Exposures to the non bank financial sector are dominated by traded products and spread across a wide range of financial institutions including insurance companies, securitisations, financial intermediaries, finance companies, unleveraged and leveraged funds (including hedge funds). The majority of these are domiciled in the UK, Western Europe and US with no other material geographic or sector concentrations and business is developed selectively. Asset quality has stabilised as the economic environment has improved. Exposures to defaulted entities totalled £1.8 billion, 3% of total exposure to this sector.
Exposure to the manufacturing sector is concentrated in the industrial (40%), agriculture (24%) and food & consumer (21%) subsectors. The overall reduction in exposure of £10.9 billion is partly due to the run-off and restructuring of assets in Western Europe and in the Non-Core portfolio. Portfolio asset quality has held up well during the year but fluctuating commodity prices continue to pose a key risk to the more cyclical sub-sectors. Manufacturing exposure in default totals £1.5 billion (2009 - £3.7 billion).
Risk management: Credit risk continued Credit risk assets* continued Key credit portfolios
By division (1) Investment £m Development £m Total £m Investment £m Development £m Total £m 2010 2009 Investment Development Investment Development
By geography (1) Core £m Non-Core £m Core £m Non-Core £m Total £m Core £m Non-Core £m Core £m Non-Core £m Total £m
Liquidity in the market remains low with focus on refinancing and support for the existing client base.
Key points Of the total portfolio at 31 December 2010, £45.5 billion (2009 - £58.1 billion) is managed normally with annual reviews, £9.2 billion (2009 - £17.9 billion) is receiving heightened credit oversight under the Group watchlist process (“watch”) and £32.6 billion (2009 - £22.2 billion) is managed within the GRG.
Short-term lending to property developers without firm long-term financing in place is characterised as speculative. Speculative lending at origination represents less than 2% of the portfolio. The Group’s appetite for originating speculative commercial real estate lending is very limited and any such business requires senior management approval. Current market conditions have resulted in some borrowers experiencing difficulty in finalising long-term finance arrangements. These borrowers are managed within the problem debt management process in “watch” or the GRG.
Tighter risk appetite criteria for new business origination have been implemented during the year but will take time to be reflected in the performance of the portfolio. Whilst there has been some recovery in the value of prime properties in the UK, the Group observes that it has been selective. To date this improvement has not fed through into lower quality properties in the UK and has not been evident in other regions, notably the eurozone, Republic of Ireland and the US.
Risk management: Credit risk continued Credit risk assets* continued Key credit portfolios continued
Retail assets The Group's retail lending portfolio includes mortgages, credit cards, unsecured loans, auto finance and overdrafts. The majority of personal lending exposures are in the UK, Ireland and the US. The analysis below includes both Core and Non-Core balances.
Notes: (1) Prior years have been revised to reflect improvements in data categorisation. (2) Mainly student loans and recreational vehicles/marine. (3) Personal exposures in other divisions.
Average LTV on new originations during the year 64.2 67.2 67.2 64.8 62.6 64.3
Note: (1) Based on the 3+ months arrears rate for RBS and NatWest (81% of standard mortgages as at December 2010) together with the equivalent manually applied collections status flag for RBS/NatWest
‘Offset’ and other brand mortgages; in total 93% of total mortgage assets. The ‘One Account’ current account mortgage is excluded (£6.7 billion of assets - 7% of assets) of which 0.8% of accounts were 90 days continually in excess of the limit at 31 December 2010 (2009 - 0.6%). Consistent with the way the Council of Mortgage Lenders publishes member arrears information the 3+ month’s arrears rate now excludes accounts in repossession and cases with shortfalls post property sale; 2009 data have been revised accordingly.
The UK mortgage portfolio totalled £92.6 billion at 31 December 2010, an increase of 8% from 31 December 2009, due to continued strong sales growth and lower redemption rates in historical terms. Of the total portfolio, 98% is designated as Core business with the primary brands being the Royal Bank of Scotland, NatWest, the One Account and First Active (Non-Core is made up of Direct Line Mortgages). The assets comprise prime mortgage lending and include 6.8% (£6.2 billion) of exposure to residential buy-to-let at 31 December 2010. There is a small legacy self certification book (0.3% of total assets); which was withdrawn from sale in 2004.
Gross new mortgage lending in 2010 was strong at £15.9 billion. The average LTV for new business during 2010 was 64.2% compared with 67.2% in 2009. The maximum LTV available to new customers remains at 90%. Based on the Halifax House Price index as at September 2010, the book averaged indexed LTV has reduced to 58.2% at 31 December 2010 from 59.1% at 31 December 2009 influenced by favourable house price movements with the proportion of balances in negative equity at 31 December 2010 standing at 6.9% down from 10.9% at 31 December 2009.
The arrears rate (more than 3 payments in arrears, excluding repossessions and shortfalls post property sale) increased slightly to 1.7% at 31 December 2010 from 1.6% at 31 December 2009. After a period of deterioration the arrears rate has stabilised and has remained broadly stable since late 2009. The arrears rate on the buy-to-let portfolio was 1.3 % at 31 December 2010 (2009 - 1.4%).
The mortgage impairment charge was £183 million for the year ended 31 December 2010 compared to £129 million for 2009, with a proportion of the 2010 charge (approximately £70 million) being the result of adjustments reflecting reduced expectations of recovery on prior period defaulted debt and refinement of provision methodology. Underlying default trends improved throughout 2010 when compared with 2009. Provisions as a percentage of loans and receivables have increased to 0.37% at 31 December 2010 compared with 0.25% at 31 December 2009. Default and arrears rates remain sensitive to economic developments and are currently supported by the low interest rate environment and strong book growth with recent business yet to mature.
The SBO portfolio is part of Non-Core and consists of purchased pools of home equity loans and lines (96% second lien) with current LTV (105%) and geographic profiles (73% outside of Citizens footprint) leading to an annualised charge-off rate of 10.6% in 2010. The SBO book has been closed to new purchases since the third quarter of 2007 and is in run-off, with exposure down from $5.5 billion at 31 December 2009 to $4.5 billion at 31 December 2010. The arrears rate of the SBO portfolio decreased from 3.1% at 31 December 2009 to 2.7% at 31 December 2010 due to more effective account servicing and collections, following a service conversion in 2009.
The arrears rate decreased slightly from 1.5% at 31 December 2009 to 1.4% at 31 December 2010. Delinquency rates have stabilised in recent months for both residential mortgages and home equity loans and lines. Citizens’ participates in the US Government Home Affordable Modification Program (HAMP) alongside other bank sponsored initiatives. Under HAMP, any borrower requesting a modification must be first reviewed to see if they meet the criteria of this programme. If the borrower does not qualify for HAMP, then they are reviewed for internal modification programmes. The HAMP programme is available only for first lien loans to owner-occupied. All second lien home equity lines and loans are modified using internal programmes.
Notes: (1) The ratio for UK Retail assets refers to the impairment charges for the year. (2) The ratio for Citizens refers to charge-offs in the year, net of recoveries realised in the year. (3) The 2009 data have been revised to exclude the Kroger Personal Finance portfolio, which was sold in 2010.
Key points The UK personal lending portfolio, of which 98% is in Core businesses, comprises credit cards, unsecured loans and overdrafts and totalled £18.1 billion at 31 December 2010 (2009 - £20.3 billion), a decrease of 11% due to continued subdued loan recruitment activity and a continuing general market trend of customers repaying unsecured loan balances with cards and current account balances remaining stable. The Non-Core portfolio consists of the direct finance loan portfolios (Direct Line, Lombard, Mint and Churchill), and totalled £0.45 billion at 31 December 2010 (2009 - £0.7 billion).
Risk appetite continues to be actively managed across all products. Support continues for customers experiencing financial difficulties through “breathing space initiatives” on all unsecured products, whereby a thirty day period is given to allow customers to establish a debt repayment plan. During this time the Group suspends collection activity. A further extension of thirty days can be granted if progress is made and discussions are continuing. Investment in collection and recovery processes continues, addressing both continued support for the Group’s customers and the management of impairments.
Benefiting from a combination of risk appetite tightening and a more favourable economic environment, impairment losses on unsecured lending have reduced significantly during 2010 from £1,603 million at 31 December 2009 to £991 million at 31 December 2010 with the downward trajectory moderating significantly in the latter part of the year. Impairments will remain sensitive to the external environment.
The Citizens cards business has traditionally adopted conservative risk strategies compared to the US market as a whole. Given the economic climate, Citizens has over the past 24 months introduced tighter lending criteria and lower credit limits. These actions have led to improving new business quality and a business performing on par with industry benchmarks (provided by VISA). The latest available metrics show the rate for 60+ days delinquency as a percentage of total outstanding balances at 3.17% in December 2010 (compared to an industry figure of 3.22%) and net contractual charge-offs as a percentage of total outstanding balances at 4.76% in December 2010 (compared to an industry figure of 5.67%). We expect further improvement based on early delinquency trends.
Core Impairment charges increased by £512 million at 31 December 2009 to £1,161 million at 31 December 2010, reflecting the deteriorating economic environment in Ireland with rising default levels across both personal and corporate portfolios. Lower asset values, particularly property related, together with pressure on borrowers with a dependence on consumer spending have resulted in higher corporate loan losses while higher unemployment, lower incomes and increased taxation have driven mortgage impairment increases. Ulster Bank Group is helping customers in this difficult environment. Forbearance policies which are deployed through the 'Flex' initiative are aimed at assisting customers in financial difficulty. These policies have been reviewed in 2010 given the structural problem that exist in Ireland with the scale and duration of customers in financial difficulty. The industry definition in the Republic of Ireland of an unsustainable mortgage (18 months accumulated interest) has been used to underpin the policy which will improve identification of customers where forbearance may not be appropriate. The forbearance portfolios account for 5.8% (7,383 mortgages) of the Ulster Bank Group mortgage portfolio (by value) at 31 December 2010 with 75% of these customers (by value) in amortising or interest only agreements.
Non-Core Impairment charges increased from £1,277 million at 31 December 2009 to £2,682 million at 31 December 2010, reflecting the deteriorating economic environment in Ireland with rising default levels across the portfolio. Lower asset values, in property related lending and most specifically in development lending have resulted in higher corporate loan losses.
Industry sector (1) £m £m £m £m £m £m £m £m £m £m £m £m
Ulster Bank Group Mortgages 22,201 882 153 4.0 17.3 0.7 116 3 Personal unsecured 2,433 174 145 7.2 83.3 6.0 66 27 Commercial real estate - investment 8,192 1,748 413 21.3 23.6 5.0 370 — - development 10,109 4,268 1,106 42.2 25.9 10.9 953 4 Other corporate 12,479 1,976 648 15.8 32.8 5.2 421 — 55,414 9,048 2,465 16.3 27.2 4.4 1,926 34 Core Mortgages 16,199 558 102 3.4 18.3 0.6 74 3 Personal unsecured 2,433 174 145 7.2 83.3 6.0 66 27 Commercial real estate - investment 6,131 250 105 4.1 42.0 1.7 84 — - development 3,838 428 284 11.2 66.4 7.4 221 4 Other corporate 11,106 850 326 7.7 38.4 2.9 204 —
Key points Increases in REIL reflect difficult conditions in both commercial and residential sectors in the Republic of Ireland. Of the REIL at 31 December 2010, 74% was in Non-Core.
Risk management: Credit risk continued Ulster Bank Group (Core and Non-Core)* continued
Key points The residential mortgage portfolio across Ulster Bank Group totalled £21.2 billion at 31 December 2010; with 90% in the Republic of Ireland and 10% in Northern Ireland. The portfolio size has declined by 4% in the Republic of Ireland since 31 December 2009 with Northern Ireland increasing by 12% over the same period. New business originations continue to be very low, especially in the Republic of Ireland. In 2010, 3,557 new mortgages were originated of which, 92% were in Northern Ireland.
Property remains the primary driver of growth in the defaulted loan book for Ulster Bank Group. The outlook remains challenging with limited liquidity in the marketplace to support refinancing. The decrease in asset valuations has placed pressure on the portfolio with more clients seeking renegotiation of terms in the context of granting structural enhancements.
Within its early problem management framework, Ulster Bank Group may agree various remedial measures with customers in the performing book that are experiencing temporary financial difficulties. During 2010, customers with loans amounting to £0.4 billion (exposures greater than £5 million) benefited from such measures. During 2010, impaired loans amounting to £2.1 billion (exposures greater than £5 million) were restructured and remain in the nonperforming book.
Risk management: Credit risk continued Balance sheet analysis All the disclosures in this section (pages 166 to 180) are audited unless otherwise indicated by an asterisk (*).
Industry and geographical analysis The tables below and on pages 167 to 173 analyse total financial assets gross of provisions by industry sector (for Group before RFS MI) and geography (for Group before RFS MI and RFS MI).
Total Central and local government 7,426 1,671 9,097 130,890 7,560 291 147,838 3,916 Finance - banks 99,583 1,024 100,607 — — — 100,607 — - other (3) 97,967 7,891 105,858 95,954 399,318 12,185 613,315 403,387 Residential mortgages 140,359 6,142 146,501 808 6 — 147,315 14 Personal lending 33,581 3,891 37,472 63 15 48 37,598 11 Property 42,455 47,651 90,106 2,937 3,830 28 96,901 1,041 Construction 8,680 3,352 12,032 87 780 — 12,899 1,392 Manufacturing 26,186 6,520 32,706 897 3,229 — 36,832 2,156 Service industries and business activities 95,252 22,384 117,636 8,077 12,285 388 138,386 6,400 Agriculture, forestry and fishing 3,758 135 3,893 29 40 — 3,962 94 Finance lease and instalment credit 8,320 8,530 16,850 15 14 — 16,879 134 Interest accruals 921 279 1, 200 1,398 — — 2,598 — Total gross of provisions 564,488 109,470 673,958 241,155 427,077 12,940 1,355,130 418,545 Provisions (18,182) (1,477) — (29) (19,688) n/a Group before RFS MI 655,776 239,678 427,077 12,911 1,335,442 418,545 RFS MI gross of provisions 2 — — — 2 —
Total Central and local government 15,497 100,099 6,382 197 122,175 1,987 Finance - banks 127,287 — — — 127,287 — - other (3) 139,083 146,869 938,819 16,026 1,240,797 836,404 Residential mortgages 139,391 29 18 — 139,438 52 Personal lending 51,070 278 60 25 51,433 34 Property 103,276 2,494 5,586 71 111,427 1,067 Construction 20,250 213 984 32 21,479 1,488 Manufacturing 71,165 1,413 14,159 308 87,045 6,498 Service industries and business activities 169,844 22,764 25,417 2,463 220,488 10,918 Agriculture, forestry and fishing 4,628 144 45 16 4,833 87 Finance lease and instalment credit 22,355 23 25 — 22,403 119 Interest accruals 6,369 1,241 — — 7,610 — Total gross of provisions 870,215 275,567 991,495 19,138 2,156,415 858,654 Provisions (9,451) (210) — — (9,661) n/a Group before RFS MI 860,764 275,357 991,495 19,138 2,146,754 858,654 RFS MI gross of provisions 153,720 18,522 1,064 20 173,326 14 RFS MI provision (1,565) — — — (1,565) n/a Group 1,012,919 293,879 992,559 19,158 2,318,515 858,668
Loans and advances to customers - UK 374,822 386,798 431,302 - US 90,752 93,209 125,786 - Europe 83,586 102,571 135,524 - RoW 24,155 28,132 47,977 Group before RFS MI 573,315 610,710 740,589 RFS MI — 134,809 145,022 573,315 745,519 885,611
Group before RFS MI 673,958 694,741 870,215 RFS MI 2 142,688 153,720 Group 673,960 837,429 1,023,935
Key points Residential mortgages increased by £6 billion during 2010 with increases in UK Retail, reflecting continued strong sales growth and lower redemption rates, partially offset by reduced lending in both Ulster Bank and US Retail & Commercial (US R&C) reflecting low new business originations and tightened loan acceptance criteria respectively.
Reduction in unsecured lending reflects subdued recruitment activity and the continuing market trend of repaying unsecured loans in UK Retail and lower personal auto loans in US R&C.
The Group’s loans and advances to property and construction sectors reduced by £12 billion, primarily in the UK and Europe in both development and investment portfolios. Underlying Non-Core property loans declined by £7.7 billion during the year. This was partly offset by a transfer of £5.0 billion in development property loans as part of Ulster Banks strategic decision to cease early stage development property lending.
The tables below and on pages 169 to 173 analyse financial assets by geography (location of office) and industry.
Finance lease and instalment credit 5,589 7,785 13,374 15 14 — 13,403 134
Service industries and business activities 14,198 2,725 16,923 3,285 2,764 42 23,014 —
Finance lease and instalment credit 2,315 — 2,315 — — — 2,315 —
Finance lease and instalment credit 369 745 1,114 — — — 1,114 —
Loans and advances Core Non-Core Total Securities Derivatives Other (1) Total
US Central and local government 196 64 260 24,620 9 141 25,030 — Finance - banks 8,448 76 8,524 — — — 8,524 — - other (3) 19,404 1,803 21,207 27,086 125,599 5,779 179,671 113,670 Residential mortgages 21,842 4,317 26,159 64 — — 26,223 — Personal lending 7,373 3,599 10,972 — — — 10,972 — Property 1,498 3,788 5,286 56 30 — 5,372 — Construction 490 132 622 72 50 — 744 — Manufacturing 5,895 1,200 7,095 243 580 — 7,918 — Service industries and business activities 14,358 4,505 18,863 3,320 2,486 — 24,669 — Agriculture, forestry and fishing 27 — 27 1 2 — 30 — Finance lease and instalment credit 2,417 — 2,417 — — — 2,417 — Interest accruals 220 94 314 334 — — 648 — Group before RFS MI 82,168 19,578 101,746 55,796 128,756 5,920 292,218 113,670 RFS MI 360 — — — 360 — Group 102,106 55,796 128,756 5,920 292,578 113,670
Europe Central and local government 334 1,164 1,498 25,328 68 24 26,918 — Finance - banks 4,906 528 5,434 — — — 5,434 — - other (3) 4,161 1,028 5,189 22,913 1,699 43 29,844 — Residential mortgages 15,055 6,718 21,773 — — — 21,773 — Personal lending 1,877 1,009 2,886 — — 17 2,903 — Property 10,812 9,417 20,229 1 17 4 20,251 — Construction 1,946 1,167 3,113 1 1 1 3,116 — Manufacturing 7,311 8,609 15,920 42 123 — 16,085 — Service industries and business activities 19,088 9,895 28,983 331 88 51 29,453 — Agriculture, forestry and fishing 737 356 1,093 1 — — 1,094 — Finance lease and instalment credit 379 1,094 1,473 12 — — 1,485 — Interest accruals 266 249 515 706 — — 1,221 — Group before RFS MI 66,872 41,234 108,106 49,335 1,996 140 159,577 — RFS MI 140,098 21,681 3,232 9 165,020 — Group 248,204 71,016 5,228 149 324,597 —
RoW Central and local government 1,376 28 1,404 13,201 169 36 14,810 — Finance - banks 10,200 354 10,554 — — — 10,554 — - other (3) 8,623 1,033 9,656 3,772 25,045 796 39,269 19,747 Residential mortgages 390 1 391 — — — 391 — Personal lending 1,450 613 2,063 — 29 1 2,093 — Property 337 1,780 2,117 679 51 — 2,847 — Construction 102 319 421 188 23 — 632 — Manufacturing 2,604 1,338 3,942 26 428 14 4,410 — Service industries and business activities 4,527 3,385 7,912 589 757 1 9,259 1 Agriculture, forestry and fishing 16 59 75 — 3 — 78 — Finance lease and instalment credit 8 19 27 — — — 27 — Interest accruals 149 32 181 74 — — 255 — Group before RFS MI 29,782 8,961 38,743 18,529 26,505 848 84,625 19,748 RFS MI 1,786 — 22 — 1,808 55 Group 40,529 18,529 26,527 848 86,433 19,803
Risk management: Credit risk continued Balance sheet analysis: Industry and geography analysis continued
Europe Central and local government 1,830 21,929 228 5 23,992 — Finance - banks 7,274 — — — 7,274 — - other (3) 10,480 20,657 7,840 3,608 42,585 — Residential mortgages 23,394 29 4 — 23,427 — Personal lending 4,641 28 19 — 4,688 — Property 19,769 1 299 — 20,069 — Construction 5,183 — 91 — 5,274 — Manufacturing 25,843 53 371 — 26,267 2 Service industries and business activities 40,444 10,163 2,347 85 53,039 840 Agriculture, forestry and fishing 1,327 50 1 — 1,378 — Finance lease and instalment credit 1,815 15 — — 1,830 — Interest accruals 1,194 1 — — 1,195 — Group before RFS MI 143,194 52,926 11,200 3,698 211,018 842 RFS MI 150,304 18,367 1,009 20 169,700 1 Group 293,498 71,293 12,209 3,718 380,718 843
Notes: (1) Includes settlement balances of £11,605 million at 31 December 2010 (2009 - £12,033 million; 2008 - £17,832 million). (2) This shows the amount by which the Group´s credit risk exposure is reduced through arrangements, such as master netting agreements, which give the Group a legal right to set-off the financial asset against a financial liability due to the same counterparty. In addition, the Group holds collateral in respect of individual loans and advances to banks and customers. This collateral includes mortgages over property (both personal and commercial); charges over business assets such as plant, inventories and trade debtors; and guarantees of lending from parties other than the borrower. The Group obtains collateral in the form of securities in reverse repurchase agreements. Cash and securities are received as collateral in respect of derivative transactions.
Total AQ1 56,655 91,952 126,444 6,815 408,489 658 78,728 9,745 779,486 AQ2 14 598 13,282 1,271 2,659 3 26,128 1,980 45,935 AQ3 48 2,197 25,981 156 3,317 — 25,731 4,337 61,767 AQ4 188 639 95,777 571 3,391 6 41,027 6,522 148,121 AQ5 99 2,322 114,796 64 4,860 144 38,612 5,169 166,066 AQ6 3 159 65,497 34 1,070 — 25,991 2,230 94,984 AQ7 2 178 46,072 1 857 69 18,752 2,456 68,387 AQ8 — 15 16,573 14 403 — 9,289 9,545 35,839 AQ9 — 115 14,263 2 450 80 3,889 932 19,731 AQ10 5 355 5,644 2 1,581 — 2,829 407 10,823 Past due — 10 13,430 2,675 — — — — 16,115 Impaired — 145 35,556 — — 375 — — 36,076 Impairment provision — (127) (18,055) — — (29) — — (18,211) Group before RFS MI 57,014 98,558 555,260 11,605 427,077 1,306 270,976 43,323 1,465,119 RFS MI — 2 — — — — — 32 34 Group 57,014 98,560 555,260 11,605 427,077 1,306 270,976 43,355 1,465,153
Non-Core AQ1 18 654 22,799 1 12,070 292 7,637 94 43,565 AQ2 — 48 2,748 — 416 — 1,205 252 4,669 AQ3 — 32 3,130 1 185 — 2,185 69 5,602 AQ4 178 100 9,998 — 374 — 4,118 1,452 16,220 AQ5 — 75 14,745 — 872 129 3,310 245 19,376 AQ6 — 21 11,999 — 265 — 1,941 90 14,316 AQ7 — 24 7,634 — 262 — 1,147 147 9,214 AQ8 — — 3,283 — 146 — 672 111 4,212 AQ9 — 8 4,365 — 213 30 447 46 5,109 AQ10 — 55 2,867 — 1,213 — 1,329 157 5,621 Accruing past due — 7 2,686 46 — — — — 2,739 Impaired — 1 22,189 — — — — — 22,190 Impairment provision — (1) (10,315) — — — — — (10,316)
Note: (1) Excluding items in the course of collection from other banks of £1,958 million (2009 - £2,533 million; 2008 - £2,888 million).
Debt securities The table below analyses debt securities by issuer and external ratings. Central and local government
Total AAA 13,486 33,846 44,784 2,374 51,235 846 17 146,588 67 AA to AA+ — — 18,025 3,036 6,335 779 — 28,175 13 A to AA- — — 9,138 4,185 3,244 1,303 5 17,875 8 BBB- to A- — — 2,843 1,323 3,385 2,029 6 9,586 5 Non-investment grade — — 1,766 1,766 4,923 2,786 4 11,245 5 Unrated — — 52 310 1,703 1,722 224 4,011 2 13,486 33,846 76,608 12,994 70,825 9,465 256 217,480 100
AAA 26,601 23,219 44,396 4,012 65,067 2,263 — 165,558 66 AA to AA+ — — 22,003 4,930 8,942 1,429 — 37,304 15 A to AA- — — 13,159 3,770 3,886 1,860 — 22,675 9 BBB- to A- — — 3,847 823 4,243 2,187 — 11,100 5 Non-investment grade — — 353 169 3,515 2,042 — 6,079 2 Unrated — — 504 289 1,949 2,601 1,036 6,379 3 Group before RFS MI 26,601 23,219 84,262 13,993 87,602 12,382 1,036 249,095 100 RFS MI 721 183 11,871 3,803 580 906 95 18,159 Group 27,322 23,402 96,133 17,796 88,182 13,288 1,131 267,254 2008 AAA 18,787 16,514 43,197 8,126 93,853 3,953 — 184,430 73 BBB- to AA+ — — 15,862 13,013 11,437 10,172 — 50,484 20 Non-investment grade — — 242 127 3,678 2,259 — 6,306 2 Unrated — — 409 1,445 2,175 4,517 3,393 11,939 5 Group before RFS MI 18,787 16,514 59,710 22,711 111,143 20,901 3,393 253,159 100 RFS MI — 7 10,761 1,652 — 885 1,085 14,390 Group 18,787 16,521 70,471 24,363 111,143 21,786 4,478 267,549 Notes: (1) Asset-backed securities. (2) Percentage calculated on Group before RFS MI.
Key points The proportion of AAA rated securities was broadly unchanged during the year whilst the proportion of non-investment grade and unrated securities increased from 5% to 7%.
Increase in non-investment grade securities reflects purchases by GBM’s mortgage trading business. Non-investment grade securities also increased as a result of credit downgrades and rating withdrawals of certain ABS structures in Non-Core during the year.
Held-for-trading (HFT) 5,097 15,956 43,224 5,778 21,988 6,590 236 98,869 Designated as at fair value through profit or loss 1 — 262 3 119 16 1 402 Available-for-sale 8,377 17,890 33,122 7,198 42,515 2,011 17 111,130 Loans and receivables 11 — — 15 6,203 848 2 7,079 Total 13,486 33,846 76,608 12,994 70,825 9,465 256 217,480 Short positions (HFT) (4,200) (11,398) (18,909) (1,853) (1,335) (3,288) (34) (41,017)
Derivatives The table below analyses the Group’s derivative assets by internal credit quality banding and residual maturity. Master netting agreements in respect of mark-to-market (mtm) values and collateral do not result in a net presentation in the Group’s balance sheet under IFRS.
Net exposure £m 2008 Exchange rate 65,428 21,106 25,150 43,860 17,339 172,883 (113,451) 59,432 Interest rate 14,195 17,364 23,603 193,254 405,926 654,342 (597,482) 56,860 Credit derivatives 932 384 2,511 83,599 54,940 142,366 (112,119) 30,247 Equity and commodity 4,807 2,864 5,579 8,069 585 21,904 (10,645) 11,259 85,362 41,718 56,843 328,782 478,790 991,495 (833,697) 157,798
Key points Whilst gross exchange rate contracts increased due to the trading fluctuations and favourable movements in forward rates and volume, the mix in counterparty netting arrangements reduced the net exposure.
The reduction in credit derivatives primarily reflected the APS credit derivative reducing from £1.4 billion at the start of the year to £550 million at end of 2010. The effect of credit spread widening in GBM and Non-Core were offset by portfolio reductions, as part of derisking, and currency movements.
Cross border exposures Cross border exposures are loans and advances including finance leases and instalment credit receivables and other monetary assets, such as debt securities and net derivatives, including non-local currency claims of overseas offices on local residents.
2010 Government Banks Other Total £m £m £m £m £m £m
United States 21,201 14,382 36,813 72,396 74,409 91,544 France 17,293 16,007 6,756 40,056 37,489 58,251 Germany 22,962 6,276 10,467 39,705 41,727 40,812 Japan 7,983 6,962 7,542 22,487 18,939 14,933 Spain 1,401 4,248 11,589 17,238 27,118 36,441 Netherlands 2,900 3,055 10,824 16,779 20,262 34,283 Italy 6,409 1,083 2,188 9,680 14,412 16,582 Cayman Islands 2 94 7,330 7,426 10,786 18,126 Republic of Ireland 199 3,789 3,101 7,089 14,902 18,662 Belgium 1,461 752 2,806 5,019 9,340 16,313 *unaudited
The analysis of risk elements in lending and impairments below, form a key part of the data provided to senior management on the credit performance of the Group's portfolios.
The table below analyses the Group's REIL and PPL and takes no account of the value of any security held which could reduce the eventual loss should it occur, nor of any provisions.
Notes: (1) All loans against which an impairment provisions is held. (2) Loans where an impairment event has taken place but no impairment recognised. This category is used for fully collateralised non-revolving credit facilities. (3) Loans for which an impairment event has occurred but no impairment provision is necessary. This category is used for advances and revolving credit facilities where the past due concept is not applicable. (4) Includes gross loans relating to disposal groups but excludes reverse repos.
Key points REIL increased by £3.1 billion or 26% in Core reflecting net increases in impaired loans in UK Corporate (£1.6 billion) and Ulster Bank (£1.4 billion).
In US Retail & Commercial, impairment losses declined following a gradual improvement in the underlying credit environment, throughout 2010.
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 95,127 2,576 948 2.7 37 1.0 687 349 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 319,679 9,337 4,797 2.9 51 1.5 2,234 1,519 Europe 65,874 3,905 2,027 5.9 52 3.1 936 111 US 62,085 1,027 824 1.7 80 1.3 425 556 RoW 21,995 938 218 4.3 23 1.0 142 38 Group before RFS MI 469,633 15,207 7,866 3.2 52 1.7 3,737 2,224
REIL & PPL as a % of gross loans Impairment charge Amounts
UK Retail 108,813 4,620 175 4,795 2,741 59 57 4.4 1,160 1,135 UK Corporate 111,744 3,967 221 4,188 1,732 44 41 3.7 761 349 Wealth 18,350 223 38 261 66 30 25 1.4 18 9 Global Transaction Services 17,484 146 6 152 147 101 97 0.9 8 49 Ulster Bank 39,786 3,619 2 3,621 1,633 45 45 9.1 1,161 48 US Retail & Commercial 48,661 913 — 913 505 55 55 1.9 483 547 Retail & Commercial 344,838 13,488 442 13,930 6,824 51 49 4.0 3,591 2,137 Global Banking & Markets 122,054 1,719 31 1,750 1,042 61 60 1.4 146 87 RBS Insurance and other 2,741 — — — — — — — — — Core 469,633 15,207 473 15,680 7,866 52 50 3.3 3,737 2,224 Non-Core 109,206 23,391 160 23,551 10,316 44 44 21.6 5,407 3,818 Group before RFS MI 578,839 38,598 633 39,231 18,182 47 46 6.8 9,144 6,042 RFS MI 2 — — — — — — — 42 — Group 578,841 38,598 633 39,231 18,182 47 46 6.8 9,186 6,042 2009 UK Retail 103,812 4,641 — 4,641 2,677 58 58 4.5 1,679 1,150 UK Corporate 111,671 2,330 97 2,427 1,271 55 52 2.2 923 352 Wealth 15,525 218 38 256 55 25 21 1.6 33 12 Global Transaction Services 14,146 197 4 201 189 96 94 1.4 39 23 Ulster Bank 42,344 2,260 2 2,262 962 43 43 5.3 649 34 US Retail & Commercial 48,937 643 — 643 478 74 74 1.3 702 546 Retail & Commercial 336,435 10,289 141 10,430 5,632 55 54 3.1 4,025 2,117 Global Banking & Markets 130,898 1,800 131 1,931 1,289 72 67 1.5 542 169 RBS Insurance and other 2,648 — — — — — — — — — Core 469,981 12,089 272 12,361 6,921 57 56 2.6 4,567 2,286 Non-Core 148,623 22,900 652 23,552 8,252 36 35 15.8 8,523 4,192 Group before RFS MI 618,604 34,989 924 35,913 15,173 43 42 5.8 13,090 6,478 RFS MI 142,688 3,260 85 3,345 2,110 65 63 2.3 1,044 461 Group 761,292 38,249 1,009 39,258 17,283 45 44 5.2 14,134 6,939 2008 UK Retail 94,565 3,832 — 3,832 2,086 54 54 4.1 1,019 823 UK Corporate 117,036 1,254 74 1,328 696 56 52 1.1 319 377 Wealth 14,033 107 24 131 34 32 26 0.9 15 8 Global Transaction Services 16,950 53 — 53 43 81 81 0.3 48 15 Ulster Bank 46,628 1,196 1 1,197 491 41 41 2.6 106 20 US Retail & Commercial 62,168 424 — 424 298 70 70 0.7 437 312 Retail & Commercial 351,380 6,866 99 6,965 3,648 53 52 2.0 1,944 1,555 Global Banking & Markets 227,116 869 18 887 621 71 70 0.4 306 343 RBS Insurance and other 6,401 — — — — — — — — 80 Core 584,897 7,735 117 7,852 4,269 55 54 1.3 2,250 1,978 Non-Core 187,258 11,056 109 11,165 5,182 47 46 6.0 4,228 919 Group before RFS MI 772,155 18,791 226 19,017 9,451 50 50 2.5 6,478 2,897 RFS MI 153,696 2,470 — 2,470 1,565 63 63 1.6 613 251 Group 925,851 21,261 226 21,487 11,016 52 51 2.3 7,091 3,148 187RBS Group 2010
Latent loss provisions: provisions held against impairments in the performing portfolio that have been incurred as a result of events occurring before the balance sheet date but which have not been identified at the balance sheet date. The Group has developed methodologies to estimate latent loss provisions that reflect: – historical loss experience adjusted where appropriate, in the light of current economic and credit conditions; and
– the period (‘emergence period’) between an impairment event occurring and a loan being identified and reported as impaired.
Emergence periods are estimated at a portfolio level and reflect the portfolio product characteristics such as a coupon period and repayment terms, and the duration of the administrative process required to report and identify an impaired loan as such. Emergence periods vary across different portfolios from 2 to 225 days. They are based on actual experience within the particular portfolio and are reviewed regularly.
PDs and emergence periods. The wholesale calculation is based on similar principles but there is no segmentation into portfolios: PDs and LGDs are calculated on an individual basis.
Once a loss event has occurred, a loan is assessed for an impairment provision. In the case of loans that are restructured due to the financial condition of the borrower, the loss event and consequent loan impairment provision assessment (based on management’s best estimate of the incurred loss) almost invariably take place prior to the restructuring. The quantum of the loan impairment provision may change once the terms of the restructuring are known resulting in an additional provision charge or a release of provision in the period in which the restructuring takes place.
Provisions are assessed on a case by case basis by experienced specialists with input from professional valuers and accountants. The Group operates a transparent provisions governance framework, setting thresholds to trigger enhanced oversight and challenge.
Analyses of AFS debt securities and related AFS reserves are set out on pages 191 and 192.
Movement in loan impairment provisions The movement in provisions balance by division is shown in the table below.
Recoveries of amounts previously written-off 128 8 — 1 1 72 210 3 213 198 — 411 Charged to the 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 (89) (30) (2) — (70) — (191) (6) (197) (258) — (455)
2009 At 1 January 2,086 696 34 43 491 298 3,648 621 4,269 5,182 1,565 11,016 Transfer 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) Disposal of subsidiaries — — — — — — — (62) (62) (3) — (65)
Analysis of loan impairment charge The following table analyses impairment losses. 2010 £m
Latent loss (121) 1,184 769 Collectively assessed 3,070 3,994 2,391 Individually assessed 6,208 7,878 3,200 Loans to customers 9,157 13,056 6,360 Loans to banks (13) 34 118 Securities 112 809 961 Charge to income statement 9,256 13,899 7,439
Note: (1) Gross of provisions and excluding reverse repurchase agreements and including gross loans relating to disposal groups.
Core £m Non-Core £m Group £m Core £m Non-Core £m Group £m Group £m
Key point Provisions are 3.44% of loans and advances at 31 December 2010, compared with 2.69% at 31 December 2009. Non-Core figures were 9.14% versus 5.79%.
reserves £m £m £m £m £m £m £m £m £m £m
Key points Exposure to Spain reduced by £1.6 billion during 2010, largely in residential mortgage-backed covered bond exposures to financial institutions.
Italian exposures declined by £0.3 billion during 2010 from a combination of reductions in corporate clients and financial institutions, primarily in GBM.
Available-for-sale debt securities: gross unrealised losses The table below shows the fair value of available-for-sale debt securities that were in an unrealised loss position at 31 December, and the related gross unrealised losses. Less than 12 months More than 12 months Total Gross Gross Gross unrealised unrealised unrealised Fair value losses Fair value losses Fair value losses 2010 £m £m £m £m £m £m
UK central and local government 716 10 — — 716 10 US central and local government 51 1 4 — 55 1 Other central and local government 4,327 6 1,737 612 6,064 618 Banks and building societies 1,649 16 462 16 2,111 32 Asset backed securities 2,519 101 12,867 3,296 15,386 3,397 Corporate 204 4 108 32 312 36 Other 463 — 11 3 474 3 9,929 138 15,189 3,959 25,118 4,097
UK central and local government 2,727 57 26 — 2,753 57 US central and local government 5,349 88 7 1 5,356 89 Other central and local government 5,863 203 391 6 6,254 209 Banks and building societies 8,421 56 827 6 9,248 62 Asset backed securities 3,185 983 23,832 2,330 27,017 3,313 Corporate 384 14 166 34 550 48 Other 710 3 16 3 726 6 Group before RFS MI 26,639 1,404 25,265 2,380 51,904 3,784 RFS MI 1,890 64 161 62 2,051 126 Group 28,529 1,468 25,426 2,442 53,955 3,910
US central and local government 260 3 4,770 163 5,030 166 Other central and local government 13,341 555 39 6 13,380 561 Banks and building societies 1,402 95 1,168 49 2,570 144 Asset backed securities 15,032 2,432 25,033 693 40,065 3,125 Corporate 618 267 2,325 136 2,943 403 Other 9 1 235 78 244 79 Group before RFS MI 30,662 3,353 33,570 1,125 64,232 4,478 RFS MI 4,598 3,303 6,032 49 10,630 3,352 Group 35,260 6,656 39,602 1,174 74,862 7,830
Organisation and structure The Executive Risk Forum approves market risk appetite for trading and non-trading activities. The Global Head of Market & Insurance Risk is responsible for the Group Market Risk Control Framework and under delegated authority from the Executive Risk Forum, sets a limit framework within the context of the approved market risk appetite, 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 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 Risk Managers.
The head of each business, assisted by the business risk management team, is accountable for all market risks associated with its activities. 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 Global Market Risk Committee reviews and makes recommendations concerning the market risk profile across the Group, including risk appetite, limits and utilisation. The Committee meets monthly and is chaired by the Global Head of Market Risk & Insurance Risk. Attendees include respective business Risk Managers and Group Market Risk.
Risk measurement and control At the Group level, the risk appetite is expressed in the form of a combination of VaR, sensitivity and stress testing limits. VaR is a technique that produces estimates of the potential change in the market value of a portfolio over a specified time horizon at given confidence levels. 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.
As the VaR model is an important market risk measurement and control tool and is used for determining a significant component of the market risk capital, 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 interval. The FSA categorises a VaR model as green, amber or red. A green model is consistent with a good working model and is achieved for models that have four or less back-testing exceptions in a 12 month period. For the Group’s trading book, a green model status was maintained throughout 2010.
The Group’s VaR should be interpreted in light of the limitations of the methodology used, as follows: Historical Simulation VaR may not provide the best estimate of future market movements. It can only provide a prediction of the future based on events that occurred in the 500 trading day time series. Therefore, events that are more severe than those in the historical data series cannot be predicted.
The use of a 99% confidence level does not reflect the extent of potential losses beyond that percentile.
The Group computes the VaR of trading portfolios at the close of business. Positions may change substantially during the course of the trading day and intra-day profit and losses will be incurred.
A risk not in VaR framework has been developed to quantify those market risks not adequately captured by the market standard VaR methodology. Where risks are not included in the model, various nonVaR controls (for example, position monitoring, sensitivity limits, triggers or stress limits) are in place.
The Group undertakes daily stress testing to identify the potential losses in excess of VaR. Stress testing is used to calculate a range of trading book exposures which result from extreme market events. Stress testing measures the impact of exceptional changes in market rates and prices on the fair value of the Group’s trading portfolios. The Group calculates historical stress tests and hypothetical stress tests.
Risk management: Market risk continued Risk measurement and control continued The Global Market Risk Stress Testing Committee reviews and discusses all matters relating to Market Risk Stress Testing. Stress test exposures are discussed with senior management and relevant information is reported to the Group Risk Committee, Executive Risk Forum and the Board. Breaches in the Group’s market risk stress testing limits are monitored and reported.
Traded portfolios The primary focus of the Group’s trading activities is to provide an extensive range of debt and equity financing, risk management and investment services to its customers, including major corporations and financial institutions around the world. The Group undertakes these activities organised along six principal business lines: money markets; rates flow trading; currencies and commodities; equities; credit markets; and portfolio management & origination.
The Group participates in exchange traded and over-the-counter (OTC) derivatives markets. The Group buys and sells financial instruments that are traded or cleared on an exchange, including interest rate swaps, futures and options. Holders of exchange traded instruments provide margin daily with cash or other security at the exchange, to which the holders look for ultimate settlement.
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 between willing parties. The fair values are determined following IAS 39 guidance which requires banks to use quoted market prices or valuation techniques (models) that make the maximum use of observable inputs. When marking to market using a model, the valuation methodologies are reviewed and approved by the market risk function. Group Risk provides an independent evaluation of the model for transactions deemed by the Group Model Product Review Committee (GMPRC) to be large, complex and/or innovative. Any profits or losses on the revaluation of positions are recognised in the daily profit and loss.
January February March April May June July August September October November December £ million
Trading VaR Average £m Period end £m Maximum £m Minimum £m Average £m Period end £m Maximum £m Minimum £m *unaudited
Key points The Group’s period end VaR reduced as the exceptional volatility of the market data from the period of the financial crisis dropped out of the 500 days of time series data used in the VaR calculation. The credit spread VaR was particularly impacted as a result of this effect.
CEM VaR was greater in 2010 than 2009 due to the novation of counterparty risk hedging trades from RBS N.V. to RBS plc. For RBS N.V. there is no local regulatory requirement for counterparty hedges to be included in VaR, as they are treated on a standardised basis but on novation to CEM in RBS plc, under UK regulatory requirements, the trades were captured by the VaR model resulting in an increase in VaR.
Key points* The average daily revenue earned from GBM’s trading, balance sheet management and other trading activities in 2010 was £25.4 million compared with £37.8 million in 2009. The standard deviation of these daily revenues was £22.0 million compared with £32.3 million in 2009. The standard deviation measures the variation of daily revenues about the mean value of those revenues.
The effect of any month end adjustments, not attributable to a specific daily market move, is spread evenly over the days in the month in question.
The graph of daily revenues for 2010 shows a narrower distribution of revenues compared with 2009.
Non-traded portfolios VaR is not always the most appropriate measure of risk for assets in the non-trading book, particularly for those in Non-Core which will diminish over time as the asset inventory is sold down.
Interest rate 8.7 10.4 20.5 4.4 13.0 13.9 26.3 7.7 Credit spread 32.0 16.1 101.2 15.4 81.7 100.3 131.5 39.7 Currency 2.1 3.0 7.6 0.3 1.4 0.6 7.0 0.2 Equity 1.2 3.1 4.6 0.2 3.3 2.2 5.8 1.6 Diversification (15.9) (20.4)
Drawn notional Fair value CDOs CLOs MBS (1) Other ABS Total CDOs CLOs MBS (1) Other ABS Total 2010 £m £m £m £m £m £m £m £m £m £m 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 Note: (1) Mortgage-backed securities (MBS) include sub-prime residential mortgage-backed securities with a notional amount of £471 million (2009 - £682 million) and a fair value of £329 million (2009 - £415 million), all with residual maturities of greater than 10 years.
The SCP are within Non-Core. The risk on this portfolio is not measured or disclosed using VaR, as the Group believes this is not an appropriate tool for the banking book portfolio comprising of illiquid debt securities. The main driver of the reduction in drawn notional is the asset sales from a portfolio within an unwound securitisation arbitrage conduit. The impact of disposals on portfolio fair value has been partially offset by an increase in residual average price to 75% (2009 - 68%).
The Group underwrites retail and SME insurance with a focus on high volume, relatively straightforward products. The key insurance risks are as follows: motor insurance contracts (private and commercial): claims experience varies due to a range of factors, including age, gender and driving experience together with the type of vehicle and location; property insurance contracts (residential and commercial): the major causes of claims for property insurance are weather (flood, storm), theft, fire, subsidence and various types of accidental damage; and other commercial insurance contracts: risk arises from business interruption and loss arising from the negligence of the insured (liability insurance).
Operational risk is the risk of loss resulting from inadequate or failed internal processes, people and systems, or from external events. Operational risk is an integral and unavoidable part of the Group’s business as it is inherent in the processes it operates in to provide services to customers and generate profit for shareholders. An objective of operational risk management is not to remove operational risk altogether, but to manage the risk to an acceptable level, taking into account the cost of minimising the risk as against the resultant reduction in exposure. Strategies to manage operational risk include avoidance, transfer, acceptance and mitigation by controls.
Group Policy Framework (GPF) The GPF supports a consistent approach to how we do business and helps everyone understand their individual and collective responsibilities. It is a core component of the Group’s Risk Appetite Framework; it supports the risk appetite setting process, and also underpins the control environment.
Work to design, implement and embed an enhanced GPF has continued throughout 2010 and will extend into 2011. The Group’s plans for ongoing development of GPF will support increased consistency in risk appetite setting across all risk types faced by the Group, including alignment to the Group’s strategic business and risk objectives. The Group will use relevant external reference points such as peers and rating agencies to challenge and verify the content of the Policy Standards making up GPF.
Appropriate and effectively implemented Policy Standards are a fundamental component of GPF and support attainment and maintenance of an ‘upper quartile’ control framework as compared against the Group’s relevant peer set.
The GPF requires consideration and agreement through Group governance of the level of risk appetite we have and how this is justifiable in the context of our strategic objectives.
There will be ongoing reassessment of risks, risk appetite and controls within the GPF and where appropriate, potential issues will be identified and addressed to ensure the Group moves in line with the set objectives and remains constantly aligned with the ‘upper quartile’ objective and market practice at all times.
Responsible for testing key controls and monitoring compliance with Group policies.
Responsible for providing independent assurance on the design, adequacy and effectiveness of the Group’s system of internal controls.
The three lines of defence model and the ORPS apply throughout the Group and are implemented taking into account the nature and scale of the underlying business. The following key operational risk management techniques are included in the ORPS; Risk and control assessments: business units identify and assess operational risks to ensure that they are effectively managed, prioritised, documented and aligned to risk appetite; Scenario analysis: scenarios for operational risk are used to assess the possible impact of extreme but plausible operational risk loss events. Scenario assessments provide a forward looking basis for managing exposures that are beyond the Group’s risk appetite; Loss data management: each business unit’s internal loss data management process captures all operational risk loss events above certain minimum thresholds. The data is used to enhance the adequacy and effectiveness of controls, identify opportunities to prevent or reduce the impact of recurrence, identify emerging themes, enable formal loss event reporting and inform risk and control assessments and scenario analysis. Escalation of individual events to senior management is determined by the seriousness of the event. Operational loss events are categorised under the following headings: - clients, products and business practices; - technology and infrastructure failures; - employment practices and workplace safety; - internal fraud; - external fraud; - execution, delivery and process management; - malicious damage; and - disaster and public safety.
New product approval process: this process ensures that all new products or significant variations to existing products are subject to a comprehensive risk assessment. Products are evaluated and approved by specialist areas and are subject to executive approval prior to launch; and
Self certification process: this requires management to monitor and report regularly on the internal control framework for which they are responsible, confirming its adequacy and effectiveness. This includes certifying compliance with the requirements of Group policies.
Each business unit must manage its operational risk exposure within an acceptable level, testing the adequacy and effectiveness of controls and other risk mitigants (for example, insurance) regularly and documenting the results. Where unacceptable control weaknesses are identified, action plans must be produced and tracked to completion. 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.
Operational risk events (greater than £10,000) by event category - % of total events by count. The chart below shows as at 31 December 2010, execution, delivery and process management, together with external fraud, continued to account for circa 90% of losses by count during 2010.
Note: (1) Work continued throughout 2010 to ensure the treatment, capture and recording of losses in RBS N.V. mirrored the RBS group approach. This has resulted in a small movement in the 2009 metrics recorded in this report compared to those recorded last year.
A high proportion of the Group’s operational risk events have a low financial cost associated with them and a very small proportion of operational risk events have a material impact. In 2010, 96% of reported operational losses had a value of £100,000 or less (2009 - 95%), but accounted for 33% of the overall impact (2009 - 18%). In contrast, 0.3% of the operational risk events had a value of £1 million or greater (2009 - 1%), but accounted for 35% of the overall impact (2009 - 61%).
Fraud prevention Fraud remains a big challenge to the Group, and the rest of the financial services industry. The Group continues to respond to this threat, continually investing in people and processes for both detective and preventative measures, especially in relation to the impact of organised crime against the Group. The Group's key strategic programmes continue to focus on solutions for payment fraud, ATM security, identification of counterfeit documentation and online banking protection for the Group’s customers. The Group’s investments have resulted in multi-million pound savings and, through close working ties with law enforcement agencies, handing down of significant custodial sentences.
Risk management: Operational risk* continued Physical security The Group continues to implement strong security measures to ensure the safety of staff, the Group’s customers and businesses from physical harm. Against an ever changing threat environment, these measures are kept under constant review and adapted accordingly. The past year has seen protests groups continue to target the Group (most notably Climate Camp in August 2010); robust processes are in place to ensure the safety of customers and staff during these demonstrations. The Group also continues to mitigate against the threat posed by international related terrorism.
The Group continues to invest in programmes to enhance and maintain information security controls and systems. For example, during 2010 the Group have risk assessed the externally facing websites and penetration tested those websites that contain confidential, high-risk Group data and established an assurance team to implement an ongoing programme of third party reviews.
Business continuity The need to ensure the continuity of business across the Group and the management of crisis situations is a key activity within the risk function. Key risks and threats that the Group is consistently monitoring from a business continuity perspective include pandemics, terrorism, environmental impacts and technology disruptions. Business continuity plans are in place to ensure that the Group can continue key products, services, and operations. A consistent crisis management framework has been developed that includes a six step methodology and allows incidents to be managed and resolved through skilled global teams.
All business continuity plans, related activities and systems are tested annually. The plan data is validated every 6 months and where the impact on business is high, the validation frequency is increased to every 3 months.
Global regulatory risk policies Within the Group Policy Framework (GPF), regulatory risk and compliance policies define minimum standards for all businesses to adhere to on a global basis. These policies are primarily driven by the rules and regulations set by the FSA as the Group’s lead regulator. These global minimum standards are supplemented by division specific policies where appropriate (product specific or local market specific requirements).
Regulatory developments Regulatory environments are constantly evolving and it is critical that the Group both understands early on the drivers for this change and be able to assess the potential impact of prospective rules and regulations on the different businesses. The regulatory developments tracker seeks to identify, track and monitor all such material changes and ensure that an appointed senior executive is responsible for assessing the potential impacts on the Group’s business. Such activity supports both effective engagement in the regulatory consultation process, and planning for the introduction of new or changed rules and regulations.
During the last 12 months the Group has experienced unprecedented levels of prospective rules and regulations particularly in the area of prudential regulation (capital, liquidity, governance and risk management), and to the treatment of systemically important entities, in particular through initiatives on recovery and resolution plans (‘living wills’) - see page 398 for regulatory developments and reviews.
Training and awareness Maintaining compliance with existing rules and regulations requires a continued investment in professional training and maintaining risk awareness. The group undertakes extensive training both with group wide learning initiatives (e.g. anti-money laundering) as well as divisional or product specific training. To support the professional development of the Group’s regulatory risk staff the Group has a comprehensive progressive training programme that is deployed on a global basis.
Regulatory relationship management The Group is committed to working with its regulators in an open and constructive way as it deals with both the evolution of regulatory frameworks as well as the ongoing compliance to existing rules and regulations. The regulatory relationship management tool is used to track, record, monitor and report on all material regulatory engagement to ensure that activities remain co-ordinated across the Group - see page 397 for a description of the key regulatory and supervisory bodies with which the Group engages.
Reputation risk is defined as the potential loss in reputation that could lead to negative publicity, loss of revenue, costly litigation, a decline in the customer base or the exit of key Group employees.
The Group seeks to safeguard its reputation by considering the impact on the value of its franchise from how it conducts business, its choice of customers and the way stakeholders view the Group. Managing the Group’s reputation is the joint responsibility of all employees, and reputational considerations should, as part of standard practice, be integrated into the Group’s day-to-day decision making structures.
The RBS Group Pension Fund (“Main scheme”) is the largest of the schemes and the main source of pension risk. The Main scheme operates under a trust deed under which the corporate trustee, RBS Pension Trustees Limited, is a wholly owned subsidiary of The Royal Bank of Scotland plc and the trustee board comprises six directors selected by the Group and four directors nominated by members.
The trustee is solely responsible for the investment of the schemes assets which are held separately from the assets of the Group. The Group and the trustee must agree on the investment principles and the 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 Consumer Price Indices (CPI) inflation, if lower) to the amount of any salary increase that will count for pensionable purposes.
The funding valuation of the Main scheme at 31 March 2010 is currently in progress. Further details are given in Note 4 on the accounts.
The Main scheme, which represents 84% of plan assets at 31 December 2010, 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. 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 has an additional exposure to rewarded risk by investing in equity futures.
All the disclosures in this section (pages 204 to 220) are audited unless otherwise indicated with an asterisk (*).
Securities issued by central and local governments 124.0 134.1 146.9 95.1 105.8
Securities issued by corporates and other entities 9.7 13.4 14.4 24.3 26.2 Securities issued by banks and building societies 13.0 14.0 17.8 22.7 24.4
The Group’s credit market activities gave rise to risk concentrations in asset-backed securities (ABS). The Group has exposures to ABS which are predominantly debt securities, but can also be held in derivative form. ABS have an interest in an underlying pool of referenced assets. The risks and rewards of the referenced pool are passed onto investors by the issue of securities with varying seniority, by a special purpose entity.
Debt securities include residential mortgage-backed securities (RMBS), commercial mortgage-backed securities (CMBS), collateralised debt obligations (CDOs), collateralised loan obligations (CLOs) and other ABS. In many cases the risk associated with these assets is hedged by way of credit derivative protection, purchased over the specific asset or relevant ABS indices. The counterparty to some of these hedge transactions are monoline insurers.
Europe RoW (2) Total HFT (3) DFV (4) AFS (5) LAR (6) 2010 £m £m £m £m £m £m £m £m £m
Net exposure RMBS: G10 government 24,390 16 5,958 — 30,364 13,765 — 16,599 — RMBS: covered bond 142 208 7,522 — 7,872 — — 7,872 — 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 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 Other ABS 2,293 748 2,609 1,659 7,309 690 — 4,081 2,538 34,013 7,609 18,221 2,066 61,909 18,863 11 37,015 6,020
Europe RoW (2) Total HFT (3) DFV (4) AFS (5) LAR (6) 2008 £m £m £m £m £m £m £m £m £m
Carrying value RMBS: G10 government 33,464 25 7,642 46 41,177 18,631 — 22,546 — RMBS: covered bond 44 296 10,040 — 10,380 — — 10,380 — RMBS: prime 5,623 4,754 6,154 246 16,777 7,272 166 8,769 570 RMBS: non-conforming 1,111 2,906 — — 4,017 352 — 2,183 1,482 RMBS: sub-prime 1,824 445 439 381 3,089 1,594 16 913 566 CMBS 2,145 1,395 1,646 141 5,327 2,751 13 1,126 1,437 CDOs 8,275 259 441 45 9,020 4,389 — 4,280 351 CLOs 6,428 329 2,605 255 9,617 3,385 — 5,299 933 Other ABS 3,582 1,622 5,098 1,437 11,739 1,505 41 6,571 3,622 62,496 12,031 34,065 2,551 111,143 39,879 236 62,067 8,961
Risk management: Other risk exposures 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.
RMBS: G10 government 41,168 — — 9 41,177 RMBS: covered bond 10,380 — — — 10,380 RMBS: prime 15,252 1,417 106 2 16,777 RMBS: non-conforming 3,532 337 146 2 4,017 RMBS: sub-prime 1,362 936 790 1 3,089 CMBS 3,702 1,586 38 1 5,327 CDOs 4,510 2,041 2,088 381 9,020 CLOs 7,299 1,601 268 449 9,617 Other ABS 6,649 3,519 242 1,329 11,739 93,854 — — 11,437 3,678 2,174 111,143
Key points Carrying values of asset-backed securities decreased by £16.8 billion during 2010 with net reductions across all portfolios.
Within G10 government RMBS, net sell-downs by the US Mortgage Trading business in GBM in the first quarter of 2010, as part of the Group’s repositioning in light of the US government’s purchase of US assets was off-set by purchases in the second half of the year, with the latter reflecting the perceived investor appetite. The decrease in the US AFS portfolio reflected balance sheet restructuring in US Retail & Commercial during the third quarter of 2010.
A £5.8 billion reduction was seen in prime RMBS primarily in GBM and Group Treasury, across European (£4.7 billion) and US (£1.1 billion) portfolios reflecting respectively balance sheet management and repositioning in light of increased liquidity in the US RMBS market.
HFT AFS LAR Total HFT AFS LAR Total 2010 £m £m £m £m £m £m £m £m
Key point Non-investment grade securities increased by £1.4 billion of which £1.0 billion was in CDOs reflecting purchases by GBM’s Mortgage Trading business as well as credit down grades and rating withdrawals of certain ABS structures in Non-Core during the year.
Risk management: Other risk exposures continued Residential mortgage-backed securities RMBS are securities that represent an interest in a portfolio of residential mortgages. Repayments made on the underlying mortgages are used to make payments to holders of the RMBS. The risk of the RMBS will vary primarily depending on the quality and geographic region of the underlying mortgage assets and the credit enhancement of the securitisation structure. Several tranches of notes are issued, each secured against the same portfolio of mortgages, but providing differing levels of seniority to match the risk appetite of investors. The most junior (or equity) notes will suffer early capital and interest losses experienced by the referenced mortgage collateral, with each more senior note benefiting from the protection provided by the subordinated notes below. Additional credit enhancements may be provided to the holder of senior RMBS notes, including guarantees over the value of the exposures, often provided by monoline insurers.
The main categories of mortgages that serve as collateral to RMBS held by the Group with related vintages are set out below and described in the Glossary on pages 434 to 439. The US market has more established definitions of differing underlying mortgage quality and these are used as the basis for the Group's RMBS categorisation.
The table below details the Group’s CVA by type of counterparty.
Monoline insurers The Group has purchased protection from monoline insurers (“monolines”), mainly against specific ABS. Monolines specialise in providing credit protection against the principal and interest cash flows due to the holders of debt instruments in the event of default by the debt instrument counterparty. This protection is typically held in the form of derivatives such as credit default swaps (CDSs) referencing underlying exposures held directly or synthetically by the Group.
Gross exposure to monolines 4,023 6,170 11,581 Hedges with financial institutions (71) (531) (789) Credit valuation adjustment (2,443) (3,796) (5,988) Net exposure to monolines 1,509 1,843 4,804
Credit valuation adjustment as a % of gross exposure 61% 62% 52%
Credit valuation adjustment at 1 January (3,796) (5,988) (862) Credit valuation adjustment at 31 December (2,443) (3,796) (5,988) Decrease/(increase) in credit valuation adjustment 1,353 2,192 (5,126) Net debit relating to realisations, hedges, foreign exchange and other movements (844) (3,290) (347) Net (debit)/credit relating to reclassified debt securities (305) (1,468) 1,916 Net credit/(debit) to income statement (1) 204 (2,566) (3,557)
The reduction in the Group’s RWA requirements over the quarter was driven by the reduction in exposure to monolines and the impact of restructuring certain risk structures.
The Group has predominantly traded senior tranches with CDPCs, the average attachment and detachment points are 13% and 49% respectively (2009 - 15% and 51% respectively; 2008 - 16% and 50% respectively), and the majority of the loans and bonds in the reference portfolios are investment grade.
Gross exposure to CDPCs 1,244 1,275 4,776 Credit valuation adjustment (490) (499) (1,311) Net exposure to CDPCs 754 776 3,465
AAA 213 212 1 — 1 A to AA- 644 629 15 4 11 Non-investment grade 20,066 19,050 1,016 401 615 Unrated 4,165 3,953 212 85 127 25,088 23,844 1,244 490 754 2009 AAA 1,658 1,637 21 5 16 BBB- to A- 1,070 1,043 27 9 18 Non-investment grade 17,696 16,742 954 377 577 Unrated 3,926 3,653 273 108 165 24,350 23,075 1,275 499 776 2008 AAA 6,351 4,780 1,571 314 1,257 AA to AA+ 1,195 1,116 79 16 63 A to AA- 13,092 10,891 2,201 657 1,544 BBB- to A- 4,601 3,676 925 324 601 25,239 20,463 4,776 1,311 3,465
Credit valuation adjustment at 1 January (499) (1,311) (44) Credit valuation adjustment at 31 December (490) (499) (1,311) Decrease/(increase) in credit valuation adjustment 9 812 (1,267) Net (debit)/credit relating to realisations, hedges, foreign exchange and other movements (150) (1,769) 652 Income from trading activities - net losses (141) (957) (615)
Key points Losses reduced significantly in 2010 due to smaller exposures and reduced losses on hedges that were introduced to cap the exposures.
Expected losses are determined from the market implied probability of defaults and internally assessed recovery levels. The probability of default is calculated with reference to observable credit spreads and observable recovery levels. For counterparties where observable data do not exist, the probability of default is determined from the average credit spreads and recovery levels of baskets of similarly rated entities. A weighting of 50% to 100% is applied to arrive at the CVA. The weighting reflects portfolio churn and varies according to the counterparty credit quality.
Key points The increase in CVA held against exposures to other counterparties was driven by rating downgrades of certain counterparties and the net impact of changes in credit spreads and counterparty exposures due to market moves. This increase was partially offset by a decrease due to the disposal of parts of the RBS Sempra Commodities JV business during the year.
Losses on hedges and realised defaults are the primary driver of the loss arising on foreign exchange, hedges, realisations and other movements.
Notes: (1) Telecommunications, media and technology. (2) All of the above exposures are classified as LAR, except £154 million (2009 - £143 million; 2008 - £102 million) which are classified as HFT.
Drawn £m Undrawn £m Total £m Drawn £m Undrawn £m Total £m
Funded deals (11) 11 — 166 (166) — Lapsed/collapsed deals — — — — (19) (19) Changes in fair value 73 — 73 (31) — (31) Accretion of interest 50 — 50 100 — 100 Net recoveries/(impairment provisions) 131 — 131 (1,041) — (1,041)
Notes: (1) Loans for UK mid-market buyouts, supplementing equity capital provided by third party private equity investors. (2) Loans to UK mid-corporates supporting acquisitions, recapitalisations or general corporate purposes where higher leverage criteria were met.
Risk management: Other risk exposures continued Conduits The Group sponsors and administers a number of asset-backed commercial paper (ABCP) conduits. A conduit is an SPE that issues commercial paper and uses the proceeds to purchase or fund a pool of assets. The commercial paper is secured on the assets and is redeemed either by further commercial paper issuance, repayment of assets or funding from liquidity facilities. Commercial paper is typically short-dated, usually up to three months.
Group-sponsored conduits can be divided into multi-seller conduits and own-asset conduits. The Group consolidates both types of conduit where the substance of the relationship between the Group and the conduit vehicle is such that the vehicle is controlled by the Group. Liquidity commitments from the Group to the conduit exceed the nominal amount of assets funded by the conduit as liquidity commitments are sized to cover the funding cost of the related assets.
Core £m Non-Core £m Total £m Core £m Non-Core £m Total £m £m
Total assets held by the conduits 16,390 3,624 20,014 23,409 3,957 27,366 49,857
Total assets decreased during the year by £7.4 billion in line with the Group’s strategy of reducing conduit exposure.
The Group holds two own-asset conduits, which have assets that were previously funded by the Group. The Group’s maximum exposure to loss on these two conduits was £4.1 billion in 2010 (2009 - £9.1 billion; 2008 - £15.9 billion), with £2.2 billion of ABCP outstanding at that date (2009 - £7.7 billion; 2008 - £14.8 billion).
The Group also extends liquidity commitments to multi-seller conduits sponsored by other banks, but typically does not consolidate these entities as the Group does not retain the majority of risks and rewards. The Group’s exposure from third-party conduits was £136 million (2009 - £587 million; 2008 - £3.9 billion) representing deal specific liquidity.
Key aspects of the Scheme On 22 December 2009, the Group acceded to the Asset Protection Scheme (APS or ‘the Scheme’) with HM Treasury (HMT) 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 HMT. 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 APS. Receipts from HMT will, over time, amount to 90% of cumulative losses (net of cumulative recoveries) on the portfolio of covered assets less the first loss amount.
APS assets are spread across the Group’s main divisions. High volume commercial and retail exposures were selected on a portfolio basis where assets were high risk and in arrears at 31 December 2008. Large corporate and GBM exposures were selected at the counterparty/asset level based on individual risk reviews and defaulted assets in the workout/restructuring unit.
The table below details the movement in covered assets in the year. £bn
Covered assets at 1 January 2009 282.0 Disposals (3.0) Non-contractual early repayments (8.9) Maturities and amortisation (26.1) Rollovers and covered amount cap adjustments (1.7) Effect of foreign currency movements and other adjustments (11.8) Covered assets at 31 December 2009 230.5 Disposals (9.7) Maturities, amortisation and early repayments (28.7) Reclassified assets (2) 3.1 Withdrawals (2.9) Effect of foreign currency movements and other adjustments 2.4 Covered assets at 31 December 2010 194.7
Notes: (1) The Asset Protection Agency (APA) and the Group have now reached agreement on substantially all eligibility issues. (2) In Q2 2010, the APA and the Group reached agreement over the classification of some structured credit assets which resulted in adjustments to the covered amount, without affecting the underlying risk protection.
The reduction in covered assets was due to run-off of the portfolio, disposals, early repayments and maturing loans.
Credit impairments and write downs The table below analyses the cumulative credit impairment losses and adjustments to par value (including AFS reserves) relating to the covered assets.
Key points The increase in Non-Core impairments of £1.8 billion accounted for the majority of the increase in credit impairments and write downs in 2010.
The reduction in GBM is largely a result of transfers to Non-Core in the second half of the year.
APS recoveries include any return of value on a triggered asset, although these are only recognised for the Scheme reporting purposes when they are realised in cash. The net triggered amount at any point in time only takes into account cash recoveries to date. As with any bespoke and highly complex legal agreement there are various areas of interpretation, some of which could have a material impact on the net triggered amount identified to date.
The table below summarises the triggered amount and related cash recoveries by division.
UK Retail 3,675 455 3,220 3,340 129 3,211 UK Corporate 4,640 1,115 3,525 3,570 604 2,966 Ulster Bank 1,500 160 1,340 704 47 657 Retail & Commercial 9,815 1,730 8,085 7,614 780 6,834 Global Banking & Markets 2,547 749 1,798 1,748 108 1,640 Core 12,362 2,479 9,883 9,362 888 8,474 Non-Core 32,138 4,544 27,594 18,905 777 18,128 44,500 7,023 37,477 28,267 1,665 26,602 Loss credits 1,241 —
(4) The Group and the APA remain in discussion with regard to loss credits in relation to the withdrawal of £2.0 billion of derivative assets during Q2 2010 and the disposal of approximately £1.6 billion of structured finance and leveraged finance assets in 2010.
Retail & Commercial 43.2 56.2 Global Banking & Markets 11.5 19.9
Philip Hampton (age 57) N (Chairman) Appointed to the Board on 19 January 2009 and to the position of Chairman on 3 February 2009. Philip Hampton was previously chairman of J Sainsbury plc and group finance director of Lloyds TSB Group plc, BT Group plc, BG Group plc, British Gas and British Steel plc, an executive director of Lazards and a nonexecutive director of RMC Group plc. He is also former chairman of UK Financial Investments Limited which manages the UK Government's shareholding in banks. He is currently a non-executive director of Anglo American plc.
Bruce Van Saun (age 53) Group Finance Director Appointed to the Board on 1 October 2009, Bruce Van Saun has more than 25 years 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 he was responsible for the 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.
Aileen Taylor (age 38) Aileen Taylor assumed the role of Group Secretary in May 2010 and provides secretariat and corporate governance advice and support to the Group Board and its senior Committees. Aileen was appointed Deputy Group Secretary and Head of Group Secretariat in 2007, and prior to that held various legal, secretariat and risk roles at divisional and business level. Aileen is a Fellow of the Chartered Institute of Bankers in Scotland and a Fellow of the Industry and Parliament Trust.
Group Finance Director 4. Colin Buchan 5. Sandy Crombie 6. Penny Hughes 7. Joe MacHale 8. John McFarlane 9. Brendan Nelson 10. Arthur ‘Art’ Ryan 11. Philip Scott 12. Aileen Taylor
Abbreviations A Member of the Audit Committee N Member of the Nominations Committee R Member of the Remuneration Committee Ri Member of the Board Risk Committee * Independent non-executive director
Colin Buchan* (age 56) A, N, Ri Appointed to the Board in June 2002, Colin Buchan was educated in South Africa and spent the early part of his career in South Africa and the Far East. He has considerable international investment banking experience, as well as experience in very large risk management in the equities business. He was formerly a member of the group management board of UBS AG and head of equities of UBS Warburg, and was the former chairman of UBS Securities Canada Inc. He is chairman of Standard Life Investments Limited and a director of Standard Life plc and Black Rock World Mining Trust Plc. Colin is a fellow of the Chartered Institute of Bankers of Scotland.
Joe MacHale* (age 59) N, Ri Appointed to the Board in September 2004, Joe MacHale is currently a non-executive director and chairman of the remuneration committee of Brit Insurance Holdings plc, and a trustee and treasurer of MacMillan Cancer Support. He held a number of senior executive positions with J P Morgan between 1979 and 2001 and was latterly chief executive of J P Morgan Europe, Middle East and Africa Region. He is a fellow of the Institute of Chartered Accountants and the Chairman of Prytania Group.
Arthur ‘Art’ Ryan* (age 68) N Appointed to the Board on 1 October 2008, Art Ryan is the former chairman, chief executive officer and president of Prudential Financial Inc. Previously he held senior positions with Chase Manhattan Bank NA. He is currently a non-executive director of Regeneron Pharmaceuticals Inc. and an active member of numerous community boards. He was a founding member of the Financial Services Forum.
Philip Scott* (age 56) A, N, Ri (Chairman) Appointed to the Board on 1 November 2009, Philip Scott has 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.Philip is also an experienced non-executive director and is currently on the board of Diageo plc. He is a Fellow of the Institute of Actuaries and The Association of Certified Public Accountants.
Nathan Bostock (age 50) Head of Restructuring & Risk Nathan Bostock joined the RBS Group in June 2009 as Head of Restructuring and Risk with responsibility for the Non-Core Division & APS, the Global Restructuring Group and the control functions of Group Legal & Secretariat and Risk Management. Before joining RBS, Nathan spent eight years with Abbey National plc in several roles and was latterly the CFO 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.
Paul Geddes (age 41) Chief Executive, RBS Insurance Paul Geddes graduated from Oxford in 1990, where he read Politics, Philosophy and Economics. His career started at Procter & Gamble, in the UK and Europe. He entered retailing in 1997, holding senior roles in Kingfisher and GUS Groups before joining the RBS Group in 2004 as Managing Director, Products and Marketing, Retail Banking. He was appointed CEO, Retail Banking in December 2006 and CEO, UK Retail in February 2009, before taking overall responsibility for some of the UK’s best-known insurance brands, including Direct Line, Churchill, Privilege and Green Flag as CEO, RBS Insurance in August 2009. Paul is a Fellow of the Chartered Institute of Bankers in Scotland.
Chris Sullivan (age 53) Chief Executive, UK Corporate Chris Sullivan was appointed Chief Executive of the UK Corporate Banking Division and the GTS Division in August 2009. His previous role was Chief Executive of RBS Insurance, the second largest general insurance provider in the UK. Prior to this, Chris was Chief Executive of Retail and Deputy Chief Executive of Retail Markets. Chris is Vice Chairman of the Association of British Insurers, Chairman of the General Insurance Council and a member of the CBI President’s Committee. He spent five years as Chief Executive of Lombard Asset Finance and under his leadership it attained a leading position in the UK and Europe. Chris Sullivan earned his Fellowship of Chartered Institute of Bankers Scotland for his services to Scottish Banking.
The Management Committee, comprising our major business and functional leaders, meets three to four times annually as a vehicle for strategy and business performance review.
It comprises members of the Executive Committee plus: Elaine Arden, Group Human Resources Director Scott Barton, Chief Executive, Global Transaction Services Chris Campbell, Group General Counsel Mark Catton, Chief Executive, UK Corporate & Institutional Banking Rory Cullinan, Head of Non-Core Division John Cummins, Group Treasurer Jennifer Hill, Group Director – Strategy & Corporate Finance Suneel Kamlani, President of Global Banking & Markets Marco Mazzucchelli, Global Head of Banking & Deputy CEO, GBM Cormac McCarthy, Chief Executive, Ulster Bank John McCormick, Chief Executive, GBM Asia Pacific Andrew McLaughlin, Head of Communications and Group Chief Economist Peter Nielsen, Global Head of Markets David Stephen, Deputy Group Chief Risk Officer Brian Stevenson, Chairman, Global Transaction Services Rory Tapner, Chief Executive, Wealth Management
The directors present their report together with the audited accounts for the year ended 31 December 2010.
Following placing and open offers in December 2008 and in April 2009, HM Treasury owned approximately 70.3% of the enlarged ordinary share capital of the company. In December 2009, the company issued a further £25.5 billion of new capital to HM Treasury. This new capital took the form of B shares, which do not generally carry voting rights at general meetings of ordinary shareholders but are convertible into ordinary shares and qualify as Core Tier 1 capital.
Results and dividends The loss attributable to the ordinary and B shareholders of the company for the year ended 31 December 2010 amounted to £1,125 million compared with a loss of £3,607 million for the year ended 31 December 2009, as set out in the consolidated income statement on page 268.
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 55. Fuller details of these and other risk factors are set out on pages 405 to 422.
ABN AMRO In 2007, RFS Holdings B.V., which was jointly owned by the Group, the Dutch State (successor to Fortis) and Santander (the “Consortium Members”) completed the acquisition of ABN AMRO Holding N.V..
Legal separation of ABN AMRO Bank N.V. occurred on 1 April 2010, with the shares in that entity being transferred by ABN AMRO Holding N.V (renamed RBS Holdings N.V. at legal separation) to a holding company called ABN AMRO Group N.V., which is owned by the Dutch State. Following legal separation, RBS Holdings N.V. has one direct subsidiary, The Royal Bank of Scotland N.V. (“RBS N.V.”), a fully operational bank within the Group. RBS N.V. is independently rated and regulated by the Dutch Central Bank. Certain assets within RBS N.V. continue to be shared by the Consortium Members.
The sale of 80.01% of the Global Merchant Services (“GMS”) business to a consortium of Advent International and Bain Capital completed in November 2010. The Group holds a 19.99% minority stake in the new GMS business, to be known as WorldPay.
Employees As at 31 December 2010, the Group employed over 148,500 employees (full-time equivalent basis) throughout the world. Details of employee related costs are included in Note 3 on the accounts.
Employee consultation Each year, all employees are invited to complete the global employee opinion survey. The survey is confidential and independently managed by Towers Watson. The survey provides a channel for employees to express their views and opinions about the Group on a range of key issues.
The 2010 survey took place in September 2010 and the final response rate was 81%. This represents over 119,000 employees participating in the survey, from more than 50 countries.
The Group recognises employee representative organisations such as trade unions and work councils in a number of businesses and countries.
Safety, health and wellbeing Ensuring the safety, health and wellbeing of employees and customers is core to the Group’s business, and a fundamental social responsibility for the Group.
During 2010, the Group continued to focus on compliance, governance and managing risk across all jurisdictions. Enhanced services and supporting communication were implemented to support the health and wellbeing of employees, particularly given the impact of the economic environment.
Code of conduct The code of conduct applies to all employees globally and to all those engaged by the Group, but who are not employees, such as contractors and those engaged through external agencies.
The code of conduct exists to promote honest and ethical conduct, including the handling of actual or apparent conflicts of interest between personal and professional relationships. The Group recognises that personal conduct, business integrity and the Group’s security are crucial, and the code of conduct serves to inform employees of the Group’s expectations of their behaviour and practices.
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 social, ethical and environmental issues which confront the business on a daily basis. For more information on the governance structure, see page 44.
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 adversely affect the Group’s future results are set out on pages 405 to 422. The Group’s regulatory capital resources and significant developments since 2009 and anticipated future developments are detailed in the Capital section on pages 126 to 133. The Funding and liquidity risk section, pages 134 to 142, describes the Group’s funding and liquidity profile, including changes in key metrics, the build up of liquidity reserves and the outlook for 2011.
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 2010 financial statements have been prepared in compliance with the code’s principles.
On a show of hands at a general meeting of the company every holder of ordinary shares and cumulative preference shares present in person or by proxy and entitled to vote shall have one vote. On a poll, every holder of ordinary shares present in person or by proxy and entitled to vote shall have one vote for every share held. On a poll, holders of cumulative preference shares present in person or by proxy and entitled to vote shall have four votes for every share held. The voting rights of holders of noncumulative preference shares are set out in Note 29 on the accounts. The notices of Annual General Meetings and General Meetings specify the deadlines for exercising voting rights and appointing a proxy or proxies to vote in relation to resolutions to be passed at the meeting.
Directors The names and brief biographical details of the directors are shown on pages 226 and 227.
Gordon Pell retired as an executive director on 31 March 2010.
Group General Counsel and Group Secretary Miller McLean retired as Group General Counsel and Group Secretary on 30 April 2010. He was succeeded by Chris Campbell as Group General Counsel and Aileen Taylor as Group Secretary.
Directors’ interests The interests of the directors in the shares of the company at 31 December 2010 are shown on page 264. 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 2010 to 23 February 2011.
Directors’ indemnities In terms of section 236 of the Companies Act 2006 (the “Companies Act”), Qualifying Third Party Indemnity Provisions have been issued by the company to directors, members of the Group’s Executive and Management Committees and FSA Approved Persons.
Solicitor For The Affairs of Her Majesty’s Treasury as Nominee for Her Majesty’s Treasury Number of shares % held
Charitable contributions In 2010, the Group’s overall community contribution was £56.1 million (2009 - £63.9 million). The total amount given for charitable purposes by the company and its subsidiary undertakings during the year ended 31 December 2010 was £29.6 million (2009 - £34.7 million).
Political donations At the Annual General Meeting in 2010, shareholders gave authority under Part 14 of the Companies Act, for a period of one year, for the company (and its subsidiaries) to make political donations and incur political expenditure up to a maximum aggregate sum of £500,000. This authorisation was taken as a precaution only, as the company has a longstanding policy of not making political donations or incurring political expenditure within the ordinary meaning of those words. Shareholders will be asked to renew this authorisation at the Annual General Meeting in 2011.
During 2010, the Group made no political donations in the UK or EU. In keeping with the Group’s employment policies, Coutts & Company allowed a member of staff paid leave during the year to stand for election at the UK General Election. This might constitute political expenditure for the purposes of the Companies Act, as the definition in the Companies Act is capable of having a very wide meaning. The amount of expenditure in relation to the paid leave was £2,128.
The Royal Bank of Scotland Group plc is registered in Scotland No. 45551
The company is committed to high standards of corporate governance, business integrity and professionalism in all its activities.
The company has also complied in all material respects with the Financial Reporting Council Guidance on Audit Committees issued in December 2010.
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 US Securities Exchange Act of 1934 (“Exchange Act”).
The company has reviewed its corporate governance arrangements and is satisfied that these are consistent with the NYSE’s corporate governance listing practices, with the exception that the Chairman of the Board is also the Chairman of the Nominations Committee, which is permitted under the Code (since the Chairman was considered independent on appointment). The company’s Audit, Board Risk, Remuneration and Nominations Committees are otherwise composed solely of non-executive directors deemed by the Board to be independent. The NYSE corporate governance listing standards also require that a compensation committee has direct responsibility to review and approve the Group Chief Executive’s remuneration.
As stated above, in the case of the company, the Board, rather than the Remuneration Committee, reserves the authority to make the final determination of the remuneration of the Group Chief Executive.
All directors participate in discussing strategy, performance and the financial and risk management of the company. Meetings of the Board are structured to allow sufficient time for consideration of all items and the Chairman encourages constructive challenge and debate.
Board balance and independence The Board currently comprises the Chairman, two executive directors and eight independent non-executive directors, one of whom is the Senior Independent Director. The Board functions effectively and efficiently and is considered to be of an appropriate size. The directors provide the Group with the knowledge, mix of skills and experience required. The Board Committees comprise directors with a variety of relevant skills and experience so that no undue reliance is placed on any individual.
The non-executive directors combine broad business and commercial experience with independent and objective judgement. 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.
The names and biographical details of directors are shown on pages 226 and 227. Further information in relation to the company’s Annual General Meeting can be found in the Chairman’s letter to shareholders.
Performance evaluation Following the external Board evaluation carried out in 2009, a number of initiatives were implemented aimed at improving the overall performance and effectiveness of the Board, including greater advance planning in relation to Board agendas to allow more in-depth discussion of businesses and enhancement of Board engagement in risk management and setting risk appetite.
The Board has considered and discussed reports on the outcomes of the evaluation and is satisfied with the way in which the evaluation was conducted. The evaluation concluded that the Board is strong and operating effectively, headed by an excellent Chairman, who facilitates good, constructive debate. Generally, the Board is viewed as currently being of the appropriate size and has a good dynamic, although Board composition should be kept under continual review to ensure that the correct balance of skills and experience is maintained, particularly on Board Committees. On the structure of Board meeting agendas it was suggested that greater time could be allocated for discussions on key issues to allow in-depth focus on items which are material to the Group and to encourage an emphasis on debate and discussion rather than formal presentation.
Additionally, 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.
Board Committees In order to provide effective oversight and leadership, the Board has established a number of Board Committees with particular responsibilities. The Committee chairmanship and membership are reviewed on a regular basis. The names and biographies of all Board Committee members are set out on pages 226 and 227.
The Board Risk Committee is responsible for providing oversight and advice to the Board in relation to current and potential future risk exposures of the Group and future risk strategy, including determination of risk appetite and tolerance. The Board Risk Committee report is set out on pages 244 and 245.
Remuneration Committee The Remuneration Committee is comprised of at least three independent non-executive directors. The Remuneration Committee held nine scheduled meetings and six additional meetings in 2010.
The Remuneration Report, including a letter from the Chair of the Remuneration Committee, is set out on pages 246 to 263.
The Nominations Committee is responsible for: assisting the Board in the formal selection and appointment of directors having regard to the overall balance of skills, knowledge, experience and diversity on the Board; reviewing the structure, size and composition of the Board and making recommendations to the Board on any appropriate changes; reviewing membership and Chairmanship of Group Board Committees; and considering succession planning for the Chairman, Group Chief 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.
The Nominations Committee engages with external consultants, considers potential candidates and recommends appointments of new directors to the Board.
Group Sustainability Committee The Group Sustainability Committee (GSC) was established in 2009 and is chaired by the Senior Independent Director. The GSC is responsible for reviewing the Group’s overall sustainability strategy, values and policies and aligning the Group’s approach to social, environmental and ethical 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 44.
Former directors Archie Hunter (5) 4 3 3 Gordon Pell (6) 2
Communication with the company's largest institutional shareholders is undertaken as part of the Investor Relations programme: The Group Chief Executive meets regularly with UKFI, the organisation set up to manage the Government’s investments in financial institutions, to discuss the strategy and financial performance of the Group. He also undertakes an annual programme of meetings with the company’s largest institutional shareholders, as does the Group Finance Director.
The Chairman independently meets with the Group’s largest institutional shareholders annually to hear their feedback on management, strategy, business performance and corporate governance. Additionally, the Chairman, Senior Independent Director and chairs of the Board Committees met with the governance representatives of a number of institutional shareholders during the year.
Throughout the year, the Chairman, Group Chief Executive and Group Finance Director 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 earnings releases. 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.
The effectiveness of the Group’s internal control system is reviewed regularly by the Board, the Audit Committee and the Board Risk Committee. Executive management committees or boards of directors in each of the Group’s businesses receive regular reports on significant risks facing their business and how they are being controlled. In addition, the Board receives monthly risk management reports. Details of the Group’s approach to risk management are given in the Risk and balance sheet management section, on pages 119 to 125 of the Business review. The Audit Committee has received confirmation that management has taken, or is taking, the necessary action to remedy any failings or weaknesses identified through the operation of the Group framework of controls.
The Group assessed the effectiveness of its internal control over financial reporting as of 31 December 2010 based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in ‘Internal Control - Integrated Framework’.
The Group's auditors have audited the effectiveness of the Group's internal control over financial reporting and have given an unqualified opinion.
Membership I assumed the role of Chairman of the Audit Committee on 28 April 2010, following the retirement of Archie Hunter. The current members of the Committee are Colin Buchan, Philip Scott and myself. Joe MacHale stood down from the Audit Committee with effect from 30 April 2010 and is now a member of the Board Risk Committee and Asset Protection Scheme (APS) Senior Oversight Committee.
All members of the Audit Committee are independent non-executive directors. Colin Buchan and Philip Scott served throughout 2010, and I became a member of the Committee with effect from 1 April 2010. Attendance of each member at meetings of the Audit Committee in 2010 is shown on page 238.
The members of the Audit Committee are also members of the Board Risk Committee. This common membership ensures effective governance across all Finance and Risk issues, and that agendas are aligned and overlap is avoided. The Audit and Board Risk Committees also have strong links with the Remuneration Committee, with particular regard to ensuring that relevant Finance and Risk matters are factored into the determination of appropriate levels of compensation.
Responsibilities The Audit Committee’s primary responsibilities are to: assist the Group, The Royal Bank of Scotland plc and National Westminster Bank Plc Boards in discharging their responsibilities and in making all relevant disclosures in relation to the financial affairs of the Group; review accounting and financial reporting and regulatory compliance; review the Group's systems of internal control; and monitor the Group's processes for internal audit and external audit.
Audit Committee Chairman As Chairman of the Audit Committee, I play a leading role in the setting of the annual agenda planner for the Committee and with the agenda for each Committee meeting. Prior to every Committee meeting, I hold meetings with each of the Head of Group Internal Audit, the external auditors, the Group Finance Director and the Group Chief Accountant. These meetings are instrumental in ensuring that I am briefed on all relevant issues and that these are brought to the attention of the Audit Committee.
The Audit Committee’s annual programme of visits to the Group's business divisions and control functions continued in 2010, and these are now also attended by the Board Risk Committee. The object of the programme is to allow the Audit Committee and the Board Risk Committee to gain a better understanding of the Group and an invitation to attend is extended to all non-executive directors. The programme of future visits is considered annually. The Audit Committee and the Board Risk Committee undertook six visits in 2010. These were to the Global Banking & Markets business; the Non-Core Division, Global Restructuring Group and the Asset Protection Scheme; Major Change Projects ongoing in the Group; the US Asset-backed Securities business; Risk Management and the Global Banking & Markets, Global Transaction Services and Private Banking businesses in Asia.
The Audit Committee focused on a number of salient judgments and reporting issues in the preparation of the 2010 accounts, including: valuation methodologies and assumptions for financial instruments carried at fair value including the Group's credit market exposures and the disclosures provided; actuarial assumptions for the Group Pension Fund; impairment losses in the Group's portfolio of loans and advances and available-for-sale securities; impairment of goodwill and other purchased intangible assets; the Group’s tax position, including the treatment of deferred tax assets; and compliance with the requirements of the Sarbanes-Oxley Act 2002.
In its consideration of each of these issues, the aims of the Audit Committee have been to: understand and challenge the valuation and other accounting judgments made by management; review the conclusions of the external auditors and, where applicable, other experts and to understand how they came to their conclusions; and satisfy itself that the disclosures in the financial statements about these estimates and valuations are transparent and appropriate.
Group Internal Audit’s role is to continuously assess how operating risks are being managed and controlled throughout the Group and report regularly to the Group Executive and Audit Committee on the results of these assessments; and to influence the continuous development of the risk management and control process through sharing best practice.
External auditors Deloitte LLP has been the company’s auditors since March 2000.
In assessing the effectiveness of the Group’s external auditors the Audit Committee has regard to: the experience and expertise of the senior members of the engagement team; the proposed scope of the audit work planned and executed; the quality of the dialogue between the external auditors, the Committee and senior management; the clarity, quality and robustness of written reports presented to the Committee setting out the external auditor’s findings arising from the audit; the quality of the observations provided to the company by the external auditor on the Group’s systems of internal control; and the views of management on the performance of the external auditors.
Twelve service criteria for the audit have been defined by the external auditors to measure their performance against the quality commitments set out in their annual audit plan, under the headings of “quality of audit approach and conduct”, “independence and objectivity”, “quality of the team” and “value added”. A questionnaire is completed by each Divisional CFO and each Divisional Risk and Audit Committee chairman after the completion of the annual audit and by relevant members of Group management and the Audit Committee. A follow up interview is held with each of them by senior partners independent of their immediate service teams. The results of this exercise will be presented to the Audit Committee, with actions defined and agreed to address any areas where performance has fallen below expected standards.
The external auditors are required to rotate the lead audit partner responsible for the audit every five years and, in 2010, a new audit partner was appointed to lead the audit for the year ending 31 December 2010. There are no contractual obligations restricting the company's choice of external auditor.
Audit and non-audit services The 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.
In particular, the Group may not engage the external auditors to provide any of the non-audit services described below: bookkeeping or other services related to the accounting records or financial statements; financial information systems design and implementation; appraisal or valuation services, fairness opinions or contribution-inkind reports; actuarial services; internal audit outsourcing services; management functions or human resources; broker or dealer, investment adviser, or investment banking services; legal services and expert services unrelated to the audit; or other services determined to be impermissible by the US Public Company Accounting Oversight Board.
In addition, the Audit Committee reviews and monitors the independence and objectivity of the external auditors when it approves non-audit work to be carried out by them, taking into consideration relevant legislation, ethical guidance and the level of non-audit services relative to audit services. The approval process is rigorously applied to prevent the auditors from functioning in the role of management, auditing their own work, or serving in an advocacy role. Information on the audit and nonaudit services carried out by the external auditors is detailed in Note 5 to the Group’s accounts.
In January 2011 the Audit Committee undertook an internal evaluation of Group Internal Audit. The Committee sought views from members and attendees of the Committee, the external auditor, Divisional Chief Executive Officers and Finance Directors, Divisional Risk and Audit Committee and subsidiary audit committee Chairmen. The evaluation concluded that Group Internal Audit had operated effectively throughout 2010.
Divisional Risk and Audit Committees Since 2005, Divisional Audit Committees have been responsible for reviewing each division's business. Following the creation of the Board Risk Committee in January 2010, the Group’s Divisional Audit Committees became Divisional Risk and Audit Committees and their terms of reference were revised to ensure full alignment with the Audit Committee and Board Risk Committee. With input from the Audit Committee, Board Risk Committee, Group Finance and Group Risk, a new framework was approved by the Audit Committee and Board Risk Committee in December 2010 and implemented in January 2011.
Membership I have been Chairman of the Board Risk Committee since its formation in January 2010, and I am a member of the Committee along with Colin Buchan, Sandy Crombie, Brendan Nelson and Joe MacHale. We all served throughout 2010 with the exception of Brendan Nelson who became a member of the Committee with effect from 1 April 2010. All members of the Board Risk Committee are independent non-executive directors. Attendance of each member at meetings of the Board Risk Committee in 2010 is shown on page 238.
The Board Risk Committee is responsible for: providing oversight and advice to the Group, The Royal Bank of Scotland plc and National Westminster Bank Plc Boards (the “Boards”) in relation to current and potential future risk exposures of the Group and risk strategy, including determination of risk appetite and tolerance; reviewing the performance of the Group relative to risk appetite; assisting on such other matters as may be referred to it by the Boards; oversight of the effectiveness of key Group policies, referred to as the Group Policy Framework; promoting a risk awareness culture within the Group; and reporting to the Group Board, identifying any matters within its remit in respect of which it considers that action or improvement is needed and making recommendations as to the steps to be taken.
The terms of reference of the Board Risk Committee are available at www.rbs.com and these are considered annually by the Board Risk Committee and approved by the Board.
Qualitative and quantitative information regarding the risks arising from the Group's financial instruments required under International Financial Reporting Standard 7 are incorporated within the financial statements and Business review.
The Board Risk Committee took part in an annual programme of visits to the Group's business divisions and control functions in 2010, along with the Audit Committee. The object of the programme is to allow the Board Risk Committee and the Audit Committee to gain a better understanding of the Group and an invitation to attend is extended to all non-executive directors. The programme of future visits is considered annually. The Board Risk Committee and the Audit Committee undertook six visits in 2010. These were to the Global Banking & Markets business; the NonCore Division, Global Restructuring Group and the Asset Protection Scheme; Major Change Projects ongoing in the Group; the US Assetbacked Securities business; Risk Management and the Global Banking & Markets, Global Transaction Services and Private Banking businesses in Asia.
The Board Risk Committee played a key oversight role in the review, design and implementation of risk management and measurement strategies and risk management policy across the Group.
In February 2010, the Committee was presented with and approved the RBS Risk Management operational plan, considering the adequacy and effectiveness of resource and the scope and nature of the work undertaken by the function.
The Committee reviewed the risk input to divisional bonus pools and provided advice to the Remuneration Committee on risk weightings to be applied to performance objectives which are incorporated within the incentive structure for the Group's senior executives. The Committee also reviewed clawback proposals made by Group Human Resources and made recommendations to the Remuneration Committee in this respect.
The evaluation concluded that the Board Risk Committee operated effectively throughout 2010. The Committee was seen as effective in meeting its objectives, although it was acknowledged that this was a relatively new Committee having only been formed in January 2010. The evaluation concluded that the commitment of its members was outstanding, with members willing to spend the time necessary to discharge the Committee's responsibilities. As a new Committee, the structure, content and length of Committee meetings was considered to be appropriate. It was acknowledged that the Committee makes the best use of skills, experience and competencies of its members and a high level of technical expertise was required of members.
The Committee 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 action. The outcomes of the evaluation have been reported to the Board and the actions are being progressed.
During the year, the Remuneration Committee has built on the progress made during 2009 when significant changes were made to the structure of rewards to staff following a thorough review of remuneration policy. We have continued to embed these practices throughout the organisation to ensure that they are aligned with good corporate governance and robust risk management.
Our focus is to ensure that our remuneration policy continues to support delivery of the Group’s Strategic Plan. We are working hard to complete a hugely challenging and complex turnaround and are on track to deliver across a range of measures. The Group plays an important economic role, both as an employer and a lender. If we are going to achieve our strategic objectives and deliver a return to our shareholders including the UK taxpayer, we need talented and motivated management and employees. This requires us to pay them fairly within the context of the markets in which they operate. In setting pay policy, we take account of our duties to shareholders and our strategic objectives and seek to ensure that shareholder interests are not damaged as a result of staff retention, recruitment or motivation issues. Our commitment is to reward success not failure, and we are also very conscious of the need to demonstrate restraint.
Performance management We operate a structured process to ensure that all employees have clear objectives that are linked to long-term plans designed to drive business objectives including financial performance, risk, people and customer measures. Assessment of individuals’ performance is subject to a rigorous review of achievements against their objectives.
Deferral The Remuneration Committee is acutely aware of the external focus on the role of incentive payments in the financial sector. The reality is that these remain a key part of the structure of pay across the industry. However, we have radically reformed our incentive plans. For our more senior employees annual awards are deferred over three years and a portion of the awards are paid in shares which increases alignment with the interests of shareholders. There will be a £2,000 cap on cash bonuses paid in March 2011, as was the case last year.
Clawback We have had clawback provisions in place since 2009, which means that, in certain circumstances, the Group can reduce deferred annual incentives and long-term incentive awards up to the point they are released. Clawback allows us to respond appropriately if the performance factors on which reward decisions were based turn out not to reflect the corresponding performance in the longer term.
Shareholder consultation In early 2011, we consulted extensively with institutional shareholders and other stakeholders on our remuneration approach. The consultation process involved one to one meetings and a roundtable session hosted by the Association of British Insurers and National Association of Pension Funds. Our presentation covered our wider remuneration policy as well as executive directors’ remuneration and we have been pleased with both the level of engagement with investors and the positive feedback we have received.
Topics discussed with investors included pay positioning, scale and design of incentive structures, risk alignment of remuneration, deferral, clawback and remuneration disclosures. We have listened to the feedback from investors and have made a number of enhancements to disclosures in the Remuneration Report as a result.
Investors recognised the difficult challenge faced by the Remuneration Committee in positioning pay competitively to support business goals, while being mindful of the wider economic environment and the need to show restraint. The Remuneration Committee and the Board have considered carefully their responsibilities and have applied judgement to achieve a balance whereby remuneration policy supports business goals without causing unacceptably high people risks.
The new LTIP received the approval of over 99% of shareholders at the Annual General Meeting in 2010, and at the same meeting the Remuneration Report received overwhelming shareholder support.
The Remuneration Committee supports the UK Government’s position that an international approach is required in relation to regulation on remuneration and disclosure. To rebuild the value of the company, an international level playing field that allows the Group and other UK banks to compete fairly with international competitors is essential.
