Ordinary shares: 51⁄2% cumulative preference shares: Solicitor For The Affairs of Mr P S and Mrs J M Allen; Her Majesty’s Treasury Miss C L Allen, and Miss J C Allen 112,949 28.23 As Nominee for Commercial Union Assurance plc 91,429 22.86 Her Majesty’s Treasury 22,853,798,818 57.92 Bassett-Patrick Securities Limited (1) 46,255 11.56 11% cumulative preference shares: E M Behrens Charitable Trust 20,000 5.00 Guardian Royal Exchange Assurance plc 129,830 25.97 Trustees of The Stephen Cockburn Windsor Life Assurance Company Limited 51,510 10.30 Limited Pension Scheme 19,879 4.97 Cleaning Tokens Limited 25,500 5.10 Mrs Gina Wild 19,800 4.95 Mr S J and Mrs J A Cockburn 15,520 3.10 Miss Elizabeth Hill 16,124 4.03 Mr Stephen J Cockburn 15,290 3.06 Mr W T Hardison Jr. 13,532 3.38
Note: (1) Notification has been received on behalf of Mr A W R Medlock and Mrs H M Medlock that they each have an interest in the holding of 51⁄2% cumulative preference shares registered in the name of Bassett-Patrick Securities Limited noted above and that there are further holdings of 5,300 and 5,000 shares, respectively, of that class registered in each of their names.
During the period following the changes to the Board on 6 February 2009 to the date of this Report and Accounts, the company has not had a senior independent director and the Remuneration Committee has comprised two independent non-executive directors and the Chairman of the Board, not the three independent non-executive directors required by the Code. The Board is in the process of recruiting three additional independent non-executive directors and plans to appoint a senior independent director and an additional member of the Remuneration Committee as part of the recruitment process.
The Group Audit Committee complies with the provisions of the NYSE’s corporate governance listing standards that relate to the composition, responsibilities and operation of audit committees. In June 2008, the company submitted its required annual written affirmation to the NYSE confirming its full compliance with those and other applicable provisions. More detailed information about the Audit Committee and its work during 2008 is set out in the Audit Committee Report on pages
All directors participate in discussing strategy, performance and the financial and risk management of the company. Meetings of the Board are structured to allow open discussion.
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 company’s business activities. The names and biographies of all Board members are set out on pages 146 and 147.
In addition to the Chairman, there are five independent and three nonindependent directors (i.e. the executive directors) on the Board. Following Bob Scott ceasing to be a director on 6 February 2009, a replacement senior independent director will be appointed in due course. The Board plans to appoint, in consultation with HM Treasury, three new independent non-executive directors to the Board during 2009.
The Board considers that the Chairman was independent on appointment and all non-executive directors are independent for the purposes of the Code.
Each new director receives a formal induction on joining the Board, including visits to the Group’s major businesses and meetings with directors and senior management. The induction is tailored to the director’s specific requirements. Directors are advised of appropriate training and professional development opportunities and undertake the training and professional development they consider necessary in assisting them to carry out their duties as a director.
Performance evaluation The Board has undertaken a formal and rigorous evaluation of its own performance and that of its committees and individual directors.
In 2008, this was conducted internally using detailed questionnaires and individual meetings with each director. Amongst the areas reviewed were the role of the Board and Committees, composition, meetings and processes, performance and reporting, and external relationships. The Board has considered and discussed reports on the outcomes of the evaluations and is satisfied with the way in which the evaluations have been conducted.
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 146 and 147.
Remuneration Committee The Remuneration Committee is comprised of independent nonexecutive directors, together with the Chairman of the Board. The Remuneration Committee holds at least three meetings each year.
The Directors’ Remuneration Report is contained on pages 160 to 168.
The Nominations Committee is responsible for assisting the Board in the formal selection and appointment of directors. The committee engages with external consultants, it considers potential candidates and recommends appointments of new directors to the Board. The appointments are based on merit against objective criteria, including the time available of the potential director and the commitment which will be required.
In addition, the Nominations Committee considers succession planning for the Chairman, Group Chief Executive and non-executive directors. The Nominations Committee takes into account the knowledge, mix of skills, experience and networks of contacts which are anticipated to be needed on the Board in the future. The Chairman, Group Chief Executive and non-executive directors meet to consider executive succession planning. No director is involved in decisions regarding his or her own succession.
Number of meetings attended in 2008: Sir Fred Goodwin (2) 8 — — —
(2) Sir Fred Goodwin and Mark Fisher ceased to be directors on 21 November 2008.
(4) Jim Currie, Bill Friedrich, Bud Koch, Janis Kong, Sir Steve Robson, Bob Scott and Peter Sutherland ceased to be directors on 6 February 2009.
(5) Stephen Hester, John McFarlane and Arthur 'Art' Ryan were appointed as directors on
Shareholders are given the opportunity to ask questions at the Annual General Meeting or submit written questions in advance. The chairmen of the Audit, Remuneration and Nominations Committees are available to answer questions at the Annual General Meeting.
Communication with the company’s largest institutional shareholders is undertaken as part of the company’s investor relations programme. The Chairman meets with the Group’s top 20 investors at least once every 12 months to discuss issues such as strategy, business performance and corporate governance. During the year, the directors received analysts’ reports and a monthly report from the Group’s investor relations department which includes an analysis of share price movements, the Group’s performance against the sector, and key broker comments. In addition, information on major investor relations activities and changes to external credit ratings is provided. Detailed market and shareholder feedback is provided to the Board after results and other market announcements. The senior independent director was available throughout 2008 to shareholders should they have considered their concerns were not being addressed through the normal channels. The arrangements used to ensure that directors develop an understanding of the views of major shareholders are considered as part of the annual Board performance evaluation.
The Chairman, Group Chief Executive and Group Finance Director communicate shareholder views to the Board as a whole.
The Board has established a process for the identification, evaluation and management of the significant risks faced by the Group, which operated throughout the year ended 31 December 2008 and to 25 February 2009, the date the directors approved the Report and Accounts. This process is regularly reviewed by the Board and meets the requirements of the guidance ‘Internal Control: Revised Guidance for Directors on the Combined Code’ issued by the Financial Reporting Council in October 2005.
In addition, the Group’s independent auditors present to the Audit Committee reports that include details of any significant internal control matters which they have identified. The system of internal controls of the authorised institutions and other regulated entities in the Group is also subject to regulatory oversight in the UK and overseas. Additional details of the Group’s regulatory oversight are given in the Supervision and Regulatory reviews and developments sections on pages 279 to 281.
The Group assessed the effectiveness of its internal control over financial reporting as of 31 December 2008 based on the criteria set forth by the Committee of Sponsoring Organizations of the Treadway Commission in ‘Internal Control – Integrated Framework’.
Based on its assessment, management has concluded that, as of 31 December 2008, the Group’s internal control over financial reporting is effective.
Disclosure controls and procedures As required by US regulations, the effectiveness of the company’s disclosure controls and procedures (as defined in the rules under the US Securities Exchange Act of 1934) have been evaluated. This evaluation has been considered and approved by the Board which has instructed the Group Chief Executive and the Group Finance Director to certify that, as at 31 December 2008, the company’s disclosure controls and procedures were adequate and effective and designed to ensure that material information relating to the company and its consolidated subsidiaries would be made known to them by others within those entities.
The Board is satisfied that all the Audit Committee members have recent and relevant financial experience. Although the Board has determined that each member of the Audit Committee is an ‘Audit Committee Financial Expert’ and is independent, each as defined in the SEC rules under the US Securities Exchange Act of 1934 and related guidance, the members of the Audit Committee are selected with a view to the expertise and experience of the Audit Committee as a whole, and the Audit Committee reports to the Board as a single entity. The designation of a director or directors as an ‘Audit Committee Financial Expert’ does not impose on any such director, any duties, obligations or liability that are greater than the duties, obligations and liability imposed on such director as a member of the Audit Committee and Board in the absence of such a designation. Nor does the designation of a director as an ‘Audit Committee Financial Expert’ affect the duties, obligations or liability of any other member of the Board.
The Audit Committee is responsible for: • assisting the Board in discharging its responsibilities and in making all relevant disclosures in relation to the financial affairs of the Group; • reviewing accounting and financial reporting and regulatory compliance; • reviewing the Group’s systems of internal control; and
Corporate governance continued 2008 saw considerable economic uncertainty and unprecedented upheaval in financial markets worldwide. These conditions severely affected the Group and it has recorded significant asset write-downs in its 2008 financial statements. In these circumstances, particular attention of the Audit Committee was focused on a number of salient judgments involved in the preparation of the accounts: • valuation methodologies and assumptions for financial instruments carried at fair value including the Group’s credit market exposures; • impairment losses in the Group’s portfolio of loans and advances; and
• satisfy itself that the disclosures in the financial statements about these estimates and valuations are transparent and appropriate.
The Committee reviews the work of the Group’s risk management and internal audit functions regularly. Four additional sessions of the Committee were held in 2008 that focused solely on risk issues; these sessions included contributions from independent advisors.
The Audit Committee undertakes an annual evaluation to assess the independence and objectivity of the external auditors and the effectiveness of the audit process, taking into consideration relevant professional and regulatory requirements. The outcomes of this evaluation are considered by the Board together with the Audit Committee’s recommendation on the re-appointment of the external auditor. In 2009 and subsequently, the annual evaluation will be carried out immediately following completion of the annual accounts and audit.
The Audit Committee is responsible for making recommendations to the Board, for it to submit the Audit Committee’s recommendations to shareholders for their approval at the Annual General Meeting in relation to the appointment, reappointment and removal of the external auditors. The Board has endorsed the Audit Committee’s recommendation that shareholders be requested to approve the reappointment of Deloitte LLP as external auditors at the Annual General Meeting in April 2009.
It is also intended that there will be an external review of the effectiveness of the Audit Committee every three to five years, with internal reviews by the Board continuing in the intervening years. PricewaterhouseCoopers conducted an external review of the effectiveness of the Audit Committee in 2005. An internal review of the Audit Committee’s performance was undertaken in 2008 and a separate report on the outcome was considered and discussed by the Board.
In recognition of the crisis in global financial services and the unprecedented losses incurred by the Group in 2008, the Remuneration Committee has been working with the executive to bring about fundamental change to the way remuneration works throughout the Group. There is an obvious need for very significant change to compensation policy and practice across the industry and we intend that the Group will lead that process in consultation with our major shareholders.
In previous years the Directors’ Remuneration Report has described how remuneration policies are being implemented for executive directors, but given the exceptional circumstances, I would like to take this opportunity to describe in greater detail how the Group is approaching remuneration for all employees.
Immediate key decisions taken by the Group were as follows: • There have been no discretionary cash bonuses for any employees for performance in 2008. No bonuses have been paid to anyone directly associated with the Group’s major losses. There are some limited contractual commitments to pay bonuses, typically as part of an agreement on recruitment, and these have been honoured.
In respect of 2009, the Remuneration Committee has made key decisions in relation to the remuneration of executive directors: • There will be no base salary increase in 2009.
• Any bonus earned in 2009 will be deferred and subject to clawback provisions.
• No further payments will be made under the company’s Profit Sharing Scheme for 2009 onwards.
• The exceptional maximum annual incentive opportunity will not be available.
• The individual performance management processes will be strengthened at executive levels. This includes a revised performance scorecard. The five performance areas are strategic direction, finance and operations, stakeholder management (including employee and customer satisfaction), efficiency and control, and capability and development.
• The provision for an undiscounted pension on early retirement at employer request will not apply to any executive director appointed in the future.
The Remuneration Committee The current members of the Remuneration Committee are Colin Buchan (committee chairman), John McFarlane and Philip Hampton. The members of the Remuneration Committee comprise independent nonexecutive directors, together with the Chairman of the Board.
During 2008, Jim Currie, Janis Kong, Sir Tom McKillop, Bob Scott and Peter Sutherland were members of the Remuneration Committee.
The Remuneration Committee’s terms of reference can be found on www.rbs.com. The Remuneration Committee makes recommendations to the Board on the remuneration arrangements for the executive directors and the Chairman. The Board as a whole reserves the authority to make the final determination of the remuneration of directors as it considers that this two-stage process allows greater consideration and evaluation and is consistent with the unitary nature of the Board. No director is included in decisions regarding his or her own remuneration.
The non-executive directors’ fees are reviewed annually by the Board, on the recommendation of the Chairman of the Board. The level of remuneration reflects the responsibility and time commitment of directors and the level of fees paid to non-executive directors of comparable major UK companies. Non-executive directors do not participate in any incentive or performance plan; with the exception of the Chairman, more details of which can be found on page 161. It has been agreed that no increase to non-executive directors’ fees will be made in 2009.
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 Defined Contribution Pension Fund 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 schemes. These schemes are not subject to performance conditions since they are operated on an allemployee basis.
Annual incentives No annual incentive has been awarded to any executive director in relation to 2008 performance.
The Remuneration Committee has determined that, for the financial year ending 31 December 2009, the exceptional maximum incentive opportunity will not be available.
Any annual incentive payments earned in 2009 will be deferred and released in equal annual instalments over three years. The Remuneration Committee will reserve the right to review performance prior to each element of deferred incentive vesting and reduce the proportion that vests if there is evidence that the financial performance for 2009 was materially inaccurate or there is a material loss or reputational damage as a result of activity during the deferral period.
Shareholding guidelines The Group operates shareholding guidelines for executive directors. The target shareholding level is 200% of gross annual salary for the Group Chief Executive and 100% of gross annual salary for executive directors. Target shareholding levels are determined by reference to ordinary shares held, together with any vested awards under the Group’s Medium-term Performance Plan. Executive directors have a period of five years in which to build up their shareholdings to meet the guideline levels.
Mr Hester also received certain share awards on appointment as Group Chief Executive and share awards to replace bonus and share awards he forfeited on leaving The British Land Company PLC. Mr Hester was granted conditional share awards over a total of 10,407,081 shares. Subject to their terms, the majority of these awards will vest between February 2009 (immediately after the announcement of the 2008 annual results) and the third anniversary of his appointment as Group Chief Executive.
Chairman – Philip Hampton Philip Hampton became Chairman-designate on 19 January 2009, and Chairman on 3 February 2009. His fee is £750,000 per annum. He will also receive a one-off restricted share award over shares in the company which will vest, subject to the satisfaction of appropriate performance conditions, on the third anniversary of the date of grant. The amount of this award will be two times his annual fee, based on the share price at the date of grant.
Former executive directors Sir Fred Goodwin Sir Fred Goodwin’s employment with the company ended on 31 January 2009. Under the terms of an agreement reached on 13 October 2008, he has waived any payment in lieu of notice and his rights in respect of unvested executive share options and unvested awards under the Medium-term Performance Plan have lapsed. He will not receive a short term incentive payment for the financial year ended 31 December 2008.
Johnny Cameron Johnny Cameron’s employment with the company will end on 28 February 2009. Under the terms of an agreement reached with him on 19 December 2008, he will not receive pay in lieu of notice or short term incentive payments for 2008 or 2009.
Mark Fisher Mark Fisher’s employment with the company will end on 6 March 2009. He will not receive any short term incentive payment in respect of either
Total shareholder return performance The performance graph illustrates the performance of the company over the past five years in terms of total shareholder return compared with that of the companies comprising the FTSE 100 Index. This Index has been selected because it represents a cross-section of leading UK companies. The total shareholder return for FTSE banks for the same period has been added for comparison. The total shareholder return for the company and the indices have been rebased to 100 for 2003.
Service contracts The company’s policy in relation to the duration of contracts with directors is that executive directors’ contracts generally continue until termination by either party, subject to the required notice, or until retirement. The notice period under the service contracts of executive directors will not normally exceed 12 months. In relation to newly recruited executive directors, subject to the prior approval of the Remuneration Committee, the notice period may be extended beyond 12 months if there is a clear case for this. Where a longer period of notice is initially approved on appointment, it will normally be structured such that it will automatically reduce to 12 months in due course.
No compensation payment was made to Sir Fred Goodwin, Johnny Cameron or Mark Fisher in respect of their ceasing to be directors.
Note: (1) On appointment, Mr Hester was entitled to 24 months notice from the company. This will be reduced on a daily basis, so that it will be 12 months by the first anniversary of the commencement of his employment. As at 25 February 2009, Mr Hester’s notice period was 201/2 months.
Chairman and non-executive directors The original dates of appointment as directors of the company and the dates for the Chairman and non-executive directors next election or re-election are as follows: Date for election Date first appointed or next re-election
Philip Hampton 19 January 2009 2009 Mr Buchan 1 June 2002 2011 Mr Hunter 1 September 2004 2010 Mr MacHale 1 September 2004 2010 Mr McFarlane 1 October 2008 2009 Mr Ryan 1 October 2008 2009
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 this period of notice. Any such payment would, at maximum, comprise base salary and a cash value in respect of fixed benefits (including pension plan contributions). 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 exercise its discretion to allow, the executive to exercise outstanding awards under long-term incentive arrangements subject to the rules of the relevant plan.
Under the company’s Articles of Association, all directors must resign and seek re-election by shareholders at least every three years. The dates in the table above reflect the latest date for election or re-election.
The tables and explanatory notes on pages 164 to 168 report the remuneration of each director for the year ended 31 December 2008 and have been audited by the company’s auditors, Deloitte LLP.
Directors’ remuneration Salary/ Pension 2008 2007 fees allowance Benefits Total Total
(3) Sir Fred Goodwin ceased to be Group Chief Executive and a director on 21 November 2008. His employment with the Group ceased on 31 January 2009.
(4) Mr Cameron ceased to be a director on 13 October 2008 and will cease employment with the Group on 28 February 2009.
(3) Mr Scott’s senior independent director fee covered all Board and Board Committee work including Chairmanship of the Remuneration Committee.
No options had their terms and conditions varied during the accounting period to 31 December 2008. No payment is required on the award of an option.
In respect of the grant of options in 2008, options will only be exercisable if, over the three-year period, the growth in the company’s adjusted EPS has been at least 5 per cent. per annum (the ‘‘threshold level’’). The percentage of options that vest is then determined on a straight-line basis between 30 per cent. at the threshold level and 100 per cent. at the maximum level for growth in adjusted EPS of 9 per cent. per annum.
The market price of the company’s ordinary shares at 31 December 2008 was 49.4p and the range during the year ended 31 December
In the ten year period to 31 December 2008, awards made that could require new issue shares under the company’s share plans represented 2.1% of the company’s issued ordinary share capital, leaving an available dilution headroom of 7.9%. The company meets its employee share plan obligations through a combination of new issue shares and market purchase shares.
Market Share interest End of period Scheme interests Awards price on Awards Awards (share for qualifying
Notes: (1) Awards to replace bonus and share awards Mr Hester forfeited on leaving The British Land Company PLC, which reflect the vesting dates of the original awards.
(5) Award has now vested and shares will be released to Mr Whittaker on 26 February 2009.
(2) When Mr Fish stepped down from the Board on 31 December 2008, under the terms of the Citizens LTIP, his outstanding awards vested, subject to pro-rating for the elapsed proportion of the performance period and for performance to date. As a result, there was nil vesting for all awards.
Awards made in 2007 and 2008 are subject to two performance measures; 50% of the award vests on a relative Total Shareholder Return (TSR) measure and 50% vests on growth in adjusted earnings per share (EPS) over the three year performance period.
AMRO by the consortium members in October 2007, the Remuneration Committee agreed that Fortis N.V. would replace ABN AMRO in the comparator group. Subsequently, for awards made in 2008, Fortis N.V. was replaced by Deutsche Bank Group.
The level of EPS growth over the three year period is calculated by comparing the adjusted EPS in the year prior to the year of grant with that in the final year of the performance period. Each year the vesting schedule for the EPS growth measure is agreed by the Remuneration Committee at the time of grant, having regard to the business plan, performance relative to comparators and analysts’ forecasts.
For the awards made in 2007, the EPS element of the awards will not vest if EPS growth is below 5% per annum compound over the three year period. Where EPS growth is between 5% per annum and 10% per annum vesting will occur on a straight-line basis from 25% to 100%. Vesting at 100% will occur if EPS growth is at least 10% per annum compound. For the awards made in 2008, an EPS growth threshold level of 5% per annum to a maximum level of 9% per annum was agreed.
Directors’ pension arrangements Stephen Hester and Guy Whittaker are provided with a cash allowance in place of pension benefits as detailed on page 164.
Johnny Cameron’s benefits were based on salary limited to the pensions earning cap and he received a cash allowance in place of pension on salary above this cap.
Disclosure of these benefits has been made in accordance with the United Kingdom Listing Authority Listing Rules and with the Directors’ Remuneration Report Regulations 2002.
Age at 31 December 31 December 31 December 31 December 31 December 31 December 31 December *Net of statutory revaluation applying to deferred pensions
There is a significant difference in the form of disclosure required by the Combined Code and the Directors’ Remuneration Report Regulations 2002. The former requires disclosure of the additional pension earned during the year and the transfer value equivalent to this pension based on stock market conditions at the end of the year. The latter requires disclosure of the difference between the transfer value at the start and end of the year and is therefore dependent on the change in stock market conditions over the course of the year. The above disclosure has been made in accordance with both of these documents.
The proportion of benefits represented by funded pension schemes for Gordon Pell and Larry Fish is 46% and 2% respectively. All benefits for Johnny Cameron, Mark Fisher and Sir Fred Goodwin are in funded pension schemes.
Larry Fish retired from employment with effect from 30 April 2008 and his pension benefits started on 1 May 2008.
Shares beneficially owned at or date of Shares appointment, beneficially Value(1) Executive directors if later owned £
Shares beneficially owned at 1 January Shares 2008 beneficially or date of owned at appointment, 31 December Non-executive directors if later 2008 Value(1)
No director held a non-beneficial interest in the shares of the company at 31 December 2008, at 1 January 2008 or date of appointment if later.
As at 25 February 2009 there were no changes to the directors’ interests in shares shown in the tables above.
(excluding insurance premium income) 3 Operating expenses 190 4 Pension costs 192 5 Auditors’ remuneration 194 7 Profit attributable to other owners 195 8 Ordinary dividends 195 9 Profit dealt with in the accounts of the company 195 10 Earnings per ordinary share 196 11 Financial instruments 196 12 Past due and impaired financial assets 212 14 Debt securities 216 15 Equity shares 218 16 Investments in Group undertakings 219 17 Intangible assets 220 18 Property, plant and equipment 223 19 Prepayments, accrued income and other assets 224 20 Discontinued operations and assets and 225 liabilities of disposal groups 21 Settlement balances and short positions 226 22 Accruals, deferred income and other liabilities 226 23 Deferred taxation 227 24 Insurance business 228 25 Subordinated liabilities 235 26 Minority interests 241 27 Share capital 242 28 Owners’ equity 245 30 Collateral and securitisations 248 31 Capital resources 250 32 Memorandum items 251 33 Net cash (outflow)/inflow from operating activities 255 34 Analysis of the net investment in business 256 interests and intangible assets 35 Interest received and paid 257 36 Analysis of changes in financing during the year 258 37 Analysis of cash and cash equivalents 258 38 Segmental analysis 259 39 Directors’ and key management remuneration 264 40 Transactions with directors, officers and others 265 41 Related parties 265 42 Post balance sheet events 266
Respective responsibilities of directors and auditors The directors’ responsibilities for preparing the annual report, the directors’ remuneration report and the financial statements in accordance with applicable law and International Financial Reporting Standards (IFRS), as adopted by the European Union, are set out in the statement of directors’ responsibilities.
In addition we report to you if, in our opinion, the company has not kept proper accounting records, we have not received all the information and explanations we require for our audit, or if information specified by law regarding directors’ remuneration and other transactions is not disclosed.
We read the other information contained in the Annual Report and Accounts 2008 as described in the contents section, including the unaudited part of the directors’ remuneration report, and consider whether it is consistent with the audited financial statements. We consider the implications for our report if we become aware of any apparent misstatements or material inconsistencies with the financial statements. Our responsibilities do not extend to any further information outside the Annual Report and Accounts 2008.
UK opinion In our opinion: • the Group financial statements give a true and fair view, in accordance with IFRS as adopted by the European Union, of the state of the Group’s affairs as at 31 December 2008 and of its loss and cash flows for the year then ended; • the company financial statements give a true and fair view, in accordance with IFRS as adopted by the European Union as applied in accordance with the provisions of the companies Act 1985, of the state of affairs of the company as at 31 December 2008; • the financial statements and the part of the directors’ remuneration report described as having been audited have been properly prepared in accordance with the Companies Act 1985 and, as regards the Group financial statements, Article 4 of the IAS Regulation; and
Separate opinion in relation to IFRS As explained in the accounting policies, the Group, in addition to complying with its legal obligation to comply with IFRS as adopted by the European Union, has also complied with IFRS as issued by the International Accounting Standards Board (IASB).
Neither an audit nor a review provides assurance on the maintenance and integrity of the website, including controls used to achieve this, and in particular on whether any changes may have occurred to the financial information since first published. These matters are the responsibility of the directors but no control procedures can provide absolute assurance in this area.
Premises and equipment 2,593 1,703 1,421 Other administrative expenses 5,464 2,969 2,658 Depreciation and amortisation 3,154 1,932 1,678 Write-down of goodwill and other intangible assets 32,581 — —
(Loss)/profit from continuing operations (38,344) 7,788 6,497 Profit/(loss) from discontinued operations, net of tax 20 3,971 (76) — (Loss)/profit for the year (34,373) 7,712 6,497
Assets Cash and balances at central banks 11 12,400 17,866 — — Loans and advances to banks 11 138,197 219,460 27,031 7,686 Loans and advances to customers 11 874,722 828,538 — 307 Debt securities subject to repurchase agreements 30 80,576 107,651 — — Other debt securities 186,973 187,005 — —
Prepayments, accrued income and other assets 19 24,402 15,662 489 127 Assets of disposal groups 20 1,581 45,850 — —
Available-for-sale investments Net valuation (losses)/gains taken direct to equity (8,096) (776) 4,792 — — — Net loss/(profit) taken to income 690 (513) (313) — — —
Operating activities Operating (loss)/profit before tax (40,667) 9,832 9,186 (10,017) 2,372 3,486 Operating profit before tax on discontinued activities 4,208 68 — — — —
Net cash flows from operating activities 33 (75,338) 25,604 17,441 (16,032) 18,353 3,648
Investing activities Sale and maturity of securities 53,390 63,007 27,126 — — — Purchase of securities (55,229) (61,020) (19,126) — — — Investment in subsidiaries — — — (10,349) (18,510) (1,097) Disposal of subsidiaries — — — 700 6 — Sale of property, plant and equipment 2,228 5,786 2,990 — — — Purchase of property, plant and equipment (5,757) (5,080) (4,282) — — — Proceeds on disposal of discontinued activities 20,113 (334) — — — — Net investment in business interests and intangible assets 34 2,252 13,640 (63) — — — Loans to subsidiaries — — — — — — Repayments from subsidiaries — — — — 469 547 Net cash flows from investing activities 16,997 15,999 6,645 (9,649) (18,035) (550)
The Group adopted IFRS 8 ‘Operating Segments’ with effect from 1 January 2008. Early adoption of IFRS 8 has not materially affected segmental disclosures.
The company accounts are presented in accordance with the Companies Act 1985.
On implementation of IFRS, the Group did not restate business combinations that occurred before January 2004. Under previous GAAP, goodwill arising on acquisitions after 1 October 1998 was capitalised and amortised over its estimated useful economic life. Goodwill arising on acquisitions before 1 October 1998 was deducted from equity. The carrying amount of goodwill in the Group’s opening IFRS balance sheet (1 January 2004) was £13,131 million, its carrying value under previous GAAP.
Finance lease receivables are stated in the balance sheet at the amount of the net investment in the lease being the minimum lease payments and any unguaranteed residual value discounted at the interest rate implicit in the lease. Finance lease income is allocated to accounting periods so as to give a constant periodic rate of return before tax on the net investment. Unguaranteed residual values are subject to regular review to identify potential impairment. If there has been a reduction in the estimated unguaranteed residual value, the income allocation is revised and any reduction in respect of amounts accrued is recognised immediately.
Reclassifications – held-for-trading and available-for-sale financial assets that meet the definition of loans and receivables (non-derivative financial assets with fixed or determinable payments that are not quoted in an active market) may be reclassified to loans and receivables if the Group has the intention and ability to hold the financial asset for the foreseeable future or until maturity. The Group typically regards the foreseeable future as twelve months from the date of reclassification. Additionally, held-for-trading financial assets that do not meet the definition of loans and receivables may, in rare circumstances, be transferred to available-for-sale financial assets or to held-to-maturity investments.
A financial liability is classified as held-for-trading if it is incurred principally for repurchase in the near term, or forms part of a portfolio of financial instruments that are managed together and for which there is evidence of short-term profit taking, or it is a derivative (not in a qualifying hedge relationship). Held-for-trading financial liabilities are recognised at fair value with transaction costs being recognised in profit or loss. Subsequently they are measured at fair value. Gains and losses are recognised in profit or loss as they arise.
Fair value for a net open position in a financial liability that is quoted in an active market is the current offer price times the number of units of the instrument held or issued. Fair values for financial liabilities not quoted in an active market are determined using appropriate valuation techniques including discounting future cash flows, option pricing models and other methods that are consistent with accepted economic methodologies for pricing financial liabilities.
24. Share-based payments The Group grants options over shares in The Royal Bank of Scotland Group plc to its employees under various share option schemes. The Group has applied IFRS 2 ‘Share-based Payment’ to grants under these schemes after 7 November 2002 that had not vested on 1 January 2005. The expense for these transactions is measured based on the fair value on the date the options are granted. The fair value is estimated using valuation techniques which take into account the option’s exercise price, its term, the risk-free interest rate and the expected volatility of the market price of The Royal Bank of Scotland Group plc’s shares. Vesting conditions are not taken into account when measuring fair value, but are reflected by adjusting the number of options included in the measurement of the transaction such that the amount recognised reflects the number that actually vest. The fair value is expensed on a straight-line basis over the vesting period.
26. Shares in Group entities The company’s investments in its subsidiaries are stated at cost less any impairment.
Debt securities (held-for-trading, designated as at fair value though profit or loss and available-for-sale) – debt securities include those issued by governments, municipal bodies, mortgage agencies and financial institutions as well as corporate bonds, debentures and residual interests in securitisations.
Forwards include forward foreign exchange contracts and forward rate agreements. A forward contract is a contract to buy (or sell) a specified amount of a physical or financial commodity, at an agreed price, on an agreed future date. Forward foreign exchange contracts are contracts for the delayed delivery of currency on a specified future date. Forward
Provisions are determined by management based on experience of claims settled and on statistical models which require certain assumptions to be made regarding the incidence, timing and amount of claims and any specific factors such as adverse weather conditions. In order to calculate the total provision required, the historical development of claims is analysed using statistical methodology to extrapolate, within acceptable probability parameters, the value of outstanding claims at the balance sheet date. Also included in the estimation of outstanding claims are other assumptions such as the inflationary factor used for bodily injury claims which is based on historical trends and, therefore, allows for some increase due to changes in common law and statute. Costs for both direct and indirect claims handling expenses are also included. Outward reinsurance recoveries are accounted for in the same accounting period as the direct claims to which they relate. The outstanding claims provision is based on information available to management and the eventual outcome may vary from the original assessment. Actual claims experience may differ from the historical pattern on which the estimate is based and the cost of settling individual claims may exceed that assumed.
Goodwill The Group capitalises goodwill arising on the acquisition of businesses, as discussed in accounting policy 6. The carrying value of goodwill as at 31 December 2008 was £15,562 million (2007 – £42,953 million).
Accounting developments International Financial Reporting Standards The International Accounting Standards Board issued a revised IAS 23 ‘Borrowing Costs’ in March 2007. Entities are required to capitalise borrowing costs attributable to the development or construction of intangible assets or property plant or equipment. The standard is effective for accounting periods beginning on or after 1 January 2009 and is not expected to have a material effect on the Group or company.
The IASB published a revised IFRS 3 ‘Business Combinations’ and related revisions to IAS 27 ‘Consolidated and Separate Financial Statements’ following the completion in January 2008 of its project on the acquisition and disposal of subsidiaries. The standards improve convergence with US GAAP and provide new guidance on accounting for changes in interests in subsidiaries. The cost of an acquisition will comprise only consideration paid to vendors for equity; other costs will be expensed immediately. Groups will only account for goodwill on acquisition of a subsidiary; subsequent changes in interest will be recognised in equity and only on a loss of control will there be a profit or loss on disposal to be recognised in income. The changes are effective for accounting periods beginning on or after 1 July 2009 but both standards may be adopted together for accounting periods beginning on or after 1 July 2007. These changes will affect the Group’s accounting for future acquisitions and disposals of subsidiaries.
The IASB issued amendments to a number of standards in May 2008 as part of its annual improvements project. The amendments are effective for accounting periods beginning on or after 1 January 2009 and are not expected to have a material effect on the Group or company.
The International Financial Reporting Interpretations Committee (IFRIC) issued interpretation IFRIC 15 ‘Agreements for the Construction of Real Estate’ in July 2008. This interpretation clarifies the accounting for construction profits. It is applicable for accounting periods beginning on or after 1 January 2009 and is not expected to have a material effect on the Group or company.
The IFRIC issued interpretation IFRIC 18 ‘Transfers of Assets from Customers’ in January 2009. The interpretation addresses the accounting by suppliers that receive assets from customers, requiring measurement at fair value. The interpretation is effective for assets from customers received on or after 1 July 2009 and is not expected to have a material effect on the Group or company.
189RBS Group Annual Report and Accounts 2008 1 Net interest income Group £m £m £m
Net interest income 18,675 12,069 10,596 2 Non-interest income (excluding insurance premium income) Group £m £m £m
Fees and commissions payable: (Loss)/income from trading activities: Other operating income: Operating lease and other rental income 1,525 1,671 1,755 Changes in the fair value of own debt 977 152 — Changes in the fair value of securities and other financial assets and liabilities (1,730) 970 430 Changes in the fair value of investment properties (86) 288 486 Profit on sale of securities 342 544 369 Profit on sale of property, plant and equipment 167 741 216 Profit on sale of subsidiaries and associates 943 67 44 Life company (losses)/profits (52) 187 219
(4) Equities and commodities: equities, commodities, equity derivatives, commodity contracts and related hedges and funding.
RBS Group Annual Report and Accounts 2008190 3 Operating expenses Group £m £m £m
Premises and equipment 25 4 10 Other administrative expenses 486 26 32 Depreciation and amortisation 36 60 16
Group before RFS Holdings minority interest 172,400 173,700 141,800 RBS share of shared assets 400 1,200 — RFS Holdings minority interest 26,700 28,600 —
Discontinued operations, excluding temporary staff, employed 2,600 persons at 31 December 2008 (2007 – 53,200; 2006 – nil).
RBS Group Annual Report and Accounts 2008192 4 Pension costs Members of the Group sponsor a number of pension schemes in the UK and overseas, predominantly defined benefit schemes, whose assets are independent of the Group’s finances. The Group’s defined benefit schemes generally provide a pension of one-sixtieth 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 Royal Bank of Scotland Group Pension Fund (‘Main scheme’) has been closed to new entrants.
* Rate of increase in salaries in the Main Scheme assumed to be 2.0% over the next two years.
Major classes of plan assets as a percentage of total plan assets 2008 2007 2006 2008 2007 2006
Currency translation and other adjustments — — — 381 397 16 Income statement: Statement of recognised income and expense: Acquisition of subsidiaries — — — 6,997 7,173 176 Intra-group transfers 30 30 — — — —
Expenses included in service cost (24) (24) — (26) (26) —
At 31 December 2008, ABN AMRO’s principal pension scheme in the Netherlands had fair value of plan assets of £8,181 million (2007 – £6,417 million) and present value of defined benefit obligations £8,589 million (2007 – £6,189 million). The principal actuarial assumptions at 31 December 2008 were: discount rate 5.4% (2007 – 5.4%); expected return on plan assets (weighted average) 4.7% (2007 – 6.2%); rate of increase in salaries 2.5% (2007 – 2.5%); rate of increase in pensions in payment 2.0% (2007 – 2.0%); and inflation assumption 2.0% (2007 – 2.0%).
RBS Group Annual Report and Accounts 2008194 4 Pension costs (continued) Main scheme All schemes
Fair value of plan assets 14,804 18,575 17,374 15,914 13,569 25,756 27,662 18,959 17,388 14,798 Present value of defined
25 bps additional rate of increase in pensions in payment 41 43 383 461 63 51 695 760 25 bps additional rate of increase in deferred pensions 8 5 94 113 15 7 227 239 25 bps additional rate of increase in salaries 28 35 168 216 35 40 219 265 5 Auditors’ remuneration Amounts paid to the company’s auditors for statutory audit and other services were as follows: Group £m £m
– Other services pursuant to legislation (2) 8.6 4.9 – Other services relating to taxation 0.6 0.4 – Services relating to corporate finance transactions, including securitisations, entered into by the Group (3) 7.4 5.5 – All other services 3.5 3.4
Fees payable to the auditors and their associates in respect of pension schemes: Notes: (1) Includes fees of £23.1 million (2007 – nil) in respect of the audit of ABN AMRO Holding N.V. Deloitte were appointed as auditors of ABN AMRO in 2008. In 2007, fees paid to Ernst & Young for the audit of ABN AMRO Holding N.V. were £33.9 million. These fees are not included above.
(2) Includes fees of £5.5 million (2007 – £3.5 million) for work relating to Section 404 of the US Sarbanes-Oxley Act, £2.0 million (2007 – £0.2 million) in relation to the review of interim financial statements and £1.1 million (2007 – £1.2 million) in respect of reports to the Group’s regulators in the UK and overseas.
(3) Includes fees of £3.1 million (2007 – £2.5 million) in respect of work performed by the auditors as reporting accountants on debt and equity issuances undertaken by the Group, including securitisations.
(4) Including other assurance and advisory services such as ad hoc accounting advice and reporting on internal controls.
Deferred taxation: (Credit)/charge for the year (3,167) 95 396 (Under)/over provision in respect of prior periods (98) (328) 67 Tax (credit)/charge for the year (2,323) 2,044 2,689
The actual tax charge differs from the expected tax charge computed by applying the standard rate of UK corporation tax of 28.5% (2007 – 30%; 2006 – 30%) as follows: £m £m £m
The effective tax rate for the year was 5.7% (2007 – 20.8%; 2006 – 29.3%). The deferred tax credit is net of £210 million deferred tax expense arising from the write-down of the carrying value of previously recognised deferred tax assets.
Dividends paid to other owners: Non-cumulative preference shares of US$0.01 293 152 99 Non-cumulative preference shares of €0.01 183 94 92 Non-cumulative preference shares of £1 60 — — Interest on securities classified as equity, net of tax 60 — —
(2) Between 1 January 2009 and the date of approval of these accounts, dividends amounting to US$163 million have been declared in respect of equity preference shares for payment on 31 March 2009.
8 Ordinary dividends Prior year ordinary dividends per share in the table below have been restated for the effect of the rights issue in June 2008 and the capitalisation issue in September 2008.
Final dividend for previous year declared during the current year 19.3 18.5 14.8 2,312 2,091 1,699
Assets Cash and balances at central banks — — — 12,400 — 12,400 Loans and advances to banks (1) 56,234 — — 81,963 — 138,197 Loans and advances to customers (2, 3) 51,501 2,141 — 806,627 14,453 874,722
Retirement benefit liabilities 2,032 2,032 Deferred taxation 4,165 4,165 Insurance liabilities 9,976 9,976
Designated as at fair Non value Other financial Held-for- through Hedging Available- Loans and (amortised Finance assets/ trading profit or loss derivatives for-sale receivables cost) leases liabilities Total 2007 £m £m £m £m £m £m £m £m £m
Intangible assets 49,916 49,916 Property, plant and equipment 18,745 18,745 Deferred taxation — — — — — — — 3,119 3,119 Prepayments, accrued income and other assets — — — 877 — 14,785 15,662
Notes: (1) Includes reverse repurchase agreements of £58,771 million (2007 – £175,941 million) and items in the course of collection from other banks of £2,888 million (2007 – £3,095 million).
(5) Includes repurchase agreements of £83,666 million (2007 – £163,038 million) and items in the course of transmission to other banks of £542 million (2007 – £372 million).
(6) Includes repurchase agreements of £58,143 million (2007 – £134,916 million).
(7) The carrying amount of other customer accounts designated as at fair value through profit or loss is £47 million lower (2007 – £77 million greater) than the principal amount. No amounts have been recognised in profit or loss for changes in credit risk associated with these liabilities as the changes are immaterial measured as the change in fair value from movements in the period in the credit risk premium payable. The amounts include investment contracts with a carrying value of £5,364 million (2007 – £5,555 million).
(8) Comprises bonds and medium term notes of £156,841 million (2007 – £119,578 million) and certificates of deposit and other commercial paper of £143,448 million (2007 – £154,594 million).
(9) £1,054 million (2007 – £162 million) has been recognised in profit or loss for changes in credit risk associated with debt securities in issue designated as at fair value through profit or loss measured as the change in fair value from movements in the period in the credit risk premium payable by the Group. The carrying amount is £1,145 million (2007 – £317 million) lower than the principal amount.
Held-for- Hedging Loans and (amortised assets/ trading derivatives receivables cost) liabilities Total 2008 £m £m £m £m £m £m
Accruals, deferred income and other liabilities — — — 47 47 Subordinated liabilities — — 10,314 — 10,314
Accruals, deferred income and other liabilities — — — 8 8 Deferred taxation — — — 3 3 Subordinated liabilities — — 7,743 — 7,743
The business entering into the transaction is responsible for the initial determination and recording of the fair value of the transaction. There are daily controls over the profit or loss recorded by trading and treasury front office traders.
A key element of the control environment, segregated from the recording of the transaction’s valuation, is the independent price verification (IPV) process. Valuations are first calculated by the business which entered into the transaction. Such valuations may be direct prices, or may be derived using a model and variable model inputs. These valuations are reviewed, and if necessary amended, by the IPV process. This process involves a team, independent of those trading the financial instruments, reviewing valuations in the light of available pricing evidence. IPV is performed at a frequency to match the availability of independent data, and the size of the Group’s exposure. For liquid instruments the process is performed daily. The minimum frequency of review in GBM is monthly for regulatory trading book positions, and six monthly for regulatory banking book positions. The IPV control includes formalised reporting and escalation of any valuation differences in breach of defined thresholds. In addition, within GBM, there is a dedicated team (the Global Pricing Unit) which determines IPV policy, monitors adherence to policy, and performs additional independent review on highly subjective valuation issues.
• Foreign currency exchange rates – there are observable markets both for spot and forward contracts and futures in the world’s major currencies.
RBS Group Annual Report and Accounts 2008200 11 Financial instruments (continued)
The Group refines and modifies its valuation techniques as markets and products develop and as the pricing for individual products becomes more or less readily available. While the Group believes its valuation techniques are appropriate and consistent with other market participants, the use of different methodologies or assumptions could result in different estimates of fair value at the balance sheet date.
Level 1(1) Level 2 (2) Level 3 (3) Total Level 1(1) Level 2 (2) Level 3(3) Total £bn £bn £bn £bn £bn £bn £bn £bn
Assets Fair value through profit or loss: Loans and advances to banks — 56.2 — 56.2 — 71.5 0.1 71.6 Loans and advances to customers — 50.5 3.1 53.6 — 93.8 13.1 106.9
Notes: (1) Valued using unadjusted quoted prices in active markets for identical financial instruments. This category includes listed equity shares, certain exchange-traded derivatives, G10 government securities and certain US agency securities.
The type of instruments that trade in markets that are not considered to be active, but are based on quoted market prices, broker dealer quotations, or alternative pricing sources with reasonable levels of price transparency and those instruments valued using techniques include most government agency securities, investment-grade corporate bonds, certain mortgage products, certain bank and bridge loans, repos and reverse repos, less liquid listed equities, state and municipal obligations, most physical commodities, investment contracts issued by the Group’s life assurance businesses and certain money market securities and loan commitments and most OTC derivatives.
(4) Other financial liabilities comprise subordinated liabilities and write downs relating to undrawn syndicated loan facilities.
The tables below presents the Level 3 financial instruments carried at fair value as at the balance sheet date, valuation basis, main assumptions used in the valuation of these instruments and reasonably possible increases or decreases in fair value based on reasonably possible alternative assumptions: Reasonably possible alternative assumptions
Level 3 derivative assets at 31 December 2008 include credit derivative trades with credit derivative product companies (CDPCs) with a fair value of £3.5 billion after credit valuation adjustments of £1.3 billion. At 31 December 2007 these credit derivative trades with CDPCs had a fair value of £0.8 billion after a credit valuation of £44 million and were included within level 2 of the fair value hierarchy. Other level 3 derivative assets at 31 December 2008 include illiquid credit default swaps (CDSs), other credit derivatives, commodity derivatives and illiquid interest rate derivatives.
Carrying Increase Decrease Valuation basis/ Main amount fair value fair value
Loans and advances to customers Loans in level 3 primarily comprise US commercial mortgages and syndicated loans.
Commercial mortgages These senior and mezzanine commercial mortgages are loans secured on commercial land and buildings that were originated or acquired by GBM for securitisation. Senior commercial mortgages carry a variable interest rate and mezzanine or more junior commercial mortgages may carry a fixed or variable interest rate. Factors affecting the value of these loans may include, but are not limited to, loan type, underlying property type and geographic location, loan interest rate, loan to value ratios, debt service coverage ratios, prepayment rates, cumulative loan loss information, yields, investor demand, market volatility since the last securitisation, and credit enhancement. Where observable market prices for a particular loan are not available, the fair value will typically be determined with reference to observable market transactions in other loans or credit related products including debt securities and credit derivatives. Assumptions are made about the relationship between the loan and the available benchmark data. Using reasonably possible alternative assumptions for credit spreads (taking into account all other applicable factors) would reduce the fair value of these mortgages of £1.1 billion by up to £18 million or increase the fair value by up to £25 million.
Using reasonably possible alternative assumptions for expected cash flows to value these assets of £2.0 billion would reduce the fair value by up to £32 million or increase the fair value by up to £45 million. The assumptions to determine these amounts were based on restructuring scenarios and expected margins.
In determining whether an instrument is similar to that being valued, the Group considers a range of factors, principally: the lending standards of the brokers and underwriters that originated the mortgages, the lead manager of the security, the issue date of the respective securities, the underlying asset composition (including origination date, loan to value ratios, historic loss information and geographic location of the mortgages), the credit rating of the instrument, and any credit protection that the instrument may benefit from, such as insurance wraps or subordinated tranches. Where there are instances of market observable data for several similar RMBS tranches, the Group considers the extent of similar characteristics shared with the instrument being valued, together with the frequency,
Where there is an absence of trading activity, models are used. The Group primarily uses an industry standard model to project the expected future cash flows to be received from the underlying mortgages and to forecast how these cash flows will be distributed to the various holders of the RMBS. This model utilises data provided by the servicer of the underlying mortgage portfolio, layering on assumptions for mortgage prepayments, probability of default, expected losses, and yield. The Group uses data from third-party sources to calibrate its assumptions, including pricing information from third party pricing services, independent research, broker quotes, and other independent sources. An assessment is made of third-party data source to determine its applicability and reliability. The Group adjusts the model price with a liquidity premium to reflect the price that the instrument could be traded at in the market and may also make adjustments for model deficiencies.
The Group’s proprietary model calculates the expected cashflows from the underlying mortgages using assumptions, derived from publicly available data on future macroeconomic conditions (including house price appreciation and depreciation) and on defaults and delinquencies on these underlying mortgages. The model used by the Group comprises an econometric loan-level model which provides the input to an industry standard ABS model, the output of which feeds a proprietary model generating expected cashflows which are discounted using a risk adjusted rate.
The Group, using all pricing points available, may make necessary and appropriate valuation adjustments to the pricing information derived from the proprietary model. These adjustments reflect the Group’s assessment of factors that market participants would consider in setting a price, to the extent that these factors that have not already been included in the model and may include adjustments made for liquidity discounts.
In order to provide disclosures of the valuation of super senior CDOs using reasonably possible alternative assumptions, the Group has considered macroeconomic conditions, including house price appreciation and depreciation, and the effect of regional variations. The output from using these alternative assumptions has been compared with inferred pricing from other published data. The Group believes that reasonably possible alternative assumptions could reduce or increase valuations by up to 4%. Using these alternative assumptions would reduce the fair value of level 3 CDOs of £1.7 billion by up to £440 million (super senior CDOs: £292 million) and increase the fair value by up to £410 million (super senior CDOs: £292 million).
Other debt securities Other level 3 debt securities comprise £1.4 billion of other ABS and £1.7 billion of other debt securities. Where observable market prices for a particular debt security are not available, the fair value will typically be determined with reference to observable market transactions in other related products, such as similar debt securities or credit derivatives. Assumptions are made about the relationship between the individual debt security and the available benchmark data. Where significant management judgement has been applied in identifying the most relevant related product, or in determining the relationship between the related product and the instrument itself, the valuation is shown in level 3. Using differing assumptions about this relationship would result in different fair values for these assets. The main assumption made is that of relative creditworthiness. Using reasonably possible alternative assumption credit assumptions, taking into account the underlying currency, tenor, and rating of the debt securities within each portfolio, would reduce the fair value of other debt securities of £3.1 billion by up to £50 million or increase the fair value by up to £50 million.
Credit derivatives The Group’s credit derivatives include vanilla and bespoke portfolio tranches, gap risk products and certain other unique trades. The bespoke portfolio tranches are synthetic tranches referenced to a bespoke portfolio of corporate names on which the Group purchases credit protection. Bespoke portfolio tranches are valued using Gaussian Copula, a standard method which uses observable market inputs (credit spreads, index tranche prices and recovery rates) to generate an output price for the tranche via a mapping methodology. In essence this method takes the expected loss of the tranche expressed as a fraction of the expected loss of the whole underlying portfolio and calculates which detachment point on the liquid index, and hence which correlation level, coincides with this expected loss fraction. Where the inputs into this valuation technique are observable in the market, bespoke tranches are considered to be level 2 assets. Where inputs are not observable, bespoke tranches are considered to be level 3 assets. However, all transactions executed with a CDPC counterparty are considered level 3 as the counterparty credit risk assessment is a significant component of these valuations.
RBS Group Annual Report and Accounts 2008206 11 Financial instruments (continued) Where these instruments have embedded optionality it is valued using a variation of the Black-Scholes option pricing formula, and where they have correlation exposure it is valued using a variant of the Gaussian Copula model. The volatility or unique correlation inputs required to value these products are generally unobservable and the instruments are therefore deemed to be level 3 instruments.
Exotic options do not trade in active markets except in a small number of cases. Consequently, the Group uses models to determine fair value using valuation techniques typical for the industry. These techniques can be divided, firstly, into modelling approaches and, secondly, into methods of assessing appropriate levels for model inputs. The Group uses a variety of proprietary models for valuing exotic trades. Exotic valuation inputs include correlation between equities, interest rates, foreign exchange rates and commodity prices. Correlations for more liquid equity and rate pairs are valued using independently sourced consensus pricing levels. Where a consensus pricing benchmark is unavailable, these instruments are categorised as level 3.
Other financial instruments Other than the portfolios discussed above, there are other financial instruments which are held at fair value determined from data which are not market observable, or incorporating material adjustments to market observed data. Using reasonably possible alternate assumptions appropriate to the liability in question, such as credit spreads, derivative inputs and equity correlations, would reduce the fair value of other financial instruments held at fair value of £5.0 billion, primarily debt securities in issue of £4.4 billion, by up to £250 million or increase the fair value by up to £210 million.
Own credit When valuing financial liabilities recorded at fair value, the Group takes into account the effect of its own credit standing. The categories of financial liabilities on which own credit spread adjustments are made are issued debt, including issued structured notes, and derivatives. An own credit adjustment is applied to positions where it is believed that counterparties would consider the Group’s creditworthiness when pricing trades.
For issued debt and structured notes, this adjustment is based on independent quotes from market participants for the debt issuance spreads above average inter-bank rates (at a range of tenors) which the market would demand when purchasing new senior or sub-debt issuances from the Group. Where necessary, these quotes are interpolated using a curve shape derived from CDS prices.
The fair value of the Group’s derivative financial liabilities reflects the Group’s own credit risk. The adjustment takes into account collateral posted by the Group and the effects of master netting agreements. No adjustments were made for own credit risk in relation to derivative liabilities in prior periods as it was not a significant factor in the pricing of derivative transactions by market participants. The change in methodology reflects market turbulence in 2008 which led to participants focussing increased attention on counterparty credit quality.
The table below shows the own credit spread adjustments on liabilities recorded in the income statement during the year.
Effective Expected date of (losses) that would statement Carrying interest cash Carrying Fair reclassi- Impairment in AFS have been in prior value rate flows value value fication Income losses reserves recognised periods £m % £m £m £m £m £m £m £m £m £m £m
Fair value of financial instruments not carried at fair value The following table shows the carrying values and the fair values of financial instruments carried on the balance sheets at amortised cost.
Notes: (1) Financial assets and financial liabilities for which carrying amount approximates to fair value because they are of short maturity.
(2) Fair values are estimated by discounting expected future cash flows; using current interest rates and making adjustments for credit.
(4) The fair value of short-term debt securities in issue is close to their carrying value. The fair value of other debt securities in issue is based on quoted prices; where these are unavailable fair value is estimated using other valuation techniques.
(6) The fair value of amounts due from and to subsidiaries is equal to their carrying value.
On the initial recognition of financial assets and liabilities valued using valuation techniques incorporating information other than observable market data, any difference between the transaction price and that derived from the valuation technique is deferred. Such amounts are recognised in profit or loss over the life of the transaction; when market data become observable; or when the transaction matures or is closed out as appropriate. At 31 December 2008, net gains of £102 million (2007 – £72 million) were carried forward in the balance sheet. During the year net gains of £89 million (2007 – £67 million) were deferred and £65 million (2007 – £10 million) released to profit or loss.
RBS Group Annual Report and Accounts 2008210 11 Financial instruments (continued) Remaining maturity The following table shows the residual maturity of financial instruments, based on contract date of maturity.
Settlement balances and short positions 24,448 29,829 54,277 44,466 46,555 91,021
Assets Loans and advances to banks 16,096 10,935 27,031 1,655 6,031 7,686 Loans and advances to customers — — — 307 — 307
Liabilities with a contractual maturity of greater than 20 years – the principal amounts of financial liabilities that are repayable after 20 years or where the counterparty has no right to repayment of the principal are excluded from the table as are interest payments after 20 years.
Held-for-trading liabilities – held-for-trading liabilities amounting to £1,146.7 billion (liabilities) (2007 – £478.6 billion) have been excluded from the table in view of their short term nature.
Individually Collectively Total assessed assessed Latent 2008 2007 2006 £m £m £m £m £m £m
Transfer to disposal groups (222) (351) (194) (767) — — Currency translation and other adjustments 1,065 81 295 1,441 137 (61) Acquisition of subsidiaries — — — — 2,221 — Disposal of subsidiaries — (149) (29) (178) — — Net increase in provisions of discontinued operations — — — — 46 —
Recoveries of amounts previously written-off 113 206 — 319 342 215 Charged to the income statement 3,663 2,606 822 7,091 1,946 1,877
Net book Net book Cost Provision value Cost Provision value £m £m £m £m £m £m
In general, the Group seeks to dispose of property and other assets obtained by taking possession of collateral that are not readily convertible into cash as rapidly as the market for the individual asset permits.
Notes on the accounts continued 13 Derivatives Companies in the Group transact derivatives as principal either as a trading activity or to manage balance sheet foreign exchange, interest rate and credit risk.
For fair value hedge relationships of interest rate risk, the hedged items are typically large corporate fixed-rate loans, fixed-rate finance leases, fixed-rate medium-term notes or preference shares classified as debt. As at 31 December 2008 fixed rate financial assets of £42.5 billion and fixed rate financial liabilities of £46.4 billion were hedged by interest rate swaps in fair value hedge relationships.
Included above are derivatives held for hedging purposes as follows: Assets Liabilities Assets Liabilities £m £m £m £m
Fair value hedging: Cash flow hedging: Commodity contracts 39 14 — —
Hedge ineffectiveness recognised in other operating income comprised: £m £m £m
Fair value ineffectiveness (81) (6) 4 Cash flow hedging ineffectiveness (16) 9 4
Hedged forecast cash flows years years years years years years years years Total expected to occur £m £m £m £m £m £m £m £m £m
Hedged forecast cash flows years years years years years years years years Total affect profit or loss £m £m £m £m £m £m £m £m £m
Included above are derivatives held for hedging purposes as follows; Assets Liabilities Assets Liabilities Fair value hedging £m £m £m £m
(3) During 2008 the Group reclassified financial assets from the held-for-trading and available-for-sale categories into the loans and receivables category and from the held-for-trading category into the available-for-sale category (see page 208).
The following table analyses by issuer the Group’s available-for-sale debt securities by remaining maturity and the related yield (based on weighted averages).
UK central and local government 9,320 2.0% 1,307 3.8% 670 7.2% 33 4.6% 11,330 2.5% US central and local government 37 3.6% 232 3.9% 4,980 3.8% 903 5.6% 6,152 4.0% Other central and local government 4,770 3.5% 9,046 4.3% 18,655 3.2% 9 3.2% 32,480 3.5%
(2) Includes non asset backed securities issued by US federal agencies and government sponsored entities.
The table below shows the fair value of available-for-sale debt securities that were in an unrealised loss position at 31 December.
Fair value losses Fair value losses Fair value losses 2008 £m £m £m £m £m £m
Gross gains of £1,633 million (2007 – £60 million) and gross losses of £1,411 million (2007 – £12 million) were realised on the sale of available-forsale securities.
Designated as at fair value through profit or loss 1,340 761 2,101 1,856 6,010 7,866
Gross gains of £190 million (2007 – £475 million) and gross losses of £70 million (2007 – £9 million) were realised on the sale of available-forsale equity shares.
Unquoted equity investments whose fair value cannot be reliably measured are carried at cost and classified as available-for-sale financial assets. They include capital stock (redeemable at cost) in the Federal Home Loan Bank and the Federal Reserve Bank of £0.9 billion (2007 – £0.5 billion) that the Group’s banking subsidiaries in the US are required to hold; and a number of individually small shareholdings in unlisted companies. Disposals in the year generated no gains or losses (2007 – £0.5 million gain; 2006 – £56 million gain).
14 Debt securities (continued) Impairment losses on available-for-sale debt securities are recognised when there is objective evidence of impairment. The Group reviews its portfolios of available-for-sale financial assets for such evidence which includes: default or delinquency in interest or principal payments; significant financial difficulty of the issuer or obligor; and it becoming probable that the issuer will enter bankruptcy or other financial reorganisation. However, the disappearance of an active market because an entity’s financial instruments are no longer publicly traded is not evidence of impairment. Furthermore, a downgrade of an entity’s credit rating is not, of itself, evidence of impairment, although it may be evidence of impairment when considered with other available information. A decline in the fair value of a financial asset below its cost or amortised cost is not necessarily evidence of impairment. Determining whether objective evidence of impairment exists requires the exercise of management judgment. The unrecognised losses on the Group’s available-for-sale debt securities are concentrated in its portfolios of mortgage-backed securities and of securities issued by central and local governments other than the UK and the US. The losses reflect the widening of credit spreads as a result of the reduced market liquidity in these securities and the current uncertain macro-economic outlook in US and Europe. The underlying securities remain unimpaired.
(3) Ulster Bank Limited and its subsidiaries also operate in the Republic of Ireland.
Accumulated amortisation and impairment: Transfer to disposal groups — — — (37) (37) Currency translation and other adjustments — 150 210 69 429 Disposals and write-off of fully amortised assets — (3) (1) (19) (23) Charge for the year — 337 582 651 1,570 Write down of goodwill and other intangible assets 30,062 685 1,355 453 32,555
Goodwill written off (40) — — — (40) Disposals and write-off of fully amortised assets — — (3) (84) (87)
The CGUs where the goodwill arising is significant, principally on the acquisitions of NatWest, Charter One, ABN AMRO and Churchill, are as follows: Goodwill Recoverable prior to Goodwill at amount write down Write down 31 December 2008 based on: £m £m £m
The analysis of goodwill by operating segment is shown in Note 38.
In 2007, the recoverable amounts for all CGUs, except Citizens, were based on fair value less costs to sell. Fair value was based upon a price-earnings methodology using current earnings for each unit. Approximate price earnings multiples, validated against independent analyst information, were applied to each CGU. The multiples used were in the range 9.5 – 13.0 times earnings after charging manufacturing costs. The goodwill allocated to Global Banking & Markets, UK Corporate Banking, Retail and Wealth Management principally arose from the acquisition of NatWest in 2000. The recoverable amount of these cash generating units exceeded their carrying value by over £15 billion. The recoverable amount for RBS Insurance exceeded its carrying value by over £1.5 billion. The multiples or earnings would have to be less than one third of those used to cause the value in use of the units to equal their carrying value.
In light of the unprecedented market turmoil, fair value was increasingly hard to appraise and consequently the Group has generally adopted value in use tests for CGUs in 2008, based upon management’s latest five year forecasts. The long-term growth rates have been based on respective country GDP rates adjusted for inflation. The risk discount rates are based on observable market long-term government bond yields and average industry betas adjusted for an appropriate risk premium based on independent analysis.
Goodwill in respect of Global Banking & Markets principally arose from the acquisition of ABN AMRO in October 2007. The failure of a number of banks and severe weakness in the global economy during the second half of 2008 resulted in a fundamental reappraisal of business forecasts, leading to the conclusion that the Global Banking & Markets business at 31 December 2008 could support no goodwill allocated from the ABN AMRO or NatWest acquisitions. In addition, impairments were recognised in respect of intangible assets and certain property, plant and equipment: the customer relationship intangible was impaired by £0.9 billion and capitalised software was impaired by £0.4 billion. The value in use was based on a 3% terminal growth rate and pre-tax discount rate of 19.5%. The result was insensitive to reasonably possible changes in key assumptions.
Accumulated depreciation and amortisation: Currency translation and other adjustments — (4) — (1) (1) 2 (4) Transfers to disposal groups — — — — — (52) (52)
Contractual obligations to purchase, construct or develop investment properties or to repair, maintain or enhance investment properties 7 9
Property, plant and equipment pledged as security — 935 19 Prepayments, accrued income and other assets
Accrued income 1,206 1,214 — — Deferred expenses 709 385 — — Pension schemes in net surplus 36 575 — —
Rental income from investment properties was £257 million (2007 – £300 million; 2006 – £278 million). Direct operating expenses of investment properties were £22 million (2007 – £49 million; 2006 – £54 million).
Property, plant and equipment, excluding investment properties, include £1,132 million (2007 – £717 million) assets in the course of construction.
Settlement balances (amortised cost) 11,741 17,520 Short positions (held-for-trading): Debt securities – Government 32,519 41,048
Notes in circulation 1,619 1,545 — — Current taxation 585 1,630 — —
Note: (1) Other liabilities include £1 million (2007 – £9 million) in respect of share-based compensation.
Fair Available Tax Accelerated value of for sale Cash losses capital Deferred IFRS financial financial flow Share carried Pension allowances Provisions gains transition instruments assets Intangibles hedging schemes forward Other Total £m £m £m £m £m £m £m £m £m £m £m £m £m
Notes: (1) Deferred tax assets are recognised, as set out above, that depend on the availability of future taxable profits in excess of profits arising from the reversal of other temporary differences. Business projections prepared for impairment reviews (see Note 17) indicate it is probable that sufficient future taxable income will be available against which to offset these recognised deferred tax assets within 8 years. UK losses do not expire and Netherlands losses expire after nine years. In jurisdictions where doubt exists over the availability of future taxable profits, deferred tax assets of £1,748 million (2007 – £687 million) have not been recognised in respect of tax losses carried forward of £5,779 million (2007 – £2,043 million). Of these losses, £15 million will expire within one year, £137 million within five years and £5,214 million thereafter. The balance of tax losses carried forward has no time limit.
(2) Deferred tax liabilities of £980 million (2007 – £977 million) have not been recognised in respect of retained earnings of overseas subsidiaries and held-over gains on the incorporation of overseas branches. Retained earnings of overseas subsidiaries are expected to be reinvested indefinitely or remitted to the UK free from further taxation. No taxation is expected to arise in the foreseeable future in respect of held-over gains.
Notes on the accounts continued 24 Insurance business Group £m £m £m
Cash paid for claims settled in the year (3,876) 94 (3,782) Increase/(decrease) in liabilities – arising from current year claims 4,643 (49) 4,594 – arising from prior year claims (573) (20) (593)
Acquisition of subsidiaries 2,275 3,245 Premiums received 784 140 Fees and expenses (30) (25) Investment return 251 93 Actuarial adjustments (493) — Account balances paid on surrender and other terminations in the year (468) (320) Exchange and other adjustments 168 176
Changes in assumptions during the year were not material to the profit recognised.
The Group is exposed to insurance risk, either directly through its businesses or through using insurance to reduce other risk exposures.
Insurance claims – gross £m £m £m £m £m £m £m £m £m
Six years later (9) (11) — — — — — — (20) Seven years later 6 — — — — — — — 6
Estimate of ultimate claims costs: At end of accident year 2,011 2,584 3,215 3,514 4,168 4,215 4,572 4,034 28,313
Six years later (19) (5) — — — — — — (24) Seven years later — — — — — — — — —
Current estimate of cumulative claims 1,926 2,578 2,886 3,129 3,876 3,867 4,482 4,034 26,778
Frequency and severity of specific risks and sources of uncertainty Most general insurance contracts are written on an annual basis, which means that the Group’s liability extends for a 12 month period, after which the Group is entitled to decline or renew or can impose renewal terms by amending the premium, terms and conditions, or both.
The following table shows the expected maturity of insurance liabilities up to twenty years excluding those linked directly to the financial assets backing these contracts (2008 – £4,189 million; 2007 – £4,398 million).
The Group is not exposed to price, currency, credit, or interest risk on unit linked life contracts but it is exposed to variation in management fees. A decrease of 10% in the value of the assets would reduce the asset management fees by £5 million per annum (2007 – £2 million). The Group writes insurance contracts with minimum guaranteed death benefits that expose it to the risk that declines in the value of underlying investments may increase the Group’s net exposure to death risk.
Contracts under which the Group does not accept significant insurance risk are classified as investment contracts. As required by IFRS 4 ‘Insurance Contracts’ long term business provisions are calculated in accordance with existing local GAAP (UK accounting standard FRS 27 ‘Life Assurance’).
Group 2008 – final redemption £m £m £m £m £m £m £m
Company 2007 – final redemption £m £m £m £m £m £m £m
The Royal Bank of Scotland plc €255 million 5.25% subordinated notes 2008 (redeemed July 2008) — 192
US$1,250 million floating rate subordinated notes 2014 (callable July 2009) 862 630 AUD590 million 6% subordinated notes 2014 (callable October 2009) 281 254 AUD410 million floating rate subordinated notes 2014 (callable October 2009) 195 182 CAD700 million 4.25% subordinated notes 2015 (callable March 2010) 409 358
US$750 million floating rate subordinated notes 2015 (callable September 2010) 513 374 €750 million floating rate subordinated notes 2015 783 564 CHF400 million 2.375% subordinated notes 2015 257 166 CHF100 million 2.375% subordinated notes 2015 72 41 CHF200 million 2.375% subordinated notes 2015 125 86 US$500 million floating rate subordinated notes 2016 (callable October 2011) 346 252 US$1,500 million floating rate subordinated notes 2016 (callable April 2011) 1,038 757
National Westminster Bank Plc US$1,000 million 7.375% subordinated notes 2009 697 507
Greenwich Capital Holdings, Inc US$170 million subordinated loan capital floating rate notes 2009 116 85 US$100 million 5.575% senior subordinated revolving credit 2009 69 50 US$500 million subordinated loan capital floating rate notes 2010 (callable on any interest payment date) 342 249
First Active Plc £60 million 6.375% subordinated bonds 2018 (callable April 2013) 66 65
ABN AMRO and subsidiaries €113 million 7.50% subordinated notes 2008 (redeemed January 2008) — 83 €250 million 4.70% CMS linked subordinated notes 2019 195 131 €100 million 5.13% flip flop Bermudan callable subordinated notes 2017 (callable December 2012) 89 75 €500 million floating rate Bermudan callable subordinated lower tier 2 notes 2018 (callable May 2013) 455 350 €1,000 million floating rate Bermudan callable subordinated lower tier 2 notes 2016 (callable September 2011) 923 710 €13 million zero coupon subordinated notes 2029 (callable June 2009) 8 2 €82 million floating rate subordinated notes 2017 72 55 €103 million floating rate subordinated lower tier 2 notes 2020 89 68 €170 million floating rate sinkable subordinated notes 2041 205 184 €15 million CMS linked floating rate subordinated lower tier 2 notes 2020 10 11 €1,500 million floating rate Bermudan callable subordinated lower tier 2 notes 2015 (callable June 2010) 1,419 1,087 €5 million floating rate Bermudan callable subordinated lower tier 2 notes 2015 (callable October 2010) 5 4 €65 million floating rate Bermudan callable subordinated lower tier 2 notes 2015 (callable October 2010) 62 48 US$12 million floating rate subordinated notes 2008 (redeemed June 2008) — 6 US$12 million floating rate subordinated notes 2008 (redeemed June 2008) — 6 US$165 million 6.14% subordinated notes 2019 152 94 US$72 million 5.98% subordinated notes 2019 49 7 US$500 million 4.65% subordinated notes 2018 359 214 US$500 million floating rate Bermudan callable subordinated notes 2013 (redeemed September 2008) — 232 US$1,500 million floating rate Bermudan callable subordinated notes 2015 (callable March 2010) 982 717 US$100 million floating rate Bermudan callable subordinated lower tier 2 notes 2015 (callable October 2010) 68 50 US$36 million floating rate Bermudan callable subordinated lower tier 2 notes 2015 (callable October 2010) 25 18 US$1,000 million floating rate Bermudan callable subordinated lower tier 2 notes 2017 (callable January 2012) 661 479 AUD575 million 6.50% Bermudan callable subordinated lower tier 2 notes 2018 (callable May 2013) 286 231 AUD175 million 7.46% Bermudan callable subordinated lower tier 2 notes 2018 (callable May 2013) 79 73 €256 million 5.25% subordinated notes 2008 (redeemed July 2008) — 190 €13 million floating rate subordinated notes 2008 (redeemed June 2008) — 9 £25 million 9.18% amortising MTN subordinated lower tier 2 notes 2011 9 15 £750 million 5% Bermudan callable subordinated upper tier 2 notes 2016 728 642 US$250 million 7.75% subordinated notes 2023 173 127 US$150 million 7.13% subordinated notes 2093 104 76 US$250 million 7.00% subordinated notes 2008 (redeemed April 2008) — 127 US$68 million floating rate subordinated notes 2009 (6) — 34 US$12 million floating rate subordinated notes 2009 (6) — 6 BRL50 million floating rate subordinated notes 2013 (6) — 14 BRL250 million floating rate subordinated notes 2013 (6) — 71 BRL250 million floating rate subordinated notes 2014 (6) — 71 BRL885 million floating rate subordinated notes 2014 (6) — 251 BRL300 million floating rate subordinated notes 2014 (6) — 85 PKR0.80 million floating rate subordinated notes 2012 7 6 MYR200 million subordinated notes 2017 40 30 TRY60 million subordinated notes 34 25 * In addition the company has issued 0.5 million subordinated loan notes of €1,000 each, 1.95 million subordinated loan notes of US$1,000 each and 0.4 million subordinated loan notes of £1,000 each. These loan notes are included in the company balance sheet as loan capital but are reclassified as minority interest Trust Preferred Securities on consolidation (see Note 26).
ABN AMRO and subsidiaries €9 million 4.650% perpetual convertible financing preference shares (redeemed October 2008) — 7 €1,000 million 4.310% perpetual Bermudan callable subordinated tier 1 notes (callable March 2016) 824 598
Series F US$200 million 7.65% (redeemable at option of issuer) 137 100 Series H US$300 million 7.25% (redeemable at option of issuer) 205 150 Series L US$850 million 5.75% (redeemable September 2009) 582 421
Notes: (1) Further details of the contractual terms of the preference shares are given in Note 27 on page 244.
Currency translation and other adjustments 8,098 1,158 9,256 Acquisition of outstanding ABN AMRO ordinary shares 356 — 356 (Loss)/profit attributable to minority interests (11,244) 412 (10,832) Dividends paid — (285) (285) Losses on available-for-sale securities, net of tax (144) (1,303) (1,447) Movements in cash flow hedging reserves, net of tax (831) — (831) Actuarial losses recognised in retirement benefit schemes, net of tax (478) — (478) Equity raised — 1,071 1,071
Non-voting deferred shares of £0.01 27 — 27 323 323 Additional Value Shares of £0.01 — — — 27 27 Non-cumulative preference shares of US$0.01 2 — 2 3 2 Non-cumulative convertible preference shares of US$0.01 — — — — — Non-cumulative preference shares of €0.01 — — — — — Non-cumulative convertible preference shares of €0.01 — — — — — Non-cumulative convertible preference shares of £0.25 — — — 225 225 Non-cumulative convertible preference shares of £0.01 — — — — —
Non-cumulative preference shares of £1 5,750 750 — 300,000 300,000 300,000
Shares issued in respect of the rights issue 6,123,010 Shares issued in respect of the capitalisation issue 403,468 Shares issued in respect of the placing and open offer 22,909,776 Other shares issued 13,536
In addition, 13.5 million ordinary shares were issued during the year ended 31 December 2008 following the exercise of options under the company’s share schemes.
During the year ended 31 December 2008, options were granted over 187.7 million ordinary shares under the company’s executive and sharesave schemes. At 31 December 2008, options granted under the company’s various schemes, exercisable up to 2018 at prices ranging from 189p to 586p per share, were outstanding in respect of 181.9 million ordinary shares.
In addition, options granted under the NatWest executive scheme were outstanding in respect of 0.8 million ordinary shares exercisable up to 2009 at prices ranging from 248p to 258p per share.
Employee share trusts purchased 54.0 million ordinary shares at a cost of £63.7 million and awarded 3.3 million ordinary shares on receipt of £0.9 million on the exercise of awards under employee share schemes.
Other securities Certain of the Group’s subordinated securities in the legal form of debt are classified as equity under IFRS.
The non-cumulative preference shares are redeemable at the option of the company, in whole or in part from time to time at the rates detailed on the next page plus dividends otherwise payable for the then current dividend period accrued to the date of redemption.
Holders of the non-cumulative preference shares are not entitled to receive notice of or attend general meetings of the company except if any resolution is proposed for adoption by the shareholders of the company to vary or abrogate any of the rights attaching to the noncumulative preference shares or proposing the winding-up or liquidation of the company. In any such case, they are entitled to receive notice of and to attend the general meeting of shareholders at which such resolution is to be proposed and are entitled to speak and vote on such resolution (but not on any other resolution). In addition, in the event that, prior to any general meeting of shareholders, the company has failed to pay in full the three most recent quarterly dividend payments due on the non-cumulative dollar preference shares (other than Series U), the two most recent semi-annual dividend payments due on the non-cumulative convertible dollar preference shares and the most recent dividend payments due on the non-cumulative euro preference shares, the noncumulative sterling preference shares, the Series U non-cumulative dollar preference shares and the non-cumulative convertible sterling preference shares, the holders shall be entitled to receive notice of, attend, speak and vote at such meeting on all matters together with the holders of the ordinary shares. In these circumstances only, the rights of the holders of the non-cumulative preference shares so to vote shall continue until the company shall have resumed the payment in full of the dividends in arrears.
27 Share capital (continued) Number Redemption Redemption of shares Interest date on price Debt or
Non-cumulative preference shares of US$0.01 Series F 8 million 7.65% 31 March 2007 US$25 Debt Series H 12 million 7.25% 31 March 2004 US$25 Debt Series L 34 million 5.75% 30 September 2009 US$25 Debt Series M 37 million 6.4% 30 September 2009 US$25 Equity Series N 40 million 6.35% 30 June 2010 US$25 Equity Series P 22 million 6.25% 31 December 2010 US$25 Equity Series Q 27 million 6.75% 30 June 2011 US$25 Equity Series R 26 million 6.125% 30 December 2011 US$25 Equity Series S 38 million 6.6% 30 June 2012 US$25 Equity Series T 64 million 7.25% 31 December 2012 US$25 Equity Series U 15,000 7.64% 29 September 2017 US$100,000 Equity
28 Owners’ equity Group Company £m £m £m £m £m £m
Ordinary shares issued in respect of rights issue 1,531 — — 1,531 — — Ordinary shares issued in respect of capitalisation issue 101 — — 101 — — Ordinary shares issued in respect of placing and open offer 5,728 — — 5,728 — — Preference shares issued in respect of placing and open offer 5 — — 5 — —
Bonus issue of ordinary shares — 1,576 — — 1,576 — Shares repurchased — — (13) — — (13)
Unrealised (losses)/gains in the year (6,808) (191) 2,609 — — — Realised losses/(gains) in the year 842 (513) (313) — — —
Notes: (1) Of the amount transferred to earnings, £198 million (2007 – £138 million; 2006 – £140 million) was recorded in net interest income and nil (2007 and 2006 – nil) in other operating income.
28 Owners’ equity (continued) Group Company £m £m £m £m £m £m
(Loss)/profit attributable to ordinary and equity preference shareholders (23,541) 7,549 6,393 (9,602) 2,499 3,499
Shares purchased during the year (64) (65) (254) — — — Shares issued under employee share schemes 21 119 146 — — 7
of 25p each of the company were held by Employee Share Trusts in respect of share awards and options granted to employees.
After 1 year Within 1 but within After 5 year 5 years years Total 2008 £m £m £m £m
Operating lease obligations: Future minimum lease payables: Finance lease assets: Present value amounts receivable 884 3,058 8,173 12,115
Operating lease assets: Future minimum lease receivables 1,073 3,046 1,473 5,592
Contracts for future capital expenditure not provided for at the year end Operating leases 237 545
Finance lease receivables Unearned finance income 5,711 5,343 Accumulated allowance for uncollectible minimum lease receivables 96 63
Deposits by banks 15,429 21,693 Customer accounts 11,050 6,670 Debt securities in issue 58,689 65,080
Of the assets above, £91.3 billion (2007 – £62.0 billion) relate to securitisations. In securitisations, debt securities are issued that are secured on assets of the Group: the rights to the cash flows from those assets are transferred to special purpose vehicles which issue debt securities. The holders of the notes are generally not able to sell or repledge the underlying assets. The remaining balances mainly relate to assets charged as security against deposits from central and federal banks and other public sector bodies.
Securitisations and other asset transfers Continued recognition The table below sets out the asset categories together with the carrying amounts of the assets and associated liabilities for those securitisations and other asset transfers where substantially all the risks and rewards of the asset have been retained by the Group.
Continuing involvement At 31 December 2008, securitised assets were £1.1 billion (2007 – £18.1 billion); retained interest £50 million (2007 – £1,037 million); subordinated assets £9 million (2007 – £314 million); and related liabilities £9 million (2007 – £314 million).
