Risk management The Group’s approach to risk 108 Emerging risks 110 Capital stress testing 111 How risk is managed 111 Risk governance 113 Full analysis of risk categories 115
2017 has also been a pivotal year for the UK. The Bank of England increased the bank rate for the first time in more than 10 years and the government triggered Article 50 and launched EU exit negotiations. