of significant accounting estimates made by the directors in the preparation of the financial statements; whether the accounting policies are appropriate to the circumstances of the company and the Group and have been consistently applied and adequately disclosed; and the overall presentation of the financial statements. In addition, we read all the financial and non-financial information in the annual report to identify material inconsistencies with the audited financial statements. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report.
Opinion In our opinion: the financial statements give a true and fair view of the state of the Group's and of the company’s affairs as at 31 December 2011 and of the Group’s loss for the year then ended; the Group financial statements have been properly prepared in accordance with IFRS as adopted by the European Union; the company financial statements have been properly prepared in accordance with IFRS as adopted by the European Union and as applied in accordance with the provisions of the Companies Act 2006; and the financial statements have been prepared in accordance with the requirements of the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation.
Kari Hale (Senior Statutory Auditor) for and on behalf of Deloitte LLP Chartered Accountants and Statutory Auditor London, United Kingdom 22 February 2012
Net interest income 1 12,679 14,209 13,388 Fees and commissions receivable 2 6,384 8,193 8,738 Fees and commissions payable 2 (1,460) (2,211) (2,790) Income from trading activities 2 2,701 4,517 3,761 Gain on redemption of own debt 2 255 553 3,790 Other operating income (excluding insurance net premium income) 2 4,122 1,479 873 Insurance net premium income 24 4,256 5,128 5,266 Non-interest income 16,258 17,659 19,638 Total income 28,937 31,868 33,026 Staff costs - pension schemes curtailment gains — — 2,148 Premises and equipment (2,451) (2,402) (2,594) Other administrative expenses (4,931) (3,995) (4,449) Depreciation and amortisation (1,875) (2,150) (2,166) Write-down of goodwill and other intangible assets (91) (10) (363)
Profit before insurance net claims and impairment losses 10,911 13,640 15,609 Insurance net claims 24 (2,968) (4,783) (4,357)
Loss for the year (1,969) (1,666) (2,323) Other comprehensive income/(loss) Available-for-sale financial assets 2,258 (389) 2,016 Cash flow hedges 1,424 1,454 684 Currency translation (440) 81 (3,300) Actuarial (losses)/gains on defined benefit plans 4 (581) 158 (3,665) Other comprehensive income/(loss) before tax 2,661 1,304 (4,265) Tax (charge)/credit (1,472) (309) 430 Other comprehensive income/(loss) after tax 1,189 995 (3,835) Total comprehensive loss for the year (780) (671) (6,158)
Assets Cash and balances at central banks 10 79,269 57,014 52,261 Loans and advances to banks 10 83,310 100,518 91,753 Loans and advances to customers 10 515,606 555,260 728,393 Debt securities subject to repurchase agreements 30 79,480 80,104 66,883 Other debt securities 129,600 137,376 200,371 Debt securities 15 209,080 217,480 267,254 Equity shares 16 15,183 22,198 19,528 Settlement balances 7,771 11,605 12,033 Derivatives 14 529,618 427,077 441,454 Intangible assets 17 14,858 14,448 17,847 Property, plant and equipment 18 11,868 16,543 19,397 Deferred tax 23 3,878 6,373 7,039 Prepayments, accrued income and other assets 19 10,976 12,576 20,985 Assets of disposal groups 20 25,450 12,484 18,542 Total assets 1,506,867 1,453,576 1,696,486
Non-controlling interests 26 1,234 1,719 16,895 Owners’ equity 27,28 74,819 75,132 77,736 Total equity 76,053 76,851 94,631
Merger reserve At 1 January 13,272 25,522 10,881 Issue of B shares, net of £399 million expenses — — 24,591 Transfer to retained earnings (50) (12,250) (9,950)
Available-for-sale reserve At 1 January (2,037) (1,755) (3,561) Unrealised gains 1,769 179 1,202 Realised losses/(gains) (1) 486 (519) 981 Tax (1,175) 74 (377) Recycled to profit or loss on disposal of businesses (2) — (16) — At 31 December (957) (2,037) (1,755)
Capital redemption reserve At 1 January 198 170 170 Preference shares redeemed — 1 — Cancellation of non-voting deferred shares — 27 —
Retained earnings At 1 January 21,239 12,134 7,542 (Loss)/profit attributable to ordinary and B shareholders and other equity owners
Movements in available-for-sale securities - unrealised gains/(losses) 1 (56) 299 - realised losses/(gains) 2 37 (466)
Equity raised — 559 9 Equity withdrawn and disposals (421) (11,298) (2,445) Transfer to retained earnings — (40) (629)
Total comprehensive loss recognised in the statement of changes in equity is attributable to: Non-controlling interests (24) (197) (1,346) Preference shareholders — 105 878 Paid-in equity holders — 19 57 Ordinary and B shareholders (756) (598) (5,747)
Notes: (1) Includes an impairment loss of £1,099 million in respect of the Group’s holding of Greek government bonds, together with £169 million of related interest rate hedge adjustments, for the year ended 31 December 2011. (2) Net of tax (year ended 31 December 2010 - £5 million credit) (3) Net of tax (year ended 31 December 2010 - £19 million charge). (4) Net of tax (year ended 31 December 2010 - £2 million credit). (5) Net of tax (year ended 31 December 2010 - £340 million charge).
The accompanying notes on pages 327 to 419, the accounting policies on pages 314 to 325 and the audited sections of the Business review: Risk and balance sheet management on pages 100 to 249 form an integral part of these financial statements.
Investing activities Sale and maturity of securities 80,093 47,604 76,492 Purchase of securities (77,019) (43,485) (73,593) Sale of property, plant and equipment 1,840 2,011 1,948 Purchase of property, plant and equipment (3,472) (2,113) (4,898) Net investment in business interests and intangible assets 34 (1,428) 3,446 105 Transfer out of discontinued operations — (4,112) — Net cash flows from investing activities 14 3,351 54
Financing activities Issue of ordinary shares 2 1 — Placing and open offer — — 5,274 Issue of B shares — — 25,101 Issue of subordinated liabilities — — 2,309 Proceeds of non-controlling interests issued — 559 9 Redemption of paid-in equity — (132) (308) Redemption of preference shares — (2,359) (5,000) Redemption of non-controlling interests (382) (5,282) (422) Disposal/(purchase) of own shares 20 (700) (33) Repayment of subordinated liabilities (627) (1,588) (5,145)
Interest on subordinated liabilities (714) (639) (1,746) Net cash flows from financing activities (1,741) (14,380) 18,791 Effects of exchange rate changes on cash and cash equivalents (1,473) 82 (8,592)
Revised IAS 24 ‘Related Party Disclosures’ simplifies the disclosure requirements for government-related entities and clarifies the definition of a related party.
Fees in respect of services are recognised as the right to consideration accrues through the provision of the service to the customer. The arrangements are generally contractual and the cost of providing the service is incurred as the service is rendered. The price is usually fixed and always determinable. The application of this policy to significant fee types is outlined below.
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.
Interchange received: as issuer, the Group receives a fee (interchange) each time a cardholder purchases goods and services. The Group also receives interchange fees from other card issuers for providing cash advances through its branch and automated teller machine networks. These fees are accrued once the transaction has taken place.
For defined benefit schemes, scheme liabilities are measured on an actuarial basis using the projected unit credit method and discounted at a rate determined by reference to market yields at the end of the reporting period on high quality corporate bonds of equivalent term and currency to the scheme liabilities. Scheme assets are measured at their fair value. The difference between scheme assets and scheme liabilities is recognised in the balance sheet as an asset (surplus) or liability (deficit). A net surplus is limited to any unrecognised past service cost plus the present value of any economic benefits available to the Group in the form of refunds from the plan or reduced contributions to it. The current service cost, curtailments and any past service costs together with the expected return on scheme assets less the unwinding of the discount on scheme liabilities are charged to operating expenses. A gain or loss on a curtailment is recognised in profit or loss when the curtailment occurs. A curtailment occurs when the Group is committed to making a significant reduction in the number of employees covered by a plan or a plan is amended such that future service qualifies for no or reduced benefits. Actuarial gains and losses are recognised in full in the period in which they arise in other comprehensive income. Contributions to defined contribution pension schemes are recognised in profit or loss when payable.