Notes on the accounts continued 31 Capital resources The Group’s regulatory capital resources at 31 December in accordance with Financial Services Authority (FSA) definitions were as follows: Basel II Basel I
Preference shares 16,655 10,560 Innovative Tier 1 securities 7,383 6,480 Tax on the excess of expected losses over provisions 615 n/a Tier 1 deductions (2,429) n/a Total Tier 1 capital 69,847 44,364
Supervisory deductions: Unconsolidated investments 4,044 4,297 Other deductions 111 5,986 Total deductions other than from Tier 1 capital 4,155 10,283 Total regulatory capital 98,175 67,974
The FSCS will receive funds from asset sales, surplus cash flow, or other recoveries in relation to these institutions which will be used to reduce the principal amount of the FSCS's borrowings. Only after the interest only period, which is expected to end in September 2011, will a schedule 32 Memorandum items Contingent liabilities and commitments The amounts shown in the table below are intended only to provide an indication of the volume of business outstanding at 31 December. Although the Group is exposed to credit risk in the event of non-performance of the obligations undertaken by customers, the amounts shown do not, and are not intended to, provide any indication of the Group’s expectation of future losses.
Commitments: Undrawn formal standby facilities, credit lines and other commitments to lend – less than one year 166,572 — — — 166,572 181,914
for repayment of any remaining principal outstanding (after recoveries) on the borrowings be agreed between the FSCS and HM Treasury. It is expected that, from that point, the FSCS will begin to raise compensation levies (principal repayments). No provision has been made for these levies as the amount is not yet known and is unlikely to be determined before 2011.
In 2007, the European Commission issued a decision that, while interchange is not illegal per se, MasterCard’s current multilateral interchange fee (MIF) arrangement for cross border payment card transactions with MasterCard and Maestro-branded consumer credit and debit cards in the European Union are in breach of competition law. MasterCard was required by the decision to withdraw the relevant cross border MIFs by 21 June 2008. MasterCard lodged an appeal against the decision with the European Court of First Instance on 1 March 2008, and on 12 June 2008 it announced that it would be temporarily withdrawing its cross border MIF, pending the outcome of the appeal. The Group has been granted leave to intervene in the appeal proceedings. Visa’s MIFs were exempted in 2002 by the European Commission for a period of five years up to 31 December 2007 subject to certain conditions. On 26 March 2008, the European Commission opened a formal inquiry into Visa’s current MIF arrangements for cross border payment card transactions with Visa-branded debit and consumer credit cards in the European Union. There is no deadline for the closure of the inquiry.
The FSA has been conducting a broad industry thematic review of PPI sales practices and in September 2008 announced that it intends to escalate its level of regulatory intervention. The FSA is expected to publish a further update in 2009. Substantial numbers of customer complaints alleging the mis-selling of PPI policies have been made to banks and to the Financial Ombudsman Service (FOS) and many of these are being upheld by the FOS against the banks. Discussions continue between the FSA, the FOS and industry bodies on how best to handle these complaints. Separately, discussions are ongoing between the FSA and the Group in respect of concerns expressed by the FSA over certain categories of historic PPI sales.
The OFT has carried out investigations into Visa and MasterCard domestic credit card interchange rates. The decision by the OFT in the MasterCard interchange case was set aside by the Competition Appeals Tribunal in June 2006. The OFT’s investigations in the Visa interchange case and a second MasterCard interchange case are ongoing. The outcome is not known, but these investigations may have an impact on the consumer credit industry in general and, therefore, on the Group’s business in this sector. On 9 February 2007, the OFT announced that it was expanding its investigation into domestic interchange rates to include debit cards.
On 29 March 2007, the OFT announced that, following an initial review into bank current account charges, it had decided to conduct a market study into personal current accounts in the United Kingdom and a formal investigation into the fairness of bank current account charges.
On 16 July 2008, the OFT published the results of its market study into personal current accounts in the United Kingdom. The OFT found evidence of competition and several positive features in the personal current account market but believes that the market as a whole is not working well for consumers and that the ability of the market to function well has become distorted. The OFT is currently consulting with the banking industry, consumer groups and interested parties on its report. After this consultation the OFT will decide on next steps, which could include further discussions or agreed remedies with the industry, or possibly a reference of the market to the CC.
On 26 January 2007, the FSA issued a Statement of Good Practice relating to Mortgage Exit Administration Fees. On 1 March 2007, the Group adopted a policy of charging all customers the fee applicable at the time the customers took out the mortgage or, if later, varied their mortgage. The Group believes that it is currently in compliance with the Statement of Good Practice and will continue to monitor its performance against those standards.
The New York State Attorney General has issued subpoenas to a wide array of participants in the sub-prime mortgage industry, including mortgage originators, appraisers, due diligence firms, investment banks and rating agencies, focusing on the information underwriters obtained as part of the due diligence process from the independent due diligence firms and whether that information is adequately disclosed to investors. RBS Greenwich Capital has produced documents requested by the New York State Attorney General principally related to sub-prime loans that were pooled into one securitisation transaction.
In addition to the above, certain of the Group’s subsidiaries have received requests for information from various US governmental agencies and self-regulatory organisations including in connection with sub-prime mortgages and securitisations, collateralised debt obligations and synthetic products related to sub-prime mortgages. In particular, during March 2008, the Group was advised by the SEC that it had commenced a non-public, formal investigation relating to the Group’s US sub-prime securities exposures and US residential mortgage exposures. The Group and its subsidiaries are co-operating with these various requests for information and investigations.
Litigation United Kingdom In common with other banks in the United Kingdom, the Royal Bank and NatWest have received claims and complaints from a large number of customers challenging unarranged overdraft charges (the ‘Charges’) as contravening the Unfair Terms in Consumer Contracts Regulations 1999 (the ‘Regulations’) or being unenforceable penalties (or both).
A High Court judgment in April 2008 addressed preliminary issues in respect of the banks’ contractual terms relating to the Charges in force in early 2008 (the ‘Current Terms’). The judgment held that the Current Terms used by the Royal Bank and NatWest (i) are not unenforceable as penalties, but (ii) are not exempt from assessment for fairness under the Regulations. The Group (in common with the other banks) has accepted that the ruling in the April judgment that the Current Terms are not exempt from assessment for fairness applies also to a sample of the Royal Bank and NatWest contractual terms relating to the Charges in force between 2001 and 2007 (the ‘Historic Terms’). The High Court made an order to this effect in October 2008.
The Group and the other banks have appealed against the rulings in April and October 2008 that the Current Terms and Historic Terms are not exempt from assessment for fairness under the Regulations. The hearing of the appeal in relation to Current Terms took place before the Court of Appeal in October and November 2008. The decision of the Court of Appeal is expected shortly. The appeal in relation to the Historic Terms is stayed pending the resolution of the appeal in relation to the Current Terms.
The issues relating to the legal status and enforceability of the Charges are complex. The Group maintains that its Charges are fair and enforceable and believes that it has a number of substantive and credible defences. The Group cannot at this stage predict with any certainty the final outcome of the customer claims and complaints, the appeals referred to above and any further stages of the test case. It is unable reliably to estimate the liability, if any, that may arise as a result of or in connection with these matters or its effect on the Group’s consolidated net assets, operating results or cash flows in any particular period.
United States Proceedings, including consolidated class actions on behalf of former Enron securities holders, have been brought in the United States against a large number of defendants, including the Group, following the collapse of Enron. The claims against the Group could be significant; the class plaintiff’s position is that each defendant is responsible for an entire aggregate damage amount less settlements – they have not quantified claimed damages against the Group in particular. The Group considers that it has substantial and credible legal and factual defences to these claims and will continue to defend them vigorously. Recent decisions by the US Supreme Court and the US Federal Court for the Fifth Circuit provide further support for the Group’s position. The Group is unable reliably to estimate the liability, if any, that might arise or its effect on the Group’s consolidated net assets, operating results or cash flows in any particular period.
Group companies have been named as defendants in a number of purported class action and other lawsuits in the United States that relate to the sub-prime mortgage business. In general, the cases involve the issuance of sub-prime-related securities or the issuance of shares in companies with sub-prime-related exposure, where the plaintiffs have brought actions against the issuers and underwriters (including Group companies) of such securities claiming that certain disclosures made in connection with the relevant offerings of such securities were false or misleading. The Group considers that it has substantial and credible legal and factual defences to these claims and will continue to defend them vigorously. The Group does not currently expect that these lawsuits, individually or in the aggregate, will have a material impact on its consolidated net assets, operating results or cash flows in any particular period.
Operating (loss)/profit before tax (40,667) 9,832 9,186 (10,017) 2,372 3,486 Operating profit before tax on discontinued activities 4,208 68 — — — — (Increase)/decrease in prepayments and accrued income (921) (662) 322 — (1) —
(Decrease)/increase in settlement balances and short positions (37,864) 8,073 4,068 — — —
Total income taxes (paid)/received (1,540) (2,442) (2,229) 119 6 154 Net cash (outflow)/inflow from operating activities (75,338) 25,604 17,441 (16,032) 18,353 3,648
The provisional fair values of ABN AMRO’s assets and liabilities at the date of acquisition were finalised as follows:
Cash and cash equivalents in businesses sold — 21 229 Other assets sold 739 16 36 Non-cash consideration (103) (2) (1) Profit on disposal 943 67 44 Net inflow of cash in respect of disposals 1,579 102 308 Dividends received from joint ventures 89 11 29 Cash expenditure on intangible assets 2,411 (435) (379)
Notes on the accounts continuedNotes on the accounts continued 36 Analysis of changes in financing during the year
Share capital, Share capital, share premium, paid-in share premium, paid-in equity and merger reserve Subordinated liabilities equity and merger reserve Subordinated liabilities £m £m £m £m £m £m £m £m
Issue of ordinary shares 49 77 49 77 Issue of other equity securities — 4,673 — 4,673 Placing and open offer 19,741 — 19,741 Rights issue 12,000 — 12,000 Net proceeds from issue of subordinated liabilities 2,413 1,018 —
Repayment of subordinated liabilities (1,727) (1,708) (469) Net cash inflow/(outflow) from financing 31,790 4,750 686 (690) 31,790 4,750 — (469) Acquisition of subsidiaries — 2,719 — 10,256 — 2,719 — — Transfer to retained earnings (14,273) — — — (14,273) — — — Currency translation and other adjustments — 159 10,425 823 — 159 2,571 18 37 Analysis of cash and cash equivalents Group Company £m £m £m £m £m £m
38 Segmental analysis (a) Divisions The directors manage the Group primarily by class of business and present the segmental analysis on that basis. The Group’s activities are organised as follows: Global Markets is focused on the provision of debt and equity financing, risk management and transaction banking services to large businesses and financial institutions in the United Kingdom and around the world. Its activities have been organised into two divisions, Global Banking & Markets (GBM) and Global Transaction Services (GTS), in order best to serve the Group’s customers whose financial needs are global.
GTS ranks among the top five global transaction services providers, offering global payments, cash and liquidity management, as well as trade finance, UK and international merchant acquiring and commercial card products and services. It includes the Group’s corporate money transmission activities in the United Kingdom and the United States.
Regional Markets is organised around the provision of retail and commercial banking to customers in four regions: the United Kingdom, the United States, Europe and the Middle East and Asia. This includes the provision of wealth management services both in the United Kingdom and internationally.
UK Retail & Commercial Banking comprises retail, commercial and corporate banking, and wealth management services in the United Kingdom. It supplies financial services through both the Royal Bank and NatWest brands.
Asia Retail & Commercial Banking holds prominent market positions in India, Pakistan, China and Taiwan, as well as presences in Hong Kong, Indonesia, Malaysia and Singapore. It provides financial services across four segments: affluent banking, cards and consumer finance, business banking and international wealth management, which offers private banking and investment services to clients in selected markets through the RBS Coutts brand.
Group Manufacturing comprises the Group’s worldwide manufacturing operations. It supports the Group’s customer-facing businesses and provides operational technology, customer support in telephony, account management, lending and money transmission, global purchasing, property and other services.
Segments charge market prices for services rendered to other parts of the Group with the exception of Group Manufacturing and central items. The expenditure incurred by Group Manufacturing relates to costs principally in respect of the Group’s banking and insurance operations in the UK and Ireland. These costs reflect activities that are shared between the various customer-facing divisions. These shared costs and related assets and liabilities are not allocated to divisions in the day-to-day management of the businesses and the results below reflect this. Funding charges between segments are determined by Group Treasury, having regard to commercial demands. The results of each division before amortisation of purchased intangible assets, integration costs and net gain on sale of strategic investments and subsidiaries (‘Contribution’) are shown in the following table.
Net Non- and Depreciation interest interest insurance and Impairment income income Total claims amortisation losses Contribution 2008 £m £m £m £m £m £m £m
– Europe & Middle East Retail & Commercial Banking 1,087 431 1,518 (563) — (526) 429
– Europe & Middle East Retail & Commercial Banking 824 320 1,144 (360) (5) (104) 675
Share of shared assets 257 — 257 264 — 264 — — —
Cost to Cost to acquire acquire fixed assets fixed assets and intangible and intangible
Assets Liabilities assets Assets Liabilities assets £m £m £m £m £m £m
– Europe & Middle East Retail & Commercial Banking 66,382 48,397 2 56,087 44,772 35
Notes on the accounts continuedNotes on the accounts continued 38 Segmental analysis (continued)
Goodwill written off — (40) — — — — — — (40)
Rest of UK USA Europe the World Total 2006 £m £m £m £m £m
Net assets attributable to equity owners and minority interests 21,470 13,991 4,097 5,932 45,490
Cost to acquire property, plant and equipment and intangible assets 3,040 254 1,427 19 4,740 39 Directors’ and key management remuneration Group
– amounts receivable under long-term incentive plans 646 1,839 – gains on exercise of share options 77 1,474
Retirement benefits are accruing to one director (2007 – five) under defined benefit schemes. No directors (2007 – one) are accruing benefits under defined contribution schemes.
Compensation of key management The aggregate remuneration of directors and other members of key management during the year was as follows: Group
40 Transactions with directors, officers and others (a) At 31 December 2008, the amounts outstanding in relation to transactions, arrangements and agreements entered into by authorised institutions in the Group, as defined in UK legislation, were £117,847 in respect of loans to 27 persons who were directors of the company (or persons connected with them) at any time during the financial period.
(e) On 1 December 2008, the UK Government through HM Treasury became the ultimate controlling party of The Royal Bank of Scotland Group plc. The UK Government’s shareholding is managed by UK Financial Investments Limited, a company wholly owned by the UK Government. As a result the UK Government and UK Government controlled bodies became related parties of the Group. The Group enters into transactions with many of these bodies on an arms' length basis. The volume and diversity of such transaction are such that disclosure of their amounts in the period 1 December 2008 to 31 December 2008 is impractical.
No impairment losses were recognised by the Group in 2008 in respect of balances with UK Government and UK Government controlled bodies.
• US dollar repo operations – these commenced in September 2008 taking the form of an auction. Eligible collateral consists of securities routinely eligible in the Bank's short-term repo open market operations together with conventional US Treasuries.
• The special liquidity scheme – this was launched in April 2008 to allow financial institutions to swap temporarily illiquid assets for treasury bills, with fees charged based on the spread between 3-month LIBOR and the 3-month gilt repo rate.
Government credit guarantee scheme – this was announced in October 2008. The Government, in return for a fee (50 basis points plus the bank’s median five-year credit default spread during the twelve months to 7 October 2008), guarantees new unsecured borrowing.
277 Exchange rates 278 Economic and monetary environment 279 Supervision 280 Regulatory reviews and developments 281 Description of property and equipment 281 Major shareholders 281 Material contracts 284 FSA Listing Rules disclosure
Summary consolidated income statement – IFRS $m £m £m £m £m £m
(Loss)/profit before other operating charges and impairment losses (41,175) (28,165) 16,424 15,522 13,956 13,029
(Loss)/profit from continuing operations (56,055) (38,344) 7,788 6,497 5,558 5,289 Profit/(loss) from discontinued operations, net of tax 5,805 3,971 (76) — — — (Loss)/profit for the year (50,250) (34,373) 7,712 6,497 5,558 5,289
(2) 2007 to 2004 comparative amounts have been restated for the netting of certain derivative asset and derivative liability balances with the London Clearing House.