On 9 February 2011, the UK Government issued a statement in connection with Project Merlin, which represents commitments by the UK’s four largest banks, including the RBS Group, on matters including lending, shareholder engagement and pay disclosures. The banks have agreed that aggregate UK bonus pools will be lower than last year reflecting consideration of the public mood and engagement with key stakeholders. Furthermore, as a result of the Project Merlin agreement, we are disclosing in this year’s Remuneration Report the pay of our two executive directors and the pay of the five highest paid senior executive officers. The Remuneration Committee has also reviewed the remuneration of the ten highest paid staff in each of the Group’s divisions.
On behalf of the Remuneration Committee I would like to place on record our sincere appreciation for our people who have continued to focus on service to our customers, managing risk and driving the performance of our core and non-core businesses. Our people are working hard to help return the Group to financial strength and the Remuneration Committee is committed to creating an environment in which they can meet their ambitions.
Responsibilities The Remuneration Committee is responsible for setting the Group’s policy on remuneration and overseeing its implementation, considering executive remuneration and making recommendations to the Group Board in respect of the remuneration arrangements of the executive directors of the Group. No director is included in decisions regarding his or her own remuneration.
In determining directors’ remuneration, the Remuneration Committee has taken into account pay and employment conditions of employees of the company. It does this using an analysis of annual market data against an assessment of the competitiveness of current base salary ranges or benchmarks and actual salaries in payment. Salary increases for executive directors are also considered in the context of salary increases for the wider employee population.
The Remuneration Committee considers remuneration in the context of the wider Group agenda such as talent development and the external market environment. The Remuneration Committee recognises that remuneration is only one aspect of the value proposition which the Group presents to our employees, and that engagement, flexibility and career development are important factors. It has received in-depth presentations from Human Resources functions in the USA and Asia so as to have a better understanding of the unique issues in these areas. Penny Hughes has also attended a number of external meetings and workshops with organisations such as Women in Business and the Young Bankers’ Association to gain a broader understanding of the people agenda.
The Remuneration Committee also receives regular updates on regulatory developments and general remuneration issues, as well as market and benchmarking data from its remuneration advisors to support its decisions.
The Remuneration Committee considers recommendations and reviews reports from the APSPRC and is responsible for determining the remuneration of APS In-Scope employees.
Remuneration advisors On 14 September 2010, the Remuneration Committee appointed PricewaterhouseCoopers LLP (“PwC”) as its remuneration advisors, replacing Towers Watson. PwC were appointed after a formal selection process of panel interviews following the submission of detailed written proposals by a number of remuneration advisors. One aspect taken into account as part of the selection process was that the remuneration advisors be signatories to the voluntary code of conduct in relation to executive remuneration consulting in the UK. Both PwC and Towers Watson are signatories to the code of conduct and the relationship between the Remuneration Committee and both companies takes account of this.
PwC also provides professional services in the ordinary course of business including assurance, advisory, tax and legal to subsidiaries of the Group. Towers Watson also provides actuarial advice to subsidiaries of the Group and investment consulting and actuarial advice to the trustees of some of the Group's pension funds. The advisors to the Remuneration Committee are appointed independently by the Committee, which reviews its selection of advisers annually. The Committee is notified of any work that is being undertaken by its advisors and is satisfied that there are processes in place to ensure that the advice it receives is independent.
Performance evaluation An internal review of the effectiveness of the Remuneration Committee during 2010 was conducted. The evaluation used detailed questionnaires and individual meetings were held with each member. Amongst the areas reviewed were the role of the Committee, composition, meetings and processes, continuing professional development and communication.
Market facing Reward structures are designed to offer value for money in the markets where the Group operates. Both annual compensation and total compensation are set around market median competitiveness although our pay-for-performance policy allows for higher pay for the highest performers.
Governance There is a robust governance framework in place to ensure that reward design and delivery complies with appropriate policy, standards, and meets relevant regulatory requirements.
The Remuneration Committee undertakes an annual review of the adequacy and effectiveness of the remuneration policy to ensure it is fully aligned with the Group’s long-term objectives. There is also a key role for the RBS Risk Management function in the management and oversight of reward structures and decision-making. The Remuneration Committee will consider any issues raised by the Board Risk Committee prior to approving the policy.
Annual incentives Annual incentives are designed to reward good financial and nonfinancial performance that supports the business strategy, taking into account the Group’s risk appetite and personal contribution in the context that it was delivered.
Performance is central to the determination of annual incentive pools. Performance assessment is based on a balanced scorecard of measures including financial performance, risk, people and customer measures.
Long-Term Incentive Plans To encourage the creation of value over the long term and to align the rewards of the participants with the returns to shareholders, the Group provides employees in senior roles (executive level and selected senior management) the opportunity to receive annual awards of longterm incentives.
A new Long-Term Incentive Plan was approved by shareholders on 28 April 2010, under which awards are structured as performance-vesting shares. For the most senior roles, vesting will be based partly on divisional or functional performance and partly on performance across the Group.
Awards will not vest unless the Remuneration Committee is satisfied that risk management during the performance period has been effective at a Group and division/functional level. The Remuneration Committee's determination will be informed by input from the Group Chief Risk Officer and the Board Risk Committee. Specifically, prior to vesting, the Remuneration Committee will have regard to risk and compliance across the Group and divisions and make an assessment of future risks as appropriate.
Pension arrangements The Group aims to provide competitive retirement benefits. Since October 2006, UK employees have been eligible for a cash allowance in lieu of pension provision and have had the facility to choose to have part of their remuneration in the form of contributions to The Royal Bank of Scotland Group Retirement Savings Plan. A little over one half of UK employees continue to participate in defined benefit pension arrangements.
Salary Base salaries of executive directors are reviewed annually. It has been agreed that the Group Chief Executive will receive no increase in base salary in 2011. The annual salary for the Group Finance Director will be increased from £725,000 to £750,000 with effect from 1 April 2011.
Details of pension arrangements of directors are shown on page 262. Gordon Pell retired from the Group and the Board on 31 March 2010, shortly after his normal pension age of 60. Details of his pension are shown in this report. Following Gordon Pell's retirement, no current director is a member of the Group's defined benefit pension plans.
For all executive directors joining on or after 1 October 2006, pension provision is in the form of a pension allowance which may be used to participate in The Royal Bank of Scotland Group Retirement Savings Plan which is open to all employees, or to invest in alternative pension arrangements, or to take all or some of the allowance in cash. In addition, as employees, executive directors are eligible to participate in Sharesave and Buy As You Earn plans. These plans are not subject to performance conditions since they are operated on an all-employee basis. Executive directors also receive death-in-service cover.
The 2010 targets covered progress against the Strategic Plan, financial performance, risk efficiency and control measures as well as stakeholder and people management. Executive directors have a normal maximum incentive opportunity of 200% of salary (with an exceptional maximum of 250% of salary).
For 2010 performance, the executive directors’ annual incentive will be delivered entirely as an allocation into Share Bank. The allocated shares will vest in two equal tranches in March 2012 and 2013, and must then be held for a further six months. The Group Chief Executive has voluntarily agreed to a total holding period of twelve months after vesting. Clawback provisions will again apply prior to vesting of the shares.
The maximum potential allocation of shares in respect of the 2011 financial year under Share Bank will be 6.0 million shares for the Group Chief Executive and 3.75 million shares for the Group Finance Director. These allocations were agreed, following consultation with shareholders at the beginning of 2011. The potential allocations represent normal maximum annual incentive levels for executive directors based on the share price prevailing at the start of the consultation period and will be assessed for final allocation in 2012 on that basis. Depending on share price movement during the performance period, the value of the final allocation could further increase or decrease.
Between 0% and 100% of the maximum potential allocation will be formally allocated into Share Bank in March 2012 based on 2011 performance across five performance categories: strategic direction; business delivery and financial performance; stakeholders (including delivery against UK government lending commitments); risk and control; and capability and development. Fixing the number of shares in this way avoids unintended consequences arising from share price volatility around award dates and provides a clear alignment with shareholder interests through the year.
Share awards made as part of Share Bank will be delivered under the rules of the Deferral Plan approved by shareholders in 2009.
An illustration of Share Bank for the 2011 performance year is set out below: To comply with the FSA Code, shares will be subject to a holding period of six months after vesting.
Performance conditions attaching to awards made to executive directors under the LTIP in 2010 are shown on page 259.
There is an underpin to the performance conditions whereby awards will only vest if the Committee is satisfied that risk management during the performance period has been effective and that financial and nonfinancial performance has been satisfactory, in line with the Strategic Plan. In assessing this, the Committee will be advised independently by the Board Risk Committee.
To receive any of the LTIP awards subject to this performance measure the Group’s performance must be at least as good as the median of the comparator companies, with vesting as follows: 20% of the award will vest if the Group’s TSR is at the median of the companies in the comparator group.
A pro-rata proportion of the award will vest in between these points.
Core bank Economic Profit (applying to 25% of overall 2011 LTIP award in total) At the end of the performance period for these awards, the value of the Group will be determined by the Core bank’s ability to generate enduring returns for shareholders. For this reason for the 2011 LTIP awards the Economic Profit measure is focused on the Core bank. The focus on Core bank Economic Profit ensures that performance reflects enduring earnings for the bank, while the Balance Sheet & Risk targets capture performance of Non-Core.
Economic Profit, being a risk-adjusted financial measure, is consistent with the FSA Code, and also provides a balance between measuring growth and the cost of capital employed in delivering that growth.
Core bank Economic Profit is defined as return attributable to shareholders less equity multiplied by the cost of equity: return attributable to shareholders is Core Operating Profit reported in the financial statements, excluding fair value of own debt and APS, taxed at a standard tax rate of 28%.
Due to the commercially sensitive nature of these targets details of the actual targets, and performance against these, will be disclosed retrospectively once the award vests.
To ensure that the Group is positioned to deliver sustainable value for shareholders beyond the initial turnaround timeframe, 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 our employees.
For the first of these awards, the Remuneration Committee will assess and judge performance against the measures set out below.
Where possible, quantitative strategic measures will be used. However, it is also important to the Group to focus on qualitative measures which consider issues such as reputation, customer excellence, organisational capability and sustainability given these will support the long term goals of the business.
Non-executive directors The level of remuneration for non-executive directors reflects their responsibility and time commitment and the level of fees paid to nonexecutive directors of comparable major UK companies. Non-executive directors do not participate in any incentive or performance plan. Nonexecutive director fees are reviewed regularly. Fees paid to nonexecutive directors for the year ended 31 December 2010 are set out on page 258.
Royal Bank of Scotland FTSE 100 FTSE Banks Source : Thomson Reuters Datastream
The charts above show the composition of remuneration opportunity for on-target annual performance, and with the long term incentive awards shown at the expected value. Short term incentive payments earned in relation to 2011 performance will be deferred and will vest, subject to satisfactory performance. The actual value of the long term incentive awards will depend on performance over the period 2011 to 2013 and the share price at the time the awards vest.
Any compensation payment made in connection with the departure of an executive director will be subject to approval by the Remuneration Committee, having regard to the terms of the service contract and the reasons for termination.
No compensation was paid to Gordon Pell on his retirement from employment of the Group on 31 March 2010. Details of his pension are shown on page 262.
Executive directors Stephen Hester 4 November 2008 12 months 12 months Bruce Van Saun 8 September 2009 12 months 12 months
Former executive director Gordon Pell Contract expired 12 months 6 months
Except as noted below, in the event of severance where any contractual notice period is not worked, the employing company may pay a sum to the executive in lieu of the notice period. In the event of situations involving breach of the employing company's policies resulting in dismissal, reduced or no payments may be made to the executive. Depending on the circumstances of the termination of employment, the executive may be entitled, or the Remuneration Committee may allow, outstanding awards under long-term incentive arrangements to vest, subject to the rules of the relevant plan.
In the event that Stephen Hester's employment is terminated by the company (other than by reason of his personal underperformance), the following will apply. First, he will be entitled to receive a payment in lieu of notice to the value of base salary, bonus and benefits (including pension contributions). Secondly, any share awards granted to him to replace bonus and share awards he forfeited on leaving The British Land Company PLC will vest immediately on such termination. If he resigns voluntarily and the company does not require him to work out his notice period, Stephen Hester may receive a payment in lieu of notice based on salary only (i.e. no bonus or benefits). In both cases the treatment of any other unvested stock awards will be determined at the discretion of the Remuneration Committee.
Bruce Van Saun In the event that Bruce Van Saun's employment is terminated by reason of his personal underperformance, the company is entitled to terminate by giving written notice with immediate effect and without making any payment in lieu of notice. Any payment in lieu of notice that may be made to Bruce Van Saun would be based on salary only (i.e. no bonus or benefits).
Chairman and non-executive directors Under the Articles of Association of the company, directors must stand for re-election by shareholders at least once every three years. However, in accordance with the provisions of the UK Corporate Governance Code, all directors of the company will stand for re-election by shareholders at the company’s 2011 Annual General Meeting and annually thereafter. The original dates of appointment as directors of the company for the Chairman and non-executive directors’ and the dates for next re-election are as follows: Date first appointed Date for election or next re-election
Philip Hampton is entitled to receive a cash payment in lieu of notice if his appointment is terminated as a result of the Group's majority shareholder seeking to effect the termination of his appointment. The applicable notice period is twelve months. In the event that the company terminates Philip Hampton's appointment without good reason, or his re-election is not approved by shareholders in General Meeting resulting in the termination of his appointment, he will be entitled to receive a cash payment in lieu of notice of twelve months' fees.
The tables and explanatory notes on pages 258 to 262 report the remuneration of each director for the year ended 31 December 2010 and have been audited by the company's auditors, Deloitte LLP.
Former executive director Gordon Pell (5) 233 — 1 234 933
Notes: (1) Remuneration for 2009 reflects Philip Hampton’s appointment as Deputy Chairman and Chairman-designate on 19 January 2009 and his appointment as Chairman on 3 February 2009. (2) Further information on pension arrangements for Stephen Hester and Bruce Van Saun can be found on page 262. (3) Remuneration for 2009 reflects Bruce Van Saun’s appointment to the Board on 1 October 2009. (4) Benefits include costs for Bruce Van Saun’s relocation to the UK during 2010. (5) Retired with effect from 31 March 2010.
Gordon Pell is currently Deputy Chairman of Coutts & Co and a nonexecutive director of RBS Coutts Bank Limited. He receives a combined annual fee of £100,000 in respect of these roles.
Long-Term Incentive Plan (LTIP) The LTIP was approved by shareholders in April 2010. It replaced both the ESOP and the MPP. Details of awards made in prior years under the ESOP and MPP are shown on pages 260 and 261. Employees in senior roles (executive level and selected senior management) are eligible to receive annual awards of long-term incentives. The awards will be structured as performance-vesting deferred shares.
No variation was made to any of the terms of the plan during the year.
Absolute TSR The absolute TSR measure is based on the achievement of share price targets by the end of the performance period.
Economic profit 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.
Deferred awards In 2009, the Group changed its approach to paying bonuses. Annual awards are now deferred over three years and a portion of the awards will be paid in shares. For executive directors, the entire award is delivered in the form of shares. These steps help to ensure that the interests of those receiving awards are aligned with those of our shareholders. Below are details of deferred awards granted to executive directors during the year ended 31 December 2010. Awards are structured as conditional rights to receive shares and are subject to clawback.
Share options The Executive Share Option Plan (ESOP) was approved by shareholders in April 2007. No further awards will be made under the ESOP.
Notes: (1) Options held at 31 March 2010 when Gordon Pell ceased to be a director. (2) This award was subject to performance conditions which were not achieved.
The market price of the company's ordinary shares at 31 December 2010 was 39.07p and the range during the year ended 31 December 2010 was 31.25p to 58.05p.
In the ten year period to 31 December 2010, awards made that could require new issue shares under the company's share plans represented 4.1% of the company's issued ordinary share capital (including the B share capital), leaving an available dilution headroom of 5.9%. The company meets its employee share plan obligations through a combination of new issue shares and market purchase shares.
Medium-Term Performance Plan (MPP) The MPP was approved by shareholders in April 2001. No further awards will be made under the MPP.
Stephen Hester (1) 4,800,000 0.37 4,800,000 22.06.12 Gordon Pell (2) 305,177 2.97 — lapsed Bruce Van Saun (3) 1,810,611 0.57 1,810,611 22.06.12
Notes: (1) Stephen Hester has voluntarily agreed to retain any shares that he receives for a further two years past the vesting date. (2) Awards held at 31 March 2010 when Gordon Pell ceased to be a director. This award was subject to performance conditions which were not achieved. (3) End of qualifying period 22 June 2012, however award unavailable for exercise until 8 September 2012, three years from date of award.
Disclosure of these benefits has been made in accordance with the United Kingdom Listing Authority's Listing Rules and with the Large and Medium-sized Companies and Groups (Accounts and Reports) Regulations 2008.
(2) The decrease in pension during the year is a result of the lump sum of £488,579 (plus an additional £91,075 in respect of the excess above his personal lifetime allowance) taken by Gordon Pell on retirement which offset the accrual from 31 December 2009 to 31 March 2010.
Project Merlin - disclosure commitments The Group is committed to increasing the transparency of remuneration within the financial services industry and contributing to an international level playing field on disclosure. In addition to aligning with FSA requirements on remuneration disclosure by 31 December 2011, the Group has enhanced its Directors’ Remuneration Report to include the five highest paid senior executive officers as well as maintaining disclosure levels for executive directors.
Executive A Executive B Executive C Executive D Executive E £000 £000 £000 £000 £000 £000 £000 £000 £000 £000
Variable remuneration (bond) 488 1,018 253 238 193 Variable remuneration (shares subject to retention) 490 1,020 255 240 195 Deferred remuneration (bond) 734 1,530 383 360 293 Deferred remuneration (shares subject to retention) 734 1,530 383 360 293 Variable in Executive Reward Schemes (shares) (2) 1,718 133 1,333 1,292 1,000 Total variable remuneration (3) 4,166 5,233 2,609 2,492 1,976 Total remuneration 5,945 5,933 3,359 3,242 2,626
No sign-on or severance awards have been made during 2010 to any of the above individuals.
(3) Variable remuneration reflects the amounts of variable remuneration awarded in respect of the financial year and has been split into different elements based on the deferral position applicable for each employee. Deferral arrangements are compliant with the requirements of the FSA Code.
Note: (1) Value is based on the share price at 31 December 2010, which was 39.07p. During the year ended 31 December 2010 the share price ranged from 31.25p to 58.05p.
No other director had an interest in the company's ordinary shares during the year or held a non-beneficial interest in the shares of the company at 31 December 2010, at 1 January 2010 or date of appointment if later. The interests shown above include connected persons of the directors.
As at 23 February 2011, there were no changes to the directors' interests in shares shown in the table above.
Philip Hampton Stephen Hester Bruce Van Saun Chairman Group Chief Executive Group Finance Director
Bruce Van Saun Colin Buchan Sandy Crombie Penny Hughes Joe MacHale John McFarlane Brendan Nelson Arthur ‘Art’ Ryan Philip Scott 265RBS Group 2010
We have audited the financial statements of The Royal Bank of Scotland Group plc (the "company") and its subsidiaries (together the "Group") for the year ended 31 December 2010 which comprise the accounting policies, the balance sheets as at 31 December 2010, the consolidated income statement, the consolidated statement of comprehensive income, the statements of changes in equity and the cash flow statements for the year ended 31 December 2010, the related Notes 1 to 44 and the information identified as 'audited' in the Risk and balance sheet management section of the Business review. The financial reporting framework that has been applied in their preparation is applicable law and International Financial Reporting Standards (IFRS) as adopted by the European Union and, as regards the company financial statements, as applied in accordance with the provisions of the Companies Act 2006.
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.
Profit/(loss) before other operating charges and impairment losses 13,640 15,609 (14,335)
Financial statementsConsolidated statement of comprehensive income for the year ended 31 December 2010
Assets Cash and balances at central banks 11 57,014 52,261 12,400 — — — Loans and advances to banks 11 100,518 91,753 138,197 19,535 31,238 27,031 Loans and advances to customers 11 555,260 728,393 874,722 6,689 2,777 — Debt securities subject to repurchase agreements 32 80,104 66,883 80,576 — — — Other debt securities 137,376 200,371 186,973 1,454 1,286 — Debt securities 16 217,480 267,254 267,549 1,454 1,286 — Equity shares 17 22,198 19,528 26,330 — — — Investments in Group undertakings 18 — — — 49,125 64,766 42,196 Settlement balances 11,605 12,033 17,832 — 11 — Derivatives 15 427,077 441,454 992,559 1,475 1,169 1,168 Intangible assets 19 14,448 17,847 20,049 — — — Property, plant and equipment 20 16,543 19,397 18,949 — — —
Prepayments, accrued income and other assets 21 12,576 20,985 24,402 28 43 489 Assets of disposal groups 22 12,484 18,542 1,581 — — —
Called-up share capital At 1 January 14,630 9,898 2,530 14,630 9,898 2,530 Ordinary shares issued in respect of placing and open offers — 4,227 5,728 — 4,227 5,728 Ordinary shares issued in respect of rights issue — — 1,531 — — 1,531 Ordinary shares issued in respect of capitalisation issue — — 101 — — 101 B shares issued — 510 — — 510 — Preference shares issued in respect of placing and open offer — — 5 — — 5 Ordinary shares issued 523 — 3 523 — 3 Preference shares redeemed (1) (5) — (1) (5) — Cancellation of non-voting deferred shares (27) — — (27) — — At 31 December 15,125 14,630 9,898 15,125 14,630 9,898
Merger reserve At 1 January 25,522 10,881 10,881 14,641 — — Issue of B shares, net of £399 million expenses — 24,591 — — 24,591 — Placing and open offer — — 14,273 — — 14,273 Transfer to retained earnings (12,250) (9,950) (14,273) (12,250) (9,950) (14,273)
Available-for-sale reserve At 1 January (1,755) (3,561) 1,032 — — — Unrealised gains/(losses) 179 1,202 (6,808) — — — Realised (gains)/losses (519) 981 842 — — — Tax 74 (377) 1,373 — — — Recycled to profit or loss on disposal of businesses, net of £5 million tax (16) — — — — — At 31 December (2,037) (1,755) (3,561) — — —
Cash flow hedging reserve At 1 January (252) (876) (555) (1) (4) (5) Amount recognised in equity 180 380 (603) — — — Amount transferred from equity to earnings (59) 513 198 1 3 2 Tax (67) (269) 84 — — (1) Recycled to profit or loss on disposal of businesses, net of £19 million tax 58 — — — — — At 31 December (140) (252) (876) — (1) (4)
Financial statementsStatements of changes in equity for the year ended 31 December 2010
Capital redemption reserve At 1 January 170 170 170 170 170 170 Preference shares redeemed 1 — — 1 — — Cancellation of non-voting deferred shares 27 — — 27 — — At 31 December 198 170 170 198 170 170
Contingent capital reserve At 1 January (1,208) — — (1,208) — — Contingent capital agreement - consideration payable — (1,208) — — (1,208) — At 31 December (1,208) (1,208) — (1,208) (1,208) —
- tax (11) (176) — — — — Redemption of equity preference shares (2,968) — — (2,968) — — Gain on redemption of equity preference shares 609 — — 616 — — Redemption of preference shares classified as debt (118) — — (118) — — Transfer from merger reserve 12,250 9,950 14,273 12,250 9,950 14,273 Actuarial gains/(losses) recognised in retirement benefit schemes - gross 158 (3,756) (1,807) — — —
- tax (71) 1,043 472 — — — Purchase of non-controlling interests (38) — — — — — Net cost of shares bought and used to satisfy share-based payments (13) (16) (19) — — — Share-based payments - gross 385 325 177 — — —
Own shares held At 1 January (121) (104) (61) — — — Shares purchased (700) (33) (64) — — — Shares issued under employee share schemes 13 16 21 — — — At 31 December (808) (121) (104) — — —
Statements of changes in equity for the year ended 31 December 2010 continued
Operating activities Operating loss before tax (399) (2,647) (25,691) (4,471) (1,286) (10,017) Operating loss before tax on discontinued operations (541) (49) (10,937) — — — Adjustments for: Depreciation and amortisation 2,220 2,809 3,154 — — — Write-down of goodwill and other intangible assets 10 363 32,581 — — — Write-down of investment in subsidiaries — — — 5,124 5,139 14,321 Interest on subordinated liabilities 500 1,490 2,144 462 537 499 Charge for defined benefit pension schemes 540 659 490 — — — Pension scheme curtailment gains (78) (2,148) — — — — Cash contribution to defined benefit pension schemes (832) (1,153) (810) — — — Gain on redemption of own debt (553) (3,790) — (53) (238) — Elimination of non-cash items on discontinued activities — — 592 — — — Elimination of foreign exchange differences (691) 12,217 (41,874) 272 (753) 1,778 Other non-cash items 1,455 7,940 8,772 (1) 20 (478) Net cash flows from trading activities 1,631 15,691 (31,579) 1,333 3,419 6,103 Changes in operating assets and liabilities 17,095 (15,964) (42,219) (10,238) 12,537 (22,254) Net cash flows from operating activities before tax 18,726 (273) (73,798) (8,905) 15,956 (16,151) Income taxes received/(paid) 565 (719) (1,540) (133) 409 119 Net cash flows from operating activities 35 19,291 (992) (75,338) (9,038) 16,365 (16,032)
Financing activities Issue of ordinary shares 1 — 49 1 — 49 Placing and open offers — 5,274 19,741 — 5,274 19,741 Rights issue — — 12,000 — — 12,000 Issue of B shares — 25,101 — — 12,801 — Issue of subordinated liabilities — 2,309 2,413 — — — Proceeds of non-controlling interests issued 559 9 1,427 — — — Redemption of paid-in equity (132) (308) — (132) (308) — Redemption of preference shares (2,359) (5,000) — (2,352) (5,000) — Redemption of non-controlling interests (5,282) (422) (13,579) — — — Shares purchased by employee trusts (700) (33) (64) — — — Shares issued under employee share schemes — — 2 — — — Repayment of subordinated liabilities (1,588) (5,145) (1,727) (98) (458) — Dividends paid (4,240) (1,248) (3,193) (124) (935) (2,908)
Net cash flows from financing activities (14,380) 18,791 15,102 (3,180) 10,817 28,416 Effects of exchange rate changes on cash and cash equivalents 82 (8,592) 29,209 5 (83) 761
Net increase/(decrease) in cash and cash equivalents 8,344 9,261 (14,030) (14,091) 11,379 3,496 Cash and cash equivalents at 1 January 144,186 134,925 148,955 16,448 5,069 1,573 Cash and cash equivalents at 31 December 39 152,530 144,186 134,925 2,357 16,448 5,069
The accompanying notes on pages 287 to 385, the accounting policies on pages 275 to 286 and the audited sections of the Business review: Risk and balance sheet management on pages to 119 to 224 form an integral part of these financial statements.
There are a number of other changes to IFRS that were effective from 1 January 2010. They have had no material effect on the Group’s financial statements: in April 2009, ‘Improvements to IFRS’ - making non-urgent but necessary amendments to standards, primarily to remove inconsistencies and to clarify wording; and amendments to IAS 39 ‘Financial Instruments: Recognition and Measurement’ - limited changes to IAS 39 issued in July 2008 clarified that (a) a one-sided risk can be designated as a hedged risk i.e. an option can be used to hedge a risk above or below a specified threshold and (b) inflation can be a hedged risk but only if the cash flows include a specified inflation portion.
The company accounts are presented in accordance with the Companies Act 2006.
2. Basis of consolidation The consolidated financial statements incorporate the financial statements of the company and entities (including certain special purpose entities) that are controlled by the Group. Control exists where the Group has the power to govern the financial and operating policies of the entity; generally conferred by holding a majority of voting rights. On acquisition of a subsidiary, its identifiable assets, liabilities and contingent liabilities are included in the consolidated accounts at their fair value. Any excess of the cost (the fair value of assets given, liabilities incurred or assumed and equity instruments issued by the Group plus any directly attributable costs) of an acquisition over the fair value of the net assets acquired is recognised as goodwill. The interest of minority shareholders is stated at their share of the fair value of the subsidiary's net assets.
All intra-group balances, transactions, income and expenses are eliminated on consolidation. The consolidated accounts are prepared using uniform accounting policies.
3. Revenue recognition Interest income on financial assets that are classified as loans and receivables, available-for-sale or held-to-maturity and interest expense on financial liabilities other than those at fair value through profit or loss are determined using the effective interest method. The effective interest method is a method of calculating the amortised cost of a financial asset or financial liability (or group of financial assets or liabilities) and of allocating the interest income or interest expense over the expected life of the asset or liability. The effective interest rate is the rate that exactly discounts estimated future cash flows to the instrument's initial carrying amount. Calculation of the effective interest rate takes into account fees payable or receivable that are an integral part of the instrument's yield, premiums or discounts on acquisition or issue, early redemption fees and transaction costs. All contractual terms of a financial instrument are considered when estimating future cash flows.
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; and
Depreciation is charged to profit or loss on a straight-line basis so as to write-off the depreciable amount of property, plant and equipment (including assets owned and let on operating leases) over their estimated useful lives.
The depreciable amount is the cost of an asset less its residual value. Land is not depreciated. Estimated useful lives are as follows: Freehold and long leasehold buildings 50 years Short leaseholds unexpired period of the lease Property adaptation costs 10 to 15 years Computer equipment up to 5 years Other equipment 4 to 15 years 8. Impairment of intangible assets and property, plant and equipment At each reporting date, the Group assesses whether there is any indication that its intangible assets, or property, plant and equipment are impaired. If any such indication exists, the Group estimates the recoverable amount of the asset and the impairment loss if any. Goodwill is tested for impairment annually or more frequently if events or changes in circumstances indicate that it might be impaired. If an asset does not generate cash flows that are independent from those of other assets or groups of assets, the recoverable amount is determined for the cashgenerating unit to which the asset belongs. The recoverable amount of an asset is the higher of its fair value less cost to sell and its value in use. Value in use is the present value of future cash flows from the asset or cash-generating unit discounted at a rate that reflects market interest rates adjusted for risks specific to the asset or cash-generating unit that have not been reflected in the estimation of future cash flows. If the recoverable amount of an intangible or tangible asset is less than its carrying value, an impairment loss is recognised immediately in profit or loss and the carrying value of the asset reduced by the amount of the loss. A reversal of an impairment loss on intangible assets (excluding goodwill) or property, plant and equipment is recognised as it arises provided the increased carrying value does not exceed that which it would have been had no impairment loss been recognised. Impairment losses on goodwill are not reversed.
Foreign exchange differences arising on translation are reported in income from trading activities except for differences arising on cash flow hedges and hedges of net investments in foreign operations. Nonmonetary items denominated in foreign currencies that are stated at fair value are translated into sterling at foreign exchange rates ruling at the dates the values were determined. Translation differences arising on nonmonetary items measured at fair value are recognised in profit or loss except for differences arising on available-for-sale non-monetary financial assets, for example equity shares, which are included in the available-forsale reserve in equity unless the asset is the hedged item in a fair value hedge.
11. Leases Contracts to lease assets are classified as finance leases if they transfer substantially all the risks and rewards of ownership of the asset to the customer. Other contracts to lease assets are classified as operating leases.
Rental income from operating leases is credited to the income statement on a receivable basis over the term of the lease. Operating lease assets are included within Property, plant and equipment and depreciated over their useful lives (see Accounting policy 7).
Acquisition expenses relating to new and renewed business for all classes are expensed over the period during which the premiums are earned. The principal acquisition costs so deferred are commissions payable, and costs associated with the telesales and underwriting staff. Claims and the related reinsurance are recognised in the accounting period in which the loss occurs. Provision is made for the cost of settling outstanding claims at the balance sheet date, including claims estimated to have been incurred but not yet reported at that date, and claims handling expenses. Provisions are only discounted where claims, principally motor, either have been or are expected to be settled by periodical payments. Related reinsurance receivables are recognised on the same basis and at the same time.
14. Tax Provision is made for tax at current enacted rates on taxable profits, arising in income or in equity, taking into account relief for overseas tax where appropriate. Deferred tax is accounted for in full for all temporary differences between the carrying amount of an asset or liability for accounting purposes and its carrying amount for tax purposes, except in relation to overseas earnings where remittance is controlled by the Group, and goodwill.
Designated as at fair value through profit or loss - financial assets may be designated as at fair value through profit or loss only if such designation (a) eliminates or significantly reduces a measurement or recognition inconsistency; or (b) applies to a group of financial assets, financial liabilities or both, that the Group manages and evaluates on a fair value basis; or (c) relates to an instrument that contains an embedded derivative which is not evidently closely related to the host contract.
Financial assets that the Group designates on initial recognition as being at fair value through profit or loss are recognised at fair value, with transaction costs being recognised in profit or loss, and are subsequently measured at fair value. Gains and losses on financial assets that are designated as at fair value through profit or loss are recognised in profit or loss as they arise.
Where, in the course of the orderly realisation of a loan, it is exchanged for equity shares or properties, the exchange is accounted for as the sale of the loan and the acquisition of equity securities or investment properties. Where the Group’s interest in equity shares following the exchange is such that the Group controlling an entity, that entity is consolidated.
Impaired loans and receivables are written off, i.e. the impairment provision is applied in writing down the loan's carrying value partially or in full, when the Group concludes that there is no longer any realistic prospect of recovery of part or all of the loan. For portfolios that are collectively assessed for impairment, the timing of write off principally reflects historic recovery experience for each portfolio. For loans that are individually assessed for impairment, the timing of write off is determined on a case-by-case basis. Such loans are reviewed regularly and write offs will be prompted by bankruptcy, insolvency, restructuring and similar events. Most debt is written off within five years of the recognition of the initial impairment. It is not the Group’s usual practice to write-off all or part of the asset at the time an impairment loss is recognised; it may however, take place in rare circumstances. Amounts recovered after a loan has been written off are credited to the loan impairment charge for the period in which they are received.
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 equity and there is objective evidence that the asset is impaired, the cumulative loss is removed from equity and recognised in 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.
Financial liabilities designated as at fair value through profit or loss include structured liabilities issued by the Group: designation significantly reduces the measurement inconsistency between these liabilities and the related derivatives carried at fair value; and in 2009 and 2008 investment contracts issued by the Group's life assurance businesses: fair value designation significantly reduces the measurement inconsistency that would arise if these liabilities were measured at amortised cost.
26. Cash and cash equivalents Cash and cash equivalents comprises cash and demand deposits with banks together with short-term highly liquid investments that are readily convertible to known amounts of cash and subject to insignificant risk of change in value.
Critical accounting policies and key sources of estimation uncertainty The reported results of the Group are sensitive to the accounting policies, assumptions and estimates that underlie the preparation of its financial statements. UK company law and IFRS require the directors, in preparing the Group's financial statements, to select suitable accounting policies, apply them consistently and make judgements and estimates that are reasonable and prudent. In the absence of an applicable standard or interpretation, IAS 8 ‘Accounting Policies, Changes in Accounting Estimates and Errors’, requires management to develop and apply an accounting policy that results in relevant and reliable information in the light of the requirements and guidance in IFRS dealing with similar and related issues and the IASB's ‘Framework for the Preparation and Presentation of Financial Statements’. The judgements and assumptions involved in the Group's accounting policies that are considered by the Board to be the most important to the portrayal of its financial condition are discussed below. The use of estimates, assumptions or models that differ from those adopted by the Group would affect its reported results.
Loan impairment provisions The Group's loan impairment provisions are established to recognise incurred impairment losses in its portfolio of loans classified as loans and receivables and carried at amortised cost. A loan is impaired when there is objective evidence that events since the loan was granted have affected expected cash flows from the loan. Such objective evidence, indicative that a borrower’s financial condition has deteriorated, can include for loans that are individually assessed: the non-payment of interest or principal; debt restructuring; probable bankruptcy or liquidation; significant reduction in the value of any security; breach of limits or covenants; and deteriorating trading performance and, for collectively assessed portfolios: the borrowers’ payment status and observable data about relevant macroeconomic measures.
Equity securities (held-for-trading, designated as at fair value though profit or loss and available-for-sale) - comprise equity shares of companies or corporations both listed and unlisted.
Deposits by banks and customer accounts (held-for-trading and designated as at fair value though profit or loss) - deposits measured at fair value principally include repurchase agreements (repos), cash collateral and investment contracts issued by the Group's life assurance businesses.
Accounting developments International Financial Reporting Standards The IASB issued ‘Improvements to IFRS’ in May 2010 implementing minor changes to IFRS, making non-urgent but necessary amendments to standards, primarily to remove inconsistency and to clarify wording. The revisions are effective for annual periods beginning on or after 1 July 2010 and are not expected to have a material effect on the Group or the company.
The standard is effective for annual periods beginning on or after 1 January 2013; early application is permitted.
This standard makes major changes to the framework for the classification and measurement of financial assets and will have a significant effect on the Group's financial statements. The changes relating to the classification and measurement of liabilities carried at fair value will have a less significant effect on the Group. The Group is assessing these impacts which are likely to depend on the outcome of the other phases of IASB's IAS 39 replacement project.
The IASB issued ‘Disclosures - Transfers of Financial Assets (Amendments to IFRS 7 Financial Instruments: Disclosures)’ in October 2010 to extend the standard’s disclosure requirements about derecognition to align with US GAAP. The revisions are effective for annual periods beginning on or after 1 July 2011 and will not affect the financial position or reported performance of the Group or the company.
The IASB issued an amendment to IAS 12 ‘Income Taxes’ in December 2010 to clarify that recognition of deferred tax should have regard to the expected manner of recovery or settlement of the asset or liability. The amendment and consequential withdrawal of SIC 21 ‘Deferred Tax: Recovery of Underlying Assets’, effective for annual periods beginning on or after 1 January 2012, is not expected to have a material effect on the Group or the company.
Loans and advances to customers 18,889 21,356 34,949 Loans and advances to banks 591 830 2,201 Debt securities 3,296 4,125 5,040 Interest receivable 22,776 26,311 42,190
Income/(loss) from trading activities (1) Foreign exchange 1,491 2,340 1,906 Interest rate 1,862 3,883 1,026 Credit 41 (4,147) (12,207)
Other operating income (excluding insurance net premium income) Operating lease and other rental income 1,394 1,323 1,469 Changes in the fair value of own debt attributable to own credit (3) 249 51 977 Changes in the fair value of securities and other financial assets and liabilities (180) 42 (1,266) Changes in the fair value of investment properties (405) (117) (86) Profit on sale of securities 496 162 164 Profit on sale of property, plant and equipment 50 40 177 (Loss)/profit on sale of subsidiaries and associates (107) (144) 934 Life business profits/(losses) 90 156 (52) Dividend income 69 78 276 Share of profits less losses of associated entities 70 (268) 45 Other income (4) (247) (450) (485)
Notes: (1) The analysis of trading income/(loss) is based on how the business is organised and the underlying risks managed. Trading income/(loss) comprises gains and losses on financial instruments held for trading, both realised and unrealised, interest income and dividends and the related funding costs. The types of instruments include: - Foreign exchange: spot foreign exchange contracts, currency swaps and options, emerging markets and related hedges and funding. - Interest rate: interest rate swaps, forward foreign exchange contracts, forward rate agreements, interest rate options, interest rate futures and related hedges and funding. - Credit: asset-backed securities, corporate bonds, credit derivatives and related hedges and funding. - Other: equities, commodities, equity derivatives, commodity contracts and related hedges and funding.