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. The estimated useful economic lives are as follows: Core deposit intangibles 6 to 10 years Other acquired intangibles 5 to 10 years Computer software 3 to 5 years
9. Investment property Investment property comprises freehold and leasehold properties that are held to earn rentals or for capital appreciation or both. Investment property is not depreciated but is stated at fair value based on valuations by independent registered valuers. Fair value is based on current prices for similar properties in the same location and condition. Any gain or loss arising from a change in fair value is recognised in profit or loss. Rental income from investment property is recognised on a straight-line basis over the term of the lease in Other operating income. Lease incentives granted are recognised as an integral part of the total rental income.
Group entities record transactions in foreign currencies in the currency of the primary economic environment in which they operate (their functional currency) at the foreign exchange rate ruling at the date of the transaction. Monetary assets and liabilities denominated in foreign currencies are translated into the relevant functional currency at the foreign exchange rates ruling at the balance sheet date. Foreign exchange differences arising on the settlement of foreign currency transactions and from the translation of monetary assets and liabilities are reported in income from trading activities except for differences arising on cash flow hedges and hedges of net investments in foreign operations (see Accounting policy 24).
Life assurance The Group's long-term assurance contracts include whole-life term assurance, endowment assurance, flexible whole-life, pension and annuity contracts that are expected to remain in force for an extended period of time. Long-term assurance contracts under which the Group does not accept significant insurance risk are classified as financial instruments.
Provision is made for restructuring costs, including the costs of redundancy, when the Group has a constructive obligation to restructure. An obligation exists when the Group has a detailed formal plan for the restructuring and has raised a valid expectation in those affected by starting to implement the plan or announcing its main features.
Deferred tax assets and liabilities are offset where the Group has a legally enforceable right to offset and where they relate to income taxes levied by the same taxation authority either on an individual Group company or on Group companies in the same tax group that intend, in future periods, to settle current tax liabilities and assets on a net basis or on a gross basis simultaneously.
In 2009, financial assets designated as at fair value through profit or loss included policyholders' assets underpinning insurance and investment contracts issued by the Group's life assurance businesses. Fair value designation significantly reduces the measurement inconsistency that would arise if these assets were classified as available-for-sale.
Where, in the course of the orderly realisation of a loan, it is exchanged for equity shares or property, the exchange is accounted for as the sale of the loan and the acquisition of equity securities or investment property. Where the Group’s interest in equity shares following the exchange is such that the Group controls an entity, that entity is consolidated.
Financial assets carried at fair value - when a decline in the fair value of a financial asset classified as available-for-sale has been recognised directly in other comprehensive income and there is objective evidence that it is impaired, the cumulative loss is reclassified from equity to profit or loss. The loss is measured as the difference between the amortised cost of the financial asset and its current fair value. Impairment losses on available-for-sale equity instruments are not reversed through profit or loss, but those on available-for-sale debt instruments are reversed, if there is an increase in fair value that is objectively related to a subsequent event.
Held-for-trading - a financial liability is classified as held-for-trading if it is incurred principally for repurchase in the near term, or forms part of a portfolio of financial instruments that are managed together and for which there is evidence of short-term profit taking, or it is a derivative (not in a qualifying hedge relationship). Held-for-trading financial liabilities are recognised at fair value with transaction costs being recognised in profit or loss. Subsequently they are measured at fair value. Gains and losses are recognised in profit or loss as they arise.
Fair value for a net open position in a financial liability that is quoted in an active market is the current offer price times the number of units of the instrument issued. Fair values for financial liabilities not quoted in an active market are determined using appropriate valuation techniques including discounting future cash flows, option pricing models and other methods that are consistent with accepted economic methodologies for pricing financial liabilities.
The consideration for any ordinary shares of the company purchased by the Group (treasury shares) is deducted from equity. On the cancellation of treasury shares their nominal value is removed from equity and any excess of consideration over nominal value is treated in accordance with the capital maintenance provisions of the Companies Act. On the sale or reissue of treasury shares the consideration received is credited to equity, net of any directly attributable incremental costs and related tax.
24. Derivatives and hedging Derivative financial instruments are initially recognised, and subsequently measured, at fair value. Derivative fair values are determined from quoted prices in active markets where available. Where there is no active market for an instrument, fair value is derived from prices for the derivative's components using appropriate pricing or valuation models.
25. Share-based compensation The Group operates a number of share-based compensation schemes under which it awards RBSG shares and share options to its employees. Such awards are generally subject to vesting conditions: conditions that vary the amount of cash or shares to which an employee is entitled. Vesting conditions include service conditions (requiring the employee to complete a specified period of service) and performance conditions (requiring the employee to complete a specified period of service and specified performance targets to be met). Other conditions to which an award is subject are non-vesting conditions (such as a requirement to save throughout the vesting period).
At 31 December 2011, loans and advances to customers classified as loans and receivables totalled £427,805 million (2010 - £482,710 million; 2009 - £671,037 million) and customer loan impairment provisions amounted to £19,760 million (2010 - £18,055 million; 2009 - £17,126 million).
There are two components to the Group's loan impairment provisions: individual and collective.
Financial instruments measured at fair value include: Loans and advances (held-for-trading and designated as at fair value though profit or loss) - principally comprise reverse repurchase agreements (reverse repos) and cash collateral.
Derivatives - these include swaps (currency swaps, interest rate swaps, credit default swaps, total return swaps and equity and equity index swaps), forward foreign exchange contracts, forward rate agreements, futures (currency, interest rate and equity) and options (exchange-traded options on currencies, interest rates and equities and equity indices and OTC currency and equity options, interest rate caps and floors and swaptions).
General insurance claims The Group makes provision for the full cost of settling outstanding claims arising from its general insurance business at the balance sheet date, including claims estimated to have been incurred but not yet reported at that date and claims handling expenses. General insurance claims provisions amounted to £6,219 million at 31 December 2011 (2010 - £6,726 million; 2009 - £5,802 million).
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 £3,878 million were recognised as at 31 December 2011 (2010 - £6,373 million; 2009 - £7,039 million).
The Group has recognised deferred tax assets in respect of losses, principally in the UK, and temporary differences. Deferred tax assets are recognised in respect of unused tax losses to the extent that it is probable that there will be future taxable profits against which the losses can be utilised. Business projections prepared for impairment reviews (see Note 17) indicate that sufficient future taxable income will be available against which to offset these recognised deferred tax assets within six years (2010 - eight years). The Group's cumulative losses are principally attributable to the recent unparalleled market conditions. Deferred tax assets of £3,246 million (2010 - £2,008 million; 2009 - £2,163 million) have not been recognised in respect of tax losses carried forward in jurisdictions where doubt exists over the availability of future taxable profits.
expanded use of other comprehensive income or a third business model for some debt instruments.
In May 2011, the IASB issued six new or revised standards: IFRS 10 ‘Consolidated Financial Statements’ which replaces SIC-12 ‘Consolidation - Special Purpose Entities’ and the consolidation elements of the existing IAS 27 ‘Consolidated and Separate Financial Statements’. The new standard 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 to generate returns for the reporting entity.
IFRS 13 ‘Fair Value Measurement’ which sets out a single IFRS framework for defining and measuring fair value and requiring disclosures about fair value measurements.
Amendments IAS 19 ‘Employee Benefits’ require the immediate recognition of all actuarial gains and losses eliminating the ‘corridor approach’; interest cost to be calculated on the net pension liability or asset at the appropriate corporate bond rate; and all past service costs to be recognised immediately when a scheme is curtailed or amended.
In December 2011, the IASB issued ’Offsetting Financial Assets and Financial Liabilities (Amendments to IAS 32)’ and ‘Disclosures-Offsetting Financial Assets and Financial Liabilities (Amendments to IFRS 7)’. The amendment to IAS 32 adds application guidance on the meaning of ‘a legally enforceable right to set off’ and on simultaneous settlement. IFRS 7 is amended to require disclosures facilitating comparisons between those entities reporting under IFRS and those reporting under US GAAP. The amendments are effective for annual periods beginning on or after 1 January 2014 and are required to be applied retrospectively.
Loans and advances to customers 17,969 18,889 21,356 Loans and advances to banks 697 591 830 Debt securities 2,744 3,296 4,125 Interest receivable 21,410 22,776 26,311
2 Non-interest income (excluding insurance net premium income) 2011 2010 2009 £m £m £m
Income from trading activities (1) Foreign exchange 1,327 1,491 2,340 Interest rate 760 1,862 3,883 Credit (15) 41 (4,147)
Other operating income (excluding insurance net premium income) Operating lease and other rental income 1,307 1,394 1,323 Changes in the fair value of own debt designated as at fair value through profit or loss attributable to own credit (3)
(2) In June 2011, the Group redeemed certain mortgage backed debt securities in exchange for cash, resulting in gains totalling £255 million being credited to profit or loss. In a series of exchange and tender offers in April 2009 and May 2010, the Group redeemed certain subordinated debt securities and equity preference shares in exchange for cash or senior debt. Gains of £553 million and £3,790 million were credited to profit or loss in 2010 and 2009 respectively. The exchanges involving instruments classified as liabilities all met the criteria in IFRS for treatment as the extinguishment of the original liability and the recognition of a new financial liability.
Bank levy The Finance Act 2011 introduced an annual bank levy in the UK. The levy is collected through the existing quarterly Corporation Tax collection mechanism starting with payment dates on or after 19 July 2011.
The levy will be set at a rate of 0.088 per cent from 2012. Three different rates applied during 2011, these average to 0.075 per cent. Certain liabilities are subject to only a half rate, namely any deposits not otherwise excluded, (except for those from financial institutions and financial traders) and liabilities with a maturity greater than one year at the balance sheet date. The levy is not charged on the first £20 billion of chargeable liabilities. The cost of the levy to the Group for 2011 is £300 million (included in Other administrative expenses). As the Group continues to target a reduction in wholesale funding, the cost should decline over time absent further rate increase.
Restructuring costs included in operating expenses comprise: 2011 2010 2009 £m £m £m
Staff costs 356 353 328 Premises and equipment 156 117 48 Other administrative expenses 276 104 51 788 574 427
Staff costs 95 51 — Premises and equipment 11 6 —
Integration and restructuring 600 300 500 RFS Holdings minority interest — — 300
There were no people employed in discontinued operations at 31 December 2011 (2010 - nil; 2009 - 24,800).
At 1 January 0.48 1,012 0.50 1,038 2.88 84 Granted 0.23 298 0.43 147 0.38 1,176 Exercised 0.38 (7) 0.38 (5) — — Cancelled 0.41 (664) 0.45 (168) 0.77 (222)
The market value of awards exercised in 2011 was £5 million (2010 - less than £1 million; 2009 - nil). There are vested options over 48 million shares exercisable up to 2019 (2010 - 33 million shares up to 2020; 2009 - 33 million shares up to 2014).
Variable compensation awards The following table analyses the Group and GBM variable compensation awards for 2011, which are 43% and 58% respectively lower than in 2010.
Year in which income statement charge is expected to be taken for deferred variable compensation £m 2013 and beyond £m
Variable compensation deferred from 2009 and earlier 383 160 78 — Variable compensation deferred from 2010 — 342 105 65 Variable compensation for 2011 deferred — — 225 77 383 502 408 142
Notes: (1) Cash payments to all employees are limited to £2,000. (2) Core operating profit pre variable compensation expense and before one-off and other items.
4 Pensions The Group sponsors a number of pension schemes in the UK and overseas, predominantly defined benefit schemes, whose assets are independent of the Group’s finances. The principal defined benefit scheme is The Royal Bank of Scotland Group Pension Fund (the “Main scheme”) which accounts for 85% (2010 - 84%; 2009 - 61%) of the Group’s retirement benefit obligations.
Since 2009, pensionable salary increases in the Main scheme and certain other UK and Irish schemes have been limited to 2% per annum or CPI inflation if lower.
Quoted equities 20.9 25.9 38.9 23.3 28.2 36.2 Private equity 5.8 5.4 5.1 4.9 4.5 3.1 Index-linked bonds 26.1 27.0 23.7 24.3 24.1 15.2 Government fixed interest bonds 0.9 — — 2.8 1.9 18.9 Corporate and other bonds 23.9 26.2 19.7 22.2 24.8 14.7 Hedge funds 2.5 3.2 3.6 2.4 3.5 3.1 Property 3.5 3.4 3.5 3.6 3.6 3.6 Derivatives 2.4 0.9 — 2.1 1.2 0.8 Cash and other assets 13.8 7.8 5.3 13.7 8.1 4.3 Equity exposure of equity futures 17.7 25.6 10.6 15.7 21.4 6.3 Cash exposure of equity futures (17.5) (25.4) (10.4) (15.0) (21.3) (6.2)
The Main scheme, which represents 84% of plan assets at 31 December 2011 (2010 - 84%; 2009 - 59%), is invested in a diversified portfolio of quoted and private equity, government and corporate fixed-interest and index-linked bonds, and other assets including property and hedge funds.
4 Pensions continued The Main scheme’s holdings of derivative instruments are summarised in the table below: 2011 2010 2009 Fair value Fair value Fair value Notional amounts Assets Liabilities Notional amounts Assets Liabilities
Swaps are part of the management of the inflation and interest rate sensitivity of the Main scheme liabilities. They have been executed at prevailing market rates and within standard market bid/offer spreads. Substantially all swaps are with The Royal Bank of Scotland plc and National Westminster Bank Plc (the “banks”). At 31 December 2011, the gross notional value of the swaps was £22,918 million (2010 - £12,352 million; 2009 - £6,064 million) and had a positive fair value of £431 million (2010 - £236 million positive; 2009 - £4 million negative) to the scheme.
Quoted equities 7.7 7.7 8.0 7.7 7.5 7.8 Private equity 7.7 7.7 8.0 7.7 7.7 8.0 Index-linked bonds 3.1 4.2 4.5 3.1 4.0 4.5 Government fixed interest bonds 3.1 — — 2.8 2.9 4.0 Corporate and other bonds 4.7 5.5 5.9 4.7 5.2 5.8 Hedge funds 6.0 6.0 6.2 6.0 5.3 4.3 Property 6.7 6.7 6.2 6.5 6.4 6.0 Cash and other assets 2.6 4.0 4.2 2.9 3.7 3.8 Equity exposure of equity futures 7.7 7.7 8.0 7.7 7.7 8.0 Cash exposure of equity futures 2.6 4.0 4.2 2.6 4.0 4.2 Total fund 5.7 6.7 6.8 5.6 6.3 6.1
Contributions by plan participants and other scheme members — — — 10 10 — Benefits paid (716) (716) — (922) (922) — Expenses included in service cost (53) (53) — (55) (55) — At 1 January 2011 19,110 21,092 1,982 22,816 24,999 2,183 Currency translation and other adjustments — — — (30) (33) (3) Income statement
Interest cost 1,150 1,150 1,354 1,354 Current service cost 327 327 440 440 Past service cost 39 39 43 43 - Actuarial gains and losses 759 1,096 337 636 1,217 581 Contributions by employer 733 — (733) 1,059 — (1,059) Contributions by plan participants and other scheme members — — — 10 10 — Benefits paid (698) (698) — (840) (840) — Expenses included in service cost (51) (51) — (53) (53) — At 31 December 2011 21,111 22,955 1,844 25,086 27,137 2,051
Net assets of schemes in surplus (included in Prepayments, accrued income and other assets, Note 19) (188) (105) (58) Net liabilities of schemes in deficit 2,239 2,288 2,963 2,051 2,183 2,905
Curtailment gains of £78 million were recognised in 2010 arising from changes to pension benefits in a subsidiary’s scheme.
Following the legal separation of ABN AMRO Bank N.V. on 1 April 2010, ABN AMRO’s principal pension scheme in the Netherlands was transferred to the State of the Netherlands. At 31 December 2009, this scheme had fair value of plan assets of £8,118 million and present value of defined benefit obligations of £8,298 million. The principal actuarial assumptions at 31 December 2009 were: discount rate 5.25%; expected return on plan assets (weighted average) 5.25%; rate of increase in salaries 2.5%; rate of increase in pensions in payment 2.0%; and inflation assumption 2.0%.
Group will pay additional contributions each year over the period 2011 to 2018. These contributions started at £375 million per annum in 2011, increasing to £400 million per annum in 2013 and from 2016 onwards will be further increased in line with price inflation. These contributions are in addition to the regular annual contributions of around £300 million for future accrual benefits.
History of defined benefit schemes 2011 £m 2009 £m £m 2007 £m £m 2008 £m £m
Experience (losses)/gains on plan liabilities (208) (858) 135 (55) (256) (200) (882) 328 (65) (210) Experience gains/(losses) on plan assets 759 1,718 993 (4,784) 163 636 1,797 1,344 (6,051) 19 Actual return/(loss) on pension schemes assets 2,017 2,832 2,022 (3,513) 1,345 2,124 3,225 2,897 (4,186) 1,413 Actual return/(loss) on pension schemes assets - % 10.6% 17.2% 13.8% (19.0%) 7.8% 9.3% 15.6% 11.4% (14.5%) 6.9%
The analysis of auditors' remuneration is as follows: 2011 £m £m
Fees payable for the audit of the Group’s annual accounts 4.0 4.0 Fees payable to the auditor and its associates for other services to the Group - the audit of the company’s subsidiaries 24.6 26.0 - audit-related assurance services (1) 4.7 4.9 Total audit and audit-related assurance services fees 33.3 34.9
Taxation compliance services 0.1 0.3 Taxation advisory services 0.2 0.2 Other assurance services (2) 1.8 5.0 Corporate finance services (3) 1.7 0.8
Notes: (1) Includes fees of £0.8 million (2010 - £1.2 million) in relation to reviews of interim financial information, £2.4 million (2010 - £2.0 million) in respect of reports to the Group’s regulators in the UK and overseas, £1.0 million (2010 - £0.9 million) in respect of internal controls assurance and £0.3 million (2010 - £0.7 million) in relation to non-statutory audit opinions. (2) Comprises fees of £0.1 million (2010 - £2.9 million) in respect of audit and assurance of financial information in connection with disposals by the Group and £1.7 million (2010 - £2.1 million) in respect of other assurance services. (3) Includes fees of £1.0 million (2010 - £0.8 million) in respect of work performed by the auditors as reporting accountants on debt and equity issuances undertaken by the Group, including securitisations, and £0.7 million (2010 - nil) in respect of reporting accountant services in connection with planned divestments by the Group. (4) Includes fees of £2.5 million (2010 - £0.3 million) for services provided in respect of US regulatory matters.
Current tax Charge for the year (338) (251) (494) Over provision in respect of prior periods 137 41 191 (201) (210) (303) Deferred tax (Charge)/credit for the year (1,108) (738) 1,041 Over/(under) provision in respect of prior periods 59 314 (309) Tax (charge)/credit for the year (1,250) (634) 429
Non-taxable items - gain on sale of Global Merchant Services 12 221 — - gain on redemption of own debt — 11 693 - other non-taxable items 245 341 410 Taxable foreign exchange movements 4 4 1 Losses brought forward and utilised 2 2 94 Adjustments in respect of prior years (2) 196 355 (118) Actual tax (charge)/credit (1,250) (634) 429
7 Profit attributable to preference shareholders and paid-in equity holders £m £m £m
Paid-in equity holders Interest on securities classified as equity, net of tax — 19 57 Total — 124 935
8 Ordinary dividends The company did not pay an ordinary dividend in 2011, 2010 or 2009.
liabilities Total 2011 £m £m £m £m £m £m £m £m £m
Liabilities Deposits by banks - repos 23,342 — 16,349 39,691 - other (3) 34,172 — 34,941 69,113 Customer accounts - repos 65,526 — 23,286 88,812 - other (4) 14,286 5,627 394,230 414,143 Debt securities in issue (5) 11,492 35,747 115,382 162,621 Settlement balances — — 7,477 7,477 Short positions 41,039 — 41,039 Derivatives 518,102 5,881 523,983 Accruals, deferred income and other liabilities 1,683 19 21,423 23,125 Retirement benefit liabilities — — 2,239 2,239 Deferred tax 1,945 1,945 Insurance liabilities 6,312 6,312 Subordinated liabilities — 903 25,416 26,319 Liabilities of disposal groups 23,995 23,995 707,959 42,277 5,881 618,764 19 55,914 1,430,814 Equity 76,053
liabilities Total 2010 £m £m £m £m £m £m £m £m £m
Assets Cash and balances at central banks — — — 57,014 57,014 Loans and advances to banks - reverse repos 38,215 — — 4,392 42,607 - other (1) 26,082 — — 31,829 57,911 Loans and advances to customers - reverse repos 41,110 — — 11,402 52,512 - other (2) 19,903 1,100 — 471,308 10,437 502,748 Debt securities 98,869 402 111,130 7,079 217,480 Equity shares 19,186 1,013 1,999 — 22,198 Settlement balances — — — 11,605 11,605 Derivatives 421,648 5,429 — 427,077 Intangible assets 14,448 14,448 Property, plant and equipment 16,543 16,543 Deferred tax 6,373 6,373 Prepayments, accrued income and other assets — — — 1,306 11,270 12,576 Assets of disposal groups 12,484 12,484 665,013 2,515 5,429 113,129 595,935 10,437 61,118 1,453,576
For the notes relating to this table refer to page 343.
Intangible assets 17,847 17,847 Property, plant and equipment 19,397 19,397 Deferred tax 7,039 7,039 Prepayments, accrued income and other assets — — — 1,421 19,564 20,985 Assets of disposal groups 18,542 18,542
Notes: (1) Includes items in the course of collection from other banks of £1,470 million (2010 - £1,958 million; 2009 - £2,533 million). (2) The change in fair value of loans and advances to customers designated as at fair value through profit or loss attributable to changes in credit risk was a £31 million charge for the year and cumulatively a credit of £71 million (2010 - £20 million charge, cumulative £82 million credit; 2009 - £157 million credit, cumulative £140 million credit). (3) Includes items in the course of transmission to other banks of £506 million (2010 - £577 million; 2009 - £770 million). (4) The carrying amount of other customer accounts designated as at fair value through profit or loss is £166 million lower (2010 - £233 million lower; 2009 - £101 million lower) than the principal amount.
No amounts have been recognised in profit or loss for changes in credit risk associated with these liabilities as the changes are immaterial, measured as the change in fair value from movements in the period in the credit risk premium payable. The amounts include investment contracts with a carrying value of £38 million (2010 - £41 million; 2009 - £5,170 million).
Reclassification of financial instruments The Group has reclassified financial assets from the held-for-trading (HFT) and available-for-sale (AFS) categories into the loans and receivables (LAR) category (as permitted by paragraph 50D of IAS 39 as amended) and from the held-for-trading category into the available-forsale category (as permitted by paragraph 50B of IAS 39 as amended).
The tables below show the carrying value, fair value and the effect on profit or loss of reclassifications undertaken by the Group in 2008 and 2009. There were no reclassifications in 2010 or 2011.
Reclassified from AFS to LAR (2) Debt securities 248 229 (11) (13) (24) — 11,197 9,640 93 (63) (31) (61)
Reclassified from HFT to AFS (1) Debt securities 6,446 6,446 441 53 765 271 Equity securities 1 1 29 — 38 9 6,447 6,447 470 53 803 280
Reclassified from AFS to LAR (2) Debt securities 422 380 (31) (50) (81) — 15,777 14,376 721 (160) 1,637 1,076
Reclassified from AFS to LAR (2) Debt securities 869 745 21 — 21 — 21,431 19,018 491 (1,707) 1,769 2,985
Notes: (1) The amount taken to AFS reserves was £152 million (2010 - £326 million; 2009 - £1,067 million). (2) The amount that would have been taken to AFS reserves if reclassification had not occurred is £24 million (2010 - £98 million; 2009 - £(73) million).
IPV is performed at a frequency to match the availability of independent data. For liquid instruments, the standard is to perform IPV daily. The minimum frequency of review in the Group is monthly for exposures in the regulatory trading book and six monthly for exposures in the regulatory banking book. Monthly meetings are held between the business and the support functions to discuss the results of the IPV and reserves process in detail. The IPV control includes formalised reporting and escalation of any valuation differences in breach of established thresholds. The Global Pricing Unit (GPU) determines IPV policy, monitors adherence to that policy and performs additional independent reviews on highly subjective valuation issues for GBM and Non-Core.
Senior management valuation control committees meet formally on a monthly basis to discuss independent pricing, reserving and valuation issues relating to both GBM and Non-Core exposures. All material methodology changes require review and ratification by these committees. The committees include valuation specialists representing several independent review functions which comprise market risk, QuaRC and finance.
Credit spreads - where available, these are derived from prices of credit default swaps or other credit based instruments, such as debt securities. For others, credit spreads are obtained from pricing services.
Interest rates - these are principally benchmark interest rates such as the London Interbank Offered Rate (LIBOR) and quoted interest rates in the swap, bond and futures markets.