Financial summary The Group’s financial statements are prepared in accordance with IFRS as issued by the IASB. Selected data under IFRS for each of the five years ended 31 December 2008 are presented on pages 268 to 276.
The per share data in the table below have been restated for the effect of the rights issue in June 2008 and the capitalisation issue in September 2008.
(2) Dividend payout ratio represents the interim dividend paid and current year final dividend proposed as a percentage of profit attributable to ordinary shareholders before discontinued operations, integration costs, amortisation of purchased intangibles and net gain on sale of strategic investments and subsidiaries (net of tax).
(5) Adjusted return on average ordinary shareholders’ equity represents profit attributable to ordinary shareholders before discontinued operations, credit market write-downs and one-off items, integration costs, restructuring costs, amortisation of purchased intangibles, write-downs of goodwill and other intangible assets and net gain on sale of strategic investments and subsidiaries expressed as a percentage of average ordinary shareholders’ equity.
Analysis of loans and advances to customers – IFRS The following table analyses loans and advances to customers before provisions by remaining maturity, geographical area and type of customer. .
After 1 Within but within After 2008 £m £m £m £m £m £m £m £m
Finance leases and instalment credit 2,705 6,666 7,992 17,363 15,632 14,218 13,909 13,044
Loans and advances to customers – net 874,722 828,538 466,893 417,226 347,251
Loans and advances to customers – gross 349,640 196,428 339,543 885,611 834,987 470,826 421,110 351,419
The table below sets out the Group’s cross border outstandings in excess of 0.75% of Group total assets (including acceptances), which totalled £2,401.7 billion at 31 December 2008 (2007 – £1,840.8 billion; 2006 – £856.8 billion). None of these countries has experienced repayment difficulties that have required refinancing of outstanding debt.
Transfer to disposal groups Domestic — — — — — Foreign (767) — — — —
Notes: (1) Includes closing provisions against loans and advances to banks of £127 million (2007 – £3 million; 2006 – £2 million; 2005 – £3 million; 2004 – £6 million).
Loan impairment provisions at end of year: Specific provisions – customers 3,607 – banks 6
% of loans % of loans % of loans % of loans % of loans Closing to total Closing to total Closing to total Closing to total Closing to total provision loans provision loans provision loans provision loans provision loans
Loans accounted for on a non-accrual basis (2): Accruing loans which are contractually overdue 90 days or more as to principal or interest (3): Loans not included above which are classified as ‘troubled debt restructurings’ by the SEC: Foreign — — — — 10
Closing provisions for impairment as a % of total risk elements in lending 52% 60% 62% 65% 76% Closing provisions for impairment as a % of total risk elements in lending
Risk elements in lending as a % of gross lending to customers excluding
(4) Loans for which an impairment event has occurred but no impairment provision is necessary. This category is used for fully collateralised advances and revolving credit facilities where identification as 90 days overdue is not feasible.
Total UK offices 456,443 527,246 360,608 Overseas Demand deposits – interest-free 29,253 27,959 12,173
Group 0-3 months 3-12 months 1-3 years 3-5 years 5-10 years 10-20 years 2008 £m £m £m £m £m £m
Exchange rates Except as stated, the following tables show, for the dates or periods indicated, the Noon Buying Rate in New York for cable transfers in sterling as certified for customs purposes by the Federal Reserve Bank of New York.
(3) On 25 February 2009, the Noon Buying Rate was £1.00 = US$1.4408.
The Eurozone started 2008 on a strong footing, with some member countries experiencing above-trend growth in the first quarter. However, for reasons that varied across countries, conditions worsened markedly throughout the remainder of the year, and the region officially entered recession in the second quarter. Growth in Germany, the region’s largest economy and the world’s largest exporter, was hit hard by the slowdown in global trade. Many of the more peripheral economies, like Ireland and Spain, with higher debt levels were hit hard by the turbulence in credit markets and falling asset prices. Economic activity in the entire region is forecast to continue to contract in 2009.
Initially, Asia Pacific appeared insulated from economic difficulties elsewhere as China and India continued to grow strongly in the first half of 2008. In fact, surging inflation reinforced concerns about overheating, and prompted a series of policy measures aimed at cooling monetary conditions. But this perception changed towards the end of 2008, when recession in the major industrialised countries highlighted the region’s exposure to a retrenchment in global trade. Growth forecasts have been cut substantially, with 2009 growth in China and India potentially falling to half its level from a year earlier. Increasing risk aversion of international investors also led to large capital outflows, putting downward pressure on floating currencies and local equity markets.
Exchange rates affect earnings and costs reported by the Group’s non-UK subsidiaries, and the value of non-sterling denominated assets and liabilities. Sterling weakened significantly during 2008, losing 28% against the dollar and 30% against the euro, respectively. These movements increase the sterling-value of non-sterling earnings, costs, assets and liabilities. As a result, the Group recognises translation benefits if it reports profits and/or has a positive net asset position denominated in foreign currency.
Investment management business is principally undertaken by companies in the Regional Markets division, including Coutts & Co, Adam & Company Investment Management Limited, and in the Global Markets division through RBS Asset Management Limited.
General insurance business is principally undertaken by Direct Line Insurance plc and Churchill Insurance Company Limited. Life assurance business is principally undertaken by Royal Scottish Assurance plc and National Westminster Life Assurance Limited (in partnership with Aviva plc).
United States The Group is both a bank holding company and a financial holding company within the meaning of the US Bank Holding Company Act of 1956. As such, it is subject to the regulation and supervision of the Board of Governors of the Federal Reserve System (the “Federal Reserve”). Among other things, the Group’s direct and indirect activities and investments in the United States are limited to those that are ‘financial in nature’ or ‘incidental’ or ‘complementary’ to a financial activity, as determined by the Federal Reserve. The Group is also required to obtain the prior approval of the Federal Reserve before acquiring directly or indirectly, the ownership or control of more than 5% of any class of the voting shares of any US bank or holding company.
The Group’s US insurance agencies are regulated by state insurance authorities. The Group’s US broker dealer, Greenwich Capital Markets, Inc., is subject to regulation and supervision by the US Securities and Exchange Commission (SEC) and the Financial Industry Regulatory Authority (FINRA) with respect to its securities activities. The futures activities of Greenwich Capital Markets, Inc. are subject to regulation and oversight by the US Commodity Futures Trading Commission (CFTC) and the Chicago Board of Trade (CBOT). The Group's US commodities business, RBS Sempra Commodities, is primarily regulated by the Federal Energy Regulatory Commission (FERC) and CFTC.
Other jurisdictions The Group operates in over 50 countries through a network of branches, local banks and non-bank subsidiaries.
United Kingdom The Group successfully implemented the Markets in Financial Instruments Directive (MiFID) by the implementation date of 1 November 2007. MiFID established a comprehensive legislative framework at the European level, which is now implemented in the UK, for the establishment and conduct of investment firms, multilateral trading facilities and regulated markets.
FSA authorised firms must also comply with rules designed to reduce the scope for firms to be used for financial crime and in particular money laundering. Revised Joint Money Laundering Steering Group Guidance Notes were issued on 13 November 2007 to take into account the new Money Laundering Regulations 2007. These Regulations came into force on 15 December 2007 and implemented the EU’s Third Money Laundering Directive. Amongst their other provisions, the Regulations endorse a risk based approach to combating money laundering, while also prescribing ‘enhanced due diligence’ for non face to face customers, ‘politically exposed persons’ (PEPs) and correspondent banking. Whilst for all material purposes the Group is already compliant – these provisions having been anticipated in industry guidance for some time – internal processes are continually reviewed to ensure best practice standards are met. In particular, the Group has issued new internal policy guidelines based on the regulations and supporting industry guidance against which all divisions have undertaken a gap analysis as a basis for further action plans where necessary.
In the UK, the Group has engaged proactively with a variety of legislative and regulatory consultations. Financial stability and depositor protection have been a key focus for the UK regulatory authorities. The Group participated fully in the consultation process on the Banking Reform Bill. In addition, the Group continues to comment on regulatory and legal changes that impact its business. Examples include the Department for Business, Enterprise and Regulatory Reform (BERR) transposition of the Consumer Credit Directive and Consumer Law Review; HM Treasury’s Dormant Bank and Building Society Accounts Bill; Lord Hunt’s Review of the Financial Ombudsman Service and the review of the Banking Codes and the FSA’s consultations on liquidity and regulatory capital.
The FSA, in their 2008/09 Business Plan, emphasised the continued focus on ‘Treating Customers Fairly’ in line with their view that the area of greatest structural concern remains the retail market. The Group has undertaken a process of continuous improvement of management information and root cause analysis of customer issues in order to ensure that it can demonstrate that it is consistently treating customers fairly throughout the product lifecycle.
European Union In the EU, the Group has also responded to a number of proposals for regulatory and legislative change, including proposed amendments to the Capital Requirements Directive and the establishment of Colleges of Supervisors to enhance cross border cooperation between supervisors. The Group also follows closely the work (and recommendations) of the G7 and G10.
United States In the US the Group also engages constructively with regulators and other bodies on regulatory and legislative change and seeks to ensure proper implementation and compliance. Current issues include mortgage reform and student lending.
Sub-prime exposures Certain of the Group’s subsidiaries have received requests for information from various US governmental agencies and self-regulatory organisations including in connection with sub-prime mortgages and securitisations, collateralised debt obligations and synthetic products related to sub-prime mortgages. In particular, during March 2008, the Group was advised by the SEC that it had commenced a non-public, formal investigation relating to the Group’s US sub-prime securities exposures and US residential mortgage exposures. The Group and its subsidiaries are cooperating with these various requests for information and investigations.
Total capital expenditure on premises (excluding investment properties), computers and other equipment in the year ended 31 December 2008
Major shareholders Details of major shareholders of the company’s ordinary and preference shares are given on page 152.
In December 2008, The Solicitor for the Affairs of Her Majesty’s Treasury acquired 22,854 million ordinary shares representing 57.92% of the company’s issued ordinary share capital. The ordinary shareholding of Legal & General Group plc decreased from 5.04% in December 2007 to below 3% in December 2008.
Other than detailed above, there have been no significant changes in the percentage ownership of major shareholders of the company’s ordinary and preference shares during the three years ended 25 February 2009. All shareholders within a class of the company’s shares have the same voting rights.
At 25 February 2009, the directors of the company had options to purchase a total of 3,073,445 ordinary shares of the company.
Material contracts The company and its subsidiaries are party to various contracts in the ordinary course of business. Material contracts include the following: Consortium and Shareholders Agreement (CSA) On 28 May 2007, Fortis, the company, Santander and RFS Holdings entered into the CSA. Fortis Bank Nederland acceded to the CSA on 26 July 2007. On 3 October 2008, the State of the Netherlands acquired Fortis Bank Nederland. On 24 December 2008 the State of the Netherlands acceded to the CSA following its acquisition of the shares held by Fortis Bank Nederland in RFS Holdings pursuant to a Deed of Accession entered into between RFS Holdings, the company, Fortis Bank Nederland, Santander and the State of the Netherlands. The CSA governs the relationships amongst the parties thereto in relation to the acquisition by RFS Holdings of ABN AMRO. The CSA details, inter alia, the funding of RFS Holdings in connection with the acquisition of ABN AMRO, the equity interests in RFS Holdings, the governance of RFS Holdings both before and after the acquisition of ABN AMRO, the arrangements for the transfer of certain ABN AMRO businesses, assets and liabilities to the State of the Netherlands (previously Fortis Bank Nederland), the company and Santander post-acquisition of ABN AMRO, further funding obligations of the State of the Netherlands (previously Fortis Bank Nederland), the company and Santander after the acquisition of ABN AMRO where funding is required by regulatory authorities in connection with the ABN AMRO businesses, the allocation of Core Tier 1 capital and the allocation of taxes and conduct of tax affairs.
Underwriting agreement On 22 April 2008, the company, Goldman Sachs International, Merrill Lynch International, UBS and the Royal Bank entered into an underwriting agreement, pursuant to which Merrill Lynch International, Goldman Sachs International and UBS agreed to procure subscribers for, or failing which themselves to subscribe for, Ordinary Shares not taken up under the Rights Issue, in each case at the relevant issue price. Pursuant to the underwriting agreement, the company agreed to pay certain fees and expenses to Merrill Lynch International, Goldman Sachs International and UBS in consideration for their underwriting commitment. The company gave certain representations and warranties and indemnities to those persons defined as underwriters in the Underwriting Agreement. The liabilities of the company were uncapped as to time and amount.
Sale of Tesco Personal Finance On 28 July 2008, the company announced that it had agreed to sell its 50 per cent. shareholding in Tesco Personal Finance to its joint venture partner Tesco plc for a cash consideration of £950 million, subject to transaction adjustments. As part of this transaction, the Group will continue to provide certain commercial services to Tesco Personal Finance post-completion. The sale completed on 19 December 2008.
First Placing and Open Offer Agreement Pursuant to a placing and open offer agreement effective as of 13 October 2008 entered into between the company, UBS, Merrill Lynch International and HM Treasury, (i) the company agreed to invite qualifying shareholders to apply to acquire new Shares at the issue price of 65.5 pence by way of the First Open Offer, (ii) UBS and Merrill Lynch International were appointed as joint sponsors, joint bookrunners and joint placing agents and agreed to use reasonable endeavours to procure placees to acquire the new Shares at not less than the issue price of 65.5 pence on such terms as agreed by HM Treasury on the basis that the new Shares placed were subject to clawback to the extent they were taken up under the Open Offer and (iii) HM Treasury agreed that, to the extent not placed or taken up under the First Open Offer and subject to the terms and conditions set out in the First Placing and Open Offer Agreement, HM Treasury would acquire such new Shares itself at the issue price of 65.5 pence.
In consideration of its services under the First Placing and Open Offer Agreement, HM Treasury was paid (i) a commission of 0.5 per cent. of the aggregate value of the new Shares at the issue price of 65.5 pence per new Share payable on Admission (as defined in the First Placing and Open Offer Agreement) and the second business day after the day on which the First Placing and Open Offer Agreement terminated and (ii) a further commission of 1 per cent. of the aggregate value of the new Shares acquired by placees (including HM Treasury) at the issue price of 65.5 pence per new Share payable on Admission (as defined in the First Placing and Open Offer Agreement). The company paid all legal and other costs and expenses of HM Treasury, those of UBS and Merrill Lynch International properly incurred and the costs and expenses of HM Treasury’s financial advisers incurred in connection with the First Placing and Open Offer and the Preference Share Issue.
The undertakings the company has given to HM Treasury included the following: • no bonus will be awarded to any director for 2008 and any bonuses earned by directors in respect of 2009 will be paid in restricted shares, remuneration will seek to reward long term value creation and not encourage excessive risk taking (short term indicators will be taken into account only where fully consistent with long term value creation and not encouraging excessive risk taking) and Directors who are dismissed will receive a severance package which is reasonable and perceived as fair; • to work with HM Treasury on the appointment of up to three new independent non-executive directors; • to maintain its SME and mortgage lending availability to at least 2007 levels until the end of 2011 with the active marketing of competitively priced loan products; • to increase its support to shared equity projects until the end of 2009 in order to assist those in difficulties with their mortgage payments to stay in their homes, either through individual bank schemes or paid into a central fund run by industry; and
Pursuant to the terms of the Second Placing and Open Offer Agreement, the aggregate proceeds of the Placing and Open Offer will be used in full to fund the redemption on Admission of the Preference Shares held by HM Treasury at 101 per cent. of their issue price (£5,050,000,000) together with the accrued dividend on the Preference Shares (from and including 1 December 2008 to but excluding the date of Admission) and the commissions payable to HM Treasury under the Second Placing and Open Offer Agreement. Should the proceeds of the Placing and Open Offer be insufficient to fund the redemption of the Preference Shares, the company shall provide additional finance from its own resources and make use of its own reserves to enable such redemption to be effected in full.