Write-down of goodwill and other intangible assets 10 363 16,911 18,228 17,417 35,065
Integration costs included in operating expenses comprise expenditure incurred in respect of cost reduction and revenue enhancement programmes connected with acquisitions made by the Group.
Staff costs 210 365 503 Premises and equipment 3 78 25 Other administrative expenses 143 398 486 Depreciation and amortisation 20 18 36 376 859 1,050
Restructuring costs included in operating expenses comprise: Staff costs 353 328 251 Premises and equipment 117 48 15 Other administrative expenses 104 51 41 574 427 307
Divestment costs included in operating expenses comprise: Staff costs 51 — — Premises and equipment 6 — — Other administrative expenses 25 — —
3 Operating expenses continued The average number of persons employed, rounded to the nearest hundred, in the continuing operations of the Group during the year, excluding temporary staff, was 153,400 (2009 - 166,400; 2008 - 175,400); on the same basis discontinued operations employed 6,200 employees (2009 - 28,100; 2008 - 58,300). The average number of temporary employees during 2010 was 11,600 (2009 - 9,700; 2008 - 7,000). The number of persons employed in the continuing operations of the Group at 31 December, excluding temporary staff, was as follows: Group 2010 2009 2008
Share-based payments As described in the Remuneration report on pages 248 to 263, the Group grants share-based awards to employees principally on the following bases: Award plan Eligible employees Nature of award (1) Vesting conditions (2) Issue dates
Options are exercisable within six months of vesting; 23 million were exercisable at 31 December 2010 (2009 - 26 million). The weighted average share price at the date of exercise of options was 45p (2009 - not applicable). At 31 December 2010, exercise prices ranged from 38p to 393p and the average contractual life was 3.3 years (2009 - 38p to 393p and 3.2 years). The fair value of options granted in 2010 was £48 million (2009 - £220 million).
None of the share awards vested in 2010. The awards granted in 2010 vest evenly over the following two anniversaries.
The market value of awards exercised in 2010 was £6 million (2009 - £2 million).
At 31 December 2010 a provision of £6 million had been made in respect of 16 million share awards and 3 million options over shares that may be cash-settled (2009 - £6 million in respect of 16 million share awards and 3 million options over shares).
The fair value of options granted in 2010 was determined using a pricing model that included: expected volatility of shares determined at the grant date based on historic volatility over a period of up to seven years; an expected option lives that equal the vesting period; no dividends on equity shares; and a risk-free interest rate determined from the UK gilt rates with terms matching the expected lives of the options.
4 Pension costs 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 Retirement Fund (the “Main scheme”) which accounts for 84% (2009 - 61%; 2008 - 56%) of the Group’s retirement benefit obligations.
The Group’s defined benefit schemes generally provide a pension of onesixtieth of final pensionable salary for each year of service prior to retirement up to a maximum of 40 years. Employees do not make contributions for basic pensions but may make voluntary contributions to secure additional benefits on a money-purchase basis. Since October 2006, the Main scheme has been closed to new entrants who have instead been offered membership of The Royal Bank of Scotland
The Main scheme, which represents 84% of plan assets at 31 December 2010 following the divestment during 2010 of ABN AMRO’s principal pension scheme in the Netherlands (2009 - 59%; 2008 - 57%), is invested in a diversified portfolio of quoted and private equity, government and corporate fixedinterest and index-linked bonds, and other assets including property and hedge funds. The Main scheme also employs derivative instruments, where appropriate, to achieve a desired asset class exposure or to match assets more closely to liabilities. The value of assets shown reflects the actual physical assets held by the scheme, with any derivative holdings valued on a mark-to-market basis. The return on assets on the total scheme has been based on the asset exposure created allowing for the net impact of the derivatives on the risk and return profile of the holdings.
The Main scheme’s holdings of derivative instruments are summarised in the table below: 2010 2009 2008 Fair value Fair value Fair value Notional amounts Assets Liabilities Notional amounts Assets Liabilities
Total return swaps 466 16 — — — — — — — Currency swaps (973) — 1 — — — — — —
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 2010, the gross notional value of the swaps was £12,352 million (2009 - £6,064 million; 2008 - £1,815 million) and had a net positive fair value of £236 million (2009 - £4 million positive; 2008 - £24 million negative) to the scheme.
Collateral is required on all swap transactions with those between the banks and the Main scheme on terms that do not allow the banks to rehypothecate. The banks had delivered £210 million of collateral at 31 December 2010 (2009 - held £6 million; 2008 - held £36 million).
Longevity at age 60 for current pensioners (years) Males 27.2 27.1 26.1
Statement of comprehensive income - Actuarial gains and losses 993 4,473 3,480 1,344 5,009 3,665 Contributions by employer 536 — (536) 1,153 — (1,153) Contributions by plan participants and other scheme members 2 2 — 15 15 — Benefits paid (741) (741) — (1,175) (1,175) — Expenses included in service cost (20) (20) — (22) (22) — At 1 January 2010 16,603 18,675 2,072 27,925 30,830 2,905 Currency translation and other adjustments — — — (206) (206) — Income statement
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 31 December 2010 19,110 21,092 1,982 22,816 24,999 2,183
Net assets of schemes in surplus (included in Prepayments, accrued income and other assets, Note 21) (105) (58) (36) Net liabilities of schemes in deficit 2,288 2,963 2,032 2,183 2,905 1,996
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 (2008 - £8,181 million) and present value of defined benefit obligations of £8,298 million (2008 - £8,589 million). The principal actuarial assumptions at 31 December 2009 were: discount rate 5.25% (2008 - 5.4%); expected return on plan assets (weighted average) 5.25% (2008 - 5.25%); rate of increase in salaries 2.5% (2008 - 2.5%); rate of increase in pensions in payment 2.0% (2008 - 2.0%); and inflation assumption 2.0% (2008 - 2.0%).
History of defined benefit schemes 2010 £m 2008 £m £m 2006 £m £m 2007 £m £m
4 Pension costs continued The table below sets out the sensitivities of the pension cost for the year and the present value of defined benefit obligations at 31 December to a change in the principal actuarial assumptions: Main scheme All schemes Increase/(decrease) Increase/(decrease)
Total other services 9.8 8.9 Fees payable to the auditor and its associates in respect of audits of pension schemes 0.2 0.4
Notes: (1) The prior year fees include £21.9 million in respect of the audit of ABN AMRO Holdings N.V., of which £8.8 million related to the interests of the State of the Netherlands and Santander. (2) Includes fees of £1.2 million (2009 - £1.7 million) in relation to reviews of interim financial information and £2.0 million (2009 - £1.6 million) in respect of reports to the Group's regulators in the UK and overseas. (3) Includes fees of £0.5 million (2009 - £2.1 million) in respect of work performed by the auditors as reporting accountants on debt and equity issuances undertaken by the Group, including securitisations. (4) Includes fees of £2.9 million (2009 - nil) in respect of audit and assurance of financial information in connection with disposals by the Group.
Non-taxable items - gain on sale of Global Merchant Services 221 — — - gain on redemption of own debt 11 693 —
Paid-in equity holders Interest on securities classified as equity, net of tax 19 57 60 Total 124 935 596
8 Ordinary dividends The company did not pay an ordinary dividend in 2010 or 2009. In 2008, the company paid a final dividend, in respect of 2007, of 19.3p per ordinary share (restated for the effect of the rights issue in June 2008 and the capitalisation issue in September 2008) amounting to £2,312 million.
9 Profit dealt with in the accounts of the company As permitted by section 408(3) of the Companies Act 2006, the primary financial statements of the company do not include an income statement or statement of comprehensive income. Condensed information is set out below: Income statement 2010 £m £m £m
Loss attributable to: Preference shareholders 105 878 536 Paid-in equity holders 19 57 60 Ordinary and B shareholders (4,678) (2,438) (10,198)
10 Earnings per ordinary and B share Earnings per ordinary and B share have been calculated based on the following: Group £m
The number of shares in issue in 2008 was adjusted retrospectively for the bonus element of the rights issue completed in June 2008 and the capitalisation issue in September 2008. None of the convertible securities had a dilutive effect in 2010, 2009 or 2008.
11 Financial instruments - classification The following tables analyse the Group’s financial assets and liabilities in accordance with the categories of financial instruments in IAS 39. Assets and liabilities outside the scope of IAS 39 are shown separately. Group
Settlement balances — — 10,413 10,413 Short positions 40,463 — 40,463
Assets Cash and balances at central banks — — — 12,400 12,400 Loans and advances to banks - reverse repos 26,056 — — 32,715 58,771
Intangible assets 20,049 20,049 Property, plant and equipment 18,949 18,949 Deferred tax 7,082 7,082 Prepayments, accrued income and other assets — — — 1,326 23,076 24,402 Assets of disposal groups 1,581 1,581
Accruals, deferred income and other liabilities 260 — 1,619 22 29,581 31,482 Retirement benefit liabilities 2,032 2,032 Deferred tax 4,165 4,165 Insurance liabilities 9,976 9,976
Gains/(losses) on financial assets/liabilities designated as at fair value through profit or loss 279 1,441 (901) Gains/(losses) on disposal or settlement of loans and receivables 267 (573) 4
Notes: (1) Includes items in the course of collection from other banks of £1,958 million (2009 - £2,533 million; 2008 - £2,888 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 £20 million charge for the year and cumulatively a credit of £82 million (2009 - release £157 million; cumulative £140 million credit; 2008 - £328 million charge; cumulative £440 million credit). (3) Includes items in the course of transmission to other banks of £577 million (2009 - £770 million; 2008 - £542 million). (4) The carrying amount of other customer accounts designated as at fair value through profit or loss is £233 million lower (2009 - £101 million lower; 2008 - £47 million lower) than the principal amount.
(5) Comprises bonds and medium term notes of £154,282 million (2009 - £164,900 million; 2008 - £156,841 million) and certificates of deposit and other commercial paper of £64,090 million (2009 - £102,668 million; 2008 - £143,448 million).
liabilities Total 2010 £m £m £m £m £m £m Assets Loans and advances to banks (1) — 19,535 19,535 Loans and advances to customers (2) — 6,689 6,689 Debt securities (2) — 1,454 1,454 Investments in Group undertakings 49,125 49,125 Derivatives (2) 1,223 252 1,475 Deferred tax 2 2 Prepayments, accrued income and other assets — — 28 28 1,223 252 27,678 — 49,155 78,308
Assets Loans and advances to banks (1) — 27,031 27,031 Investments in Group undertakings 42,196 42,196
Deferred tax 3 3 Prepayments, accrued income and other assets — — 489 489
11 Financial instruments - classification continued The following table provides information for reclassifications made in 2009.
12 Financial instruments - valuation Valuation of financial instruments carried at fair value Control environment The Group's control environment for the determination of the fair value of financial instruments includes formalised protocols for the review and validation of fair values independent of the businesses entering into the transactions. There are specific controls to ensure consistent pricing policies and procedures, incorporating disciplined price verification. The Group ensures that appropriate attention is given to bespoke transactions, structured products, illiquid products and other instruments which are difficult to price.
IPV is performed at a frequency to match the availability of independent data. For liquid instruments IPV is performed 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. 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.
Valuation issues, adjustments and reserves are reported to the GBM, Non-Core and Group Audit Committees. Key judgmental issues are described in reports submitted to these Audit Committees.
During 2010, the Group made a significant and ongoing investment into enhancing its already robust control environment. This included a new global IPV and reserving tool, which partly automates the process of carrying out IPV and consolidation of reserves into a single central portal.
Valuation techniques The Group derives fair value of its instruments differently depending on whether the instrument is a non-modelled or modelled product.
Modelled products Modelled products are those that are valued using a pricing model, ranging in complexity from comparatively vanilla products such as interest rate swaps and options (e.g. interest rate caps and floors) through to more complex derivatives. The valuation of modelled products requires an appropriate model and inputs into this model. Sometimes models are also used to derive inputs (e.g. to construct volatility surfaces). The Group uses a number of modelling methodologies.
Commodity prices - many commodities are actively traded in spot and forward contracts and futures on exchanges in London, New York and other commercial centres.
Price volatilities and correlations - volatility is a measure of the tendency of a price to change with time. Correlation measures the degree to which two or more prices or other variables are observed to move together. If they move in the same direction there is positive correlation; if they move in opposite directions there is negative correlation. Volatility is a key input in valuing options and the valuation of certain products such as derivatives with more than one underlying variable that are correlation-dependent. Volatility and correlation values are obtained from broker quotations, pricing services or derived from option prices.
Recovery rates/loss given default - these are used as an input to valuation models and reserves for asset-backed-securities and other credit products as an indicator of severity of losses on default. Recovery rates are primarily sourced from market data providers or inferred from observable credit spreads.
The Group may use consensus prices for the source of independent pricing for some assets. The consensus service encompasses the equity, interest rate, currency, commodity, credit, property, fund and bond markets, providing comprehensive matrices of vanilla prices and a wide selection of exotic products. GBM and Non-Core contribute to consensus pricing services where there is a significant interest either from a positional point of view or to test models for future business use. Data sourced from consensus pricing services is used for a combination of control processes including direct price testing, evidence of observability and model testing. In practice this means that the Group submits prices for all material positions for which a service is available.
Credit valuation adjustments (CVA) Credit valuation adjustments represent an estimate of the adjustment to fair value that a market participant would make to incorporate the credit risk inherent in counterparty derivative exposures. The Group makes such credit adjustments to derivative exposures it has to counterparties, as well as debit valuation adjustments to liabilities issued by the Group. CVA is discussed in Risk and balance sheet management - Other risk exposures - Credit valuation adjustments (pages 211 to 215).
Bid-offer and liquidity reserves Fair value positions are adjusted to bid (for assets) or offer (for liabilities) levels, by marking individual cash based positions directly to bid or offer or by taking bid-offer reserves calculated on a portfolio basis for derivatives.
The bid-offer approach is based on current market spreads and standard market bucketing of risk. Risk data is used as the primary source of information within bid-offer calculations and is aggregated when it is more granular than market standard buckets.
Vanilla risk on exotic products is typically reserved as part of the overall portfolio based calculation e.g. delta and vega risk is included within the delta and vega bid-offer calculations. Aggregation of risk arising from different models is in line with the Group's risk management practices; the model review control process considers the appropriateness of model selection in this respect.
Product related risks such as correlation risk attract specific bid-offer reserves. Additional reserves are provided for exotic products to ensure overall reserves match market close-out costs. These market close-out costs inherently incorporate risk decay and cross-effects which are unlikely to be adequately reflected in static hedges based on vanilla instruments.
Derivative discounting The market convention for some derivative products has moved to pricing collateralised derivatives using the overnight indexed swap (OIS) curve, which reflects the interest rate typically paid on cash collateral. In order to reflect observed market practice the Group’s valuation approach for the substantial portion of its collateralised derivatives was amended to use OIS. Previously the Group had discounted these collateralised derivatives based on LIBOR. The rate for discounting uncollateralised derivatives was also changed in line with observable market pricing. This change resulted in a net increase in income from trading activities of £127 million for 2010.
Own credit The Group takes into account the effect of its own credit standing when valuing financial liabilities recorded at fair value in accordance with IFRS. The categories of financial liabilities on which own credit spread adjustments are made are issued debt held at fair value, including issued structured notes and derivatives. An own credit adjustment is applied to positions where it is believed that counterparties would consider the Group's creditworthiness when pricing trades.
Debt securities Government 110.2 13.7 — 123.9 130.1 16.7 — 146.8 68.7 37.2 — 105.9 MBS — 49.5 0.7 50.2 — 61.2 0.6 61.8 — 75.6 1.1 76.7 CDOs — 1.0 2.4 3.4 — 2.6 1.0 3.6 — 6.9 1.7 8.6 CLOs — 3.6 2.1 5.7 — 8.0 0.8 8.8 — 7.7 1.0 8.7 Other ABS — 4.0 1.4 5.4 — 5.2 0.9 6.1 — 6.6 1.5 8.1 Corporate — 7.7 0.9 8.6 — 10.8 0.6 11.4 0.9 15.8 1.3 18.0 Banks and building societies 0.1 12.2 0.7 13.0 0.2 17.5 0.2 17.9 4.0 20.0 0.3 24.3 Other — 0.2 — 0.2 — 1.0 — 1.0 0.1 4.2 — 4.3
Of which: Core 52.8 49.2 1.0 103.0 Non-Core 0.6 5.8 3.7 10.1
£bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn £bn Liabilities Deposits by banks Repos — 20.6 — 20.6 — 21.0 — 21.0 — 43.1 — 43.1 Collateral — 26.6 — 26.6 — 28.2 — 28.2 — 33.2 — 33.2 Other — 1.6 — 1.6 — 4.4 — 4.4 — 4.8 — 4.8
— 72.1 0.1 72.2 — 61.3 0.1 61.4 — 63.7 0.3 64.0 Debt securities in issue — 49.0 2.2 51.2 — 43.2 2.3 45.5 — 47.0 4.4 51.4 Short positions 35.0 7.3 0.8 43.1 27.1 13.2 0.2 40.5 36.0 6.5 — 42.5 Derivatives Foreign exchange 0.1 89.3 — 89.4 — 63.9 — 63.9 2.2 171.2 — 173.4 Interest rate 0.2 298.0 1.0 299.2 0.1 310.5 0.8 311.4 0.4 639.7 0.9 641.0 Credit — 25.0 0.3 25.3 — 38.1 1.0 39.1 0.1 130.0 2.6 132.7 Equities and commodities 0.1 9.6 0.4 10.1 1.0 8.5 0.2 9.7 0.9 22.9 0.5 24.3
Of which: Core 35.4 586.9 3.8 626.1 Non-Core — 13.3 1.0 14.3 35.4 600.2 4.8 640.4
12 Financial instruments - valuation continued The table below analyses level 3 balances and related valuation sensitivities.
Of which AFS debt securities: MBS 0.4 10 — 0.2 — — CDOs 1.4 100 (10) 0.4 40 (20) CLOs 1.5 110 (10) 0.1 10 (10) Other ABS 1.1 80 (40) 0.6 40 (20)
4.4 300 (60) 1.3 90 (50) Equity shares 0.3 60 (60) 0.7 100 (90) Total AFS assets 4.7 360 (120) 2.0 190 (140)
Balance Favourable Unfavourable Balance Favourable Unfavourable £bn £m £m £bn £m £m Assumptions
Liabilities Customer accounts - other 0.1 60 (60) 0.1 — (10) Credit spreads, correlation Debt securities in issue 2.2 90 (110) 2.3 50 (10) Volatility, correlation Short positions 0.8 20 (50) 0.2 10 (20) Credit spreads, correlation Derivatives Foreign exchange — — (10) — — — Interest rate 1.0 70 (90) 0.8 40 (60) Volatility, correlation Credit - other 0.3 40 (40) 1.0 80 (100) Counterparty credit risk, correlation, volatility Equity and commodities 0.4 10 — 0.2 20 (70) Correlation, dividends
Notes: (1) Level 1: valued using unadjusted quoted prices in active markets, for identical financial instruments. Examples include G10 government securities, listed equity shares, certain exchange-traded derivatives and certain US agency securities.
Level 3: instruments in this category have been valued using a valuation technique where at least one input which could have a significant effect on the instrument’s valuation, is not based on observable market data. Where inputs can be observed from market data without undue cost and effort, the observed input is used. Otherwise, the Group determines a reasonable level for the input. Financial instruments primarily include cash instruments which trade infrequently, certain syndicated and commercial mortgage loans, unlisted equity shares, certain residual interests in securitisations, super senior tranches of high grade and mezzanine CDOs, other mortgage-based products and less liquid debt securities, certain structured debt securities in issue, and OTC derivatives where valuation depends upon unobservable inputs such as certain credit and exotic derivatives. No gain or loss is recognised on the initial recognition of a financial instrument valued using a technique incorporating significant unobservable data.