The company shall pay to each of HM Treasury, UBS and Merrill Lynch International all legal and other costs and expenses (properly incurred in the case of UBS and Merrill Lynch International) and those of HM Treasury’s financial advisers, incurred in connection with the Placing and Open Offer, the redemption of the Preference Shares or any arrangements referred to in the Second Placing and Open Offer Agreement.
The company shall also bear all costs and expenses relating to the Placing and Open Offer and the Preference Share Redemption, including (but not limited to) the fees and expenses of its professional advisers, the cost of preparation, advertising, printing and distribution of all documents connected with the Placing and Open Offer and the Preference Share Redemption, the listing fees of the FSA, any charges by CREST and the fees of the London Stock Exchange and Euronext.
The obligations of HM Treasury, UBS and Merrill Lynch International under the Second Placing and Open Offer Agreement are subject to certain conditions including, amongst others: • the passing of the Resolutions to be proposed at the General Meeting; • the obtaining of regulatory approvals; and
On termination of appointment by UBS or Merrill Lynch International, the Second Placing and Open Offer Agreement will continue to be in force as between the non-terminating parties.
The company has given certain representations and warranties and indemnities to each of HM Treasury, UBS and Merrill Lynch International under the Second Placing and Open Offer Agreement. The liabilities of the company are unlimited as to time and amount.
• a commitment to increase the level at which competitively priced lending is made available and actively marketed by the Group in the United Kingdom by £6 billion.
Preference Share Subscription Agreement Pursuant to a preference share subscription agreement effective as of 13 October 2008 between the company and HM Treasury, HM Treasury subscribed for, and the company allotted and issued to HM Treasury, the Preference Shares for a total consideration of £5 billion. The company and HM Treasury agreed that applications would be made to the UKLA for the Preference Shares to be admitted to the Official List and to the London Stock Exchange for the Preference Shares to be admitted to trading on the London Stock Exchange. Pursuant to the Preference Share Subscription Agreement, the company agreed to pay the costs and expenses of both parties in relation to the negotiation of the Preference Share Subscription Agreement and the subscription for, and allotment and issue of, the Preference Shares (including, without limitation, any stamp duty or stamp duty reserve tax). HM Treasury was entitled to novate its rights under the Preference Share Subscription Agreement to any entity that is owned, directly or indirectly, by HM Treasury.
Subscription and Transfer Agreements In connection with the First Placing and Open Offer, the company, Merrill Lynch International, UBS, Computershare and Encuentro Limited entered into several agreements dated 4 November 2008, in respect of the subscription and transfer of ordinary shares and redeemable preference shares in Encuentro Limited. Under the terms of these agreements: • the company and UBS and/or Merrill Lynch International agreed to acquire ordinary shares in Encuentro Limited and enter into put and call options in respect of the ordinary shares in Encuentro Limited subscribed for by UBS and/or Merrill Lynch that were exercisable if the Placing and Open Offer did not proceed; • Merrill Lynch International or UBS, as applicable, agreed to apply monies received from Qualifying Shareholders, placees or HM Treasury under the Placing and Open Offer to subscribe for redeemable preference shares in Encuentro Limited to an aggregate value equal to such monies, after deduction of the amount of certain commissions and expenses; and
• the company agreed to allot and issue the New Shares to those persons entitled thereto in consideration of Merrill Lynch International or UBS, as applicable, transferring its holding of redeemable preference shares and ordinary shares in Encuentro Limited to the company.
Accordingly, instead of receiving cash as consideration for the issue of the New Shares, at the conclusion of the First Placing and Open Offer the company owned the entire issued ordinary and redeemable preference share capital of Encuentro Limited whose only assets were its cash reserves, which represented an amount equivalent to the net proceeds of the First Placing and Open Offer. The company was able to utilise this amount equivalent to the First Placing and Open Offer net proceeds by exercising its right of redemption over the redeemable preference shares it held in Encuentro Limited.
FSA Listing Rules disclosure With effect from 1 July 2008, the Group sold to Santander (a related party for the purposes of the FSA Listing Rules) its interests in the European Consumer Finance businesses in Germany and Austria for €306 million.
Shareholder information 286 Financial calendar 286 Shareholder enquiries 287 Capital gains tax 287 Analyses of ordinary shareholders 288 Trading market 291 Dividend history 292 Taxation for US Holders 295 Exchange controls 295 Memorandum and Articles of Association 295 Incorporation and registration 295 Code of ethics 296 Important addresses 296 Principal offices
Dividends Payment dates: Cumulative preference shares 29 May and 31 December 2009
Ex-dividend dates: Cumulative preference shares 29 April 2009 Record dates: Cumulative preference shares 1 May 2009
Dividend payments The company pays its dividends in pounds sterling although shareholders may choose to receive payment in US dollars or euros. Shareholders wishing to receive payment in either US dollars or euros should request an instruction form from the Company’s Registrar: Computershare Investor Services PLC The Pavilions Bridgwater Road Bristol BS99 6ZZ
Warning to shareholders – boiler room scams Over the last year, many companies have become aware that their shareholders have received unsolicited phone calls or correspondence concerning investment matters. These are typically from overseas based ‘brokers’ who target UK shareholders, offering to sell them what often turn out to be worthless or high risk shares in US or UK investments. These operations are commonly known as ‘boiler rooms’. These ‘brokers’ can be very persistent and extremely persuasive, and a 2006 survey by the Financial Services Authority (FSA) has reported that the average amount lost by investors is around £20,000.
It is not just the novice investor that has been duped in this way; many of the victims had been successfully investing for several years. Shareholders are advised to be very wary of any unsolicited advice, offers to buy shares at a discount or offers of free company reports. If you receive any unsolicited investment advice: • Make sure you get the correct name of the person and organisation; • Check that they are properly authorised by the FSA before getting involved by visiting www.fsa.gov.uk/register; • Report the matter to the FSA either by calling 0845 606 1234 or visiting www.moneymadeclear.fsa.gov.uk; and
If you deal with an unauthorised firm, you will not be eligible to receive payment under the Financial Services Compensation Scheme. The FSA can be contacted by completing an online form at www.fsa.gov.uk/pages/doing/regulated/law/alerts/overseas.shtml
More detailed information on this or similar activity can be found on the FSA website www.moneymadeclear.fsa.gov.uk
For shareholders who held NatWest ordinary shares at 31 March 1982, the market value of one ordinary share held was 76.3p for shareholders who accepted the basic terms of the RBS offer. This takes account of the following: • the August 1984 rights issue of NatWest ordinary shares; • the June 1986 rights issue of NatWest ordinary shares; • the June 1989 bonus issue of NatWest ordinary shares; • the 12 July 2000 bonus issue of Additional Value Shares; • the 8 May 2007 bonus issue; • the 6 June 2008 rights issue; • the 15 September 2008 capitalisation issue; and
• the basic entitlement under the 1 December 2008 open offer.
Each of the respective ADSs set out above represents the right to receive one corresponding preference share, and is evidenced by an American Depository Receipt (ADR) and is listed on the New York Stock Exchange, a subsidiary of NYSE Euronext (NYSE).
The ADRs evidencing the ADSs above were issued pursuant to Deposit Agreements, among the company, The Bank of New York, as depository, and all holders from time-to-time of ADRs issued thereunder. Currently, there is no non-United States trading market for any of the noncumulative dollar preference shares. All of the non-cumulative dollar preference shares are held by the depository, as custodian, in bearer form.
At 31 December 2008, there were 106 registered shareholders of Series F ADSs, 68 registered shareholders of Series H ADSs, 30 registered shareholders of Series L ADSs, 7 registered shareholders of Series M ADSs, 39 registered shareholders of Series N ADSs, 50 registered shareholders of Series P ADSs, 15 registered shareholders of Series Q ADSs, 2 registered shareholders of Series R ADSs, 3 registered shareholders of Series S ADSs, 29 registered shareholders of Series T ADSs and 1 registered shareholder of Series U ADSs.
The ADSs described in the above paragraph were issued pursuant to a Deposit Agreement, among the company, The Bank of New York Mellon, as Depository, and all owners and holders from time to time of ADSs issued thereunder. The ordinary shares of the company are listed and traded on the London Stock Exchange. All ordinary shares are deposited with the principal London office of The Bank of New York Mellon, as custodian for the Depository.
The following table shows, for the periods indicated, the high and low sales prices for each of the outstanding ADSs representing non-cumulative dollar preference shares and PROs, as reported on the NYSE composite tape: Series F Series H Series L Series M Series N Series P Series Q Series R Series S Series T Series U Figures in US$ ADSs ADSs ADSs ADSs ADSs ADSs ADSs ADSs ADSs ADSs ADSs PROs(1)
2008: Fourth quarter High 1.8620 Low 0.4140 2008: Third quarter High 2.4293 Low 1.6098 2008: Second quarter High 3.2156 Low 2.0707 2008: First quarter High 3.7054 Low 2.5540 2007: Fourth quarter High 4.7689 Low 3.3265 2007: Third quarter High 5.3802 Low 4.2581 2007: Second quarter High 5.7780 Low 5.2169 2007: First quarter High 6.0208 Low 5.4514
2008: Fourth quarter High 66.00 Low 12.20 2008: Third quarter High 93.85 Low 55.00 2008: Second quarter High 129.96 Low 83.71 2008: First quarter High 149.05 Low 105.18 2007: Fourth quarter High 189.25 Low 141.18
Ordinary dividends Ordinary dividends per share for prior years in the table below have been restated for the effect of the rights issue in June 2008 and the capitalisation issue in September 2008.
Amount per share and American Depository Shares (1) pence pence pence pence
The following discussion assumes that the company is not, and will not become, a passive foreign investment company (PFIC) – see ‘Passive Foreign Investment Company Considerations’ on page 295.
Ordinary shares, preference shares, ordinary ADSs and preference ADSs Taxation of dividends For the purposes of the Treaty, the Estate Tax Treaty and the US Internal Revenue Code of 1986, as amended (the Code), US Holders of ordinary ADSs and preference ADSs should be treated as owners of the ordinary shares and the non-cumulative dollar preference shares underlying such ADSs.
The company is not required to withhold UK tax at source from dividend payments it makes or from any amount (including any amounts in respect of accrued dividends) distributed by the company. US Holders who are not resident or ordinarily resident in the UK and who do not carry on a trade, profession or vocation in the UK through a branch, agency or permanent establishment in connection with which their ordinary shares, non-cumulative preference shares, ordinary ADSs or preference ADSs are held, used or acquired will not be subject to UK tax in respect of any dividends received on the relevant shares or ADSs.
Taxation of capital gains A US Holder that is not resident (or, in the case of an individual, ordinarily resident) in the UK will not normally be liable for UK tax on capital gains realised on the disposition of an ordinary share, a noncumulative dollar preference share, an ordinary ADS or a preference ADS unless at the time of the disposal, in the case of a corporate US Holder, such US Holder carries on a trade in the UK through a permanent establishment or, in the case of any other US Holder, such US Holder carries on a trade, profession or vocation in the UK through a UK branch or agency and such ordinary share, non-cumulative dollar preference share, ordinary ADS or preference ADS is or has been used, held or acquired by or for the purposes of such trade (or profession or vocation), permanent establishment, branch or agency. Special rules apply to individuals who are temporarily not resident or ordinarily resident in the UK.
A US Holder who is liable for both UK and US tax on a gain recognised on the disposal of an ordinary share, a non-cumulative dollar preference share, an ordinary ADS or a preference ADS will generally be entitled, subject to certain limitations, to credit the UK tax against its US federal income tax liability in respect of such gain.
An ordinary share, a non-cumulative dollar preference share, an ordinary ADS or a preference ADS beneficially owned by an individual, whose domicile is determined to be the United States for purposes of the Estate Tax Treaty and who is not a national of the UK, will not be subject to UK inheritance tax on the individual’s death or on a lifetime transfer of such share or ADS, except in certain cases where the share or ADS (i) is comprised in a settlement (unless, at the time of the settlement, the settlor was domiciled in the United States and was not a national of the UK); (ii) is part of the business property of a UK permanent establishment of an enterprise; or (iii) pertains to a UK fixed base of an individual used for the performance of independent personal services. The Estate Tax Treaty generally provides a credit against US federal estate or gift tax liability for the amount of any tax paid in the UK in a case where the ordinary share, non-cumulative dollar preference share, ordinary ADS or preference ADS is subject to both UK inheritance tax and US federal estate or gift tax.
A US Holder will, upon the sale, exchange or redemption of a PRO, generally recognise capital gain or loss for US federal income tax purposes (assuming that in the case of a redemption, such US Holder does not own, and is not deemed to own, any ordinary shares or ordinary ADSs of the company) in an amount equal to the difference between the amount realised (excluding any amount in respect of mandatory interest and any missed payments which are to be satisfied on a missed payment satisfaction date, which would be treated as ordinary income) and the US Holder’s tax basis in the PRO.
HM Revenue & Customs confirmed at around the time of the issue of the PROs that interest payments would not be treated as distributions for UK tax purposes by reason of (i) the fact that interest may be deferred under the terms of issue; or (ii) the undated nature of the PROs, provided that at the time an interest payment is made, the PROs are not held by a company which is ‘associated’ with the company or by a ‘funded company’. A company will be associated with the company if, broadly speaking, it is part of the same group as the company. A company will be a ‘funded company’ for these purposes if there are arrangements involving that company being put in funds (directly or indirectly) by the company, or an entity associated with the company. In this respect, HM Revenue & Customs has confirmed that a company holding an interest in the PROs which incidentally has banking facilities with any company associated with the company will not be a ‘funded company’ by virtue of such facilities. Interest on the PROs constitutes UK source income for UK tax purposes and, as such, may be subject to income tax by direct assessment even where paid without withholding. However, interest with a UK source received without deduction or withholding on account of UK tax will not be chargeable to UK tax in the hands of a US Holder unless, in the case of a corporate US Holder, such US Holder carries on a trade in the UK through a UK permanent establishment or in the case of other US Holders, such persons carry on a trade, profession or vocation in the UK through a UK branch or agency in connection with which the interest is received or to which the PROs are attributable. There are exemptions for interest received by certain categories of agents (such as some brokers and investment managers).
EU Directive on taxation of savings income The European Union has adopted a directive regarding the taxation of savings income. The Directive requires member states of the European Union to provide to the tax authorities of other member states details of payments of interest and other similar income paid by a person to an individual or certain other persons resident in another member state, except that Belgium, Luxembourg and Austria may instead impose a withholding system for a transitional period unless during such period they elect otherwise.
Inheritance tax In relation to PROs held through DTC (or any other clearing system), the UK inheritance tax position is not free from doubt in respect of a lifetime transfer, or death of, a US Holder who is not domiciled nor deemed to be domiciled in the UK for inheritance tax purposes; HM Revenue & Customs is known to consider that the situs of securities held in this manner is not necessarily determined by the place where the securities are registered. In appropriate circumstances, there may be a charge to UK inheritance tax as a result of a lifetime transfer at less than market value by, or on the death of, such US Holder. Inheritance tax is not generally chargeable on gifts to individuals made more than seven years before the death of the donor. However, exemption from, or a reduction of, any such UK tax liability may be available under the Estate Tax Treaty (see below). US Holders should consult their professional advisers in relation to such potential liability.
Exchange controls The company has been advised that there are currently no UK laws, decrees or regulations which would prevent the import or export of capital, including the availability of cash or cash equivalents for use by the Group, or the remittance of dividends, interest or other payments to non-UK resident holders of the company’s securities.
There are no restrictions under the Articles of Association of the company or under UK law, as currently in effect, which limit the right of non-UK resident owners to hold or, when entitled to vote, freely to vote the company’s securities.
For a description of certain provisions of the company’s Memorandum and Articles, see the ‘Additional Information – Memorandum and Articles of Association’ section of the company’s Annual Report on Form 20-F for the fiscal year ended 31 December 2007.
Code of ethics As discussed on page 149, the Group has adopted a code of conduct applicable to all Group employees, which will be provided to any person without charge, upon request, by contacting Group Secretariat at the telephone number listed on page 296.
ADR Depositary Bank BNY Mellon Shareowner Services PO Box 358516 Pittsburgh, PA 15252-8516 Telephone: 866 241 9317 (US callers)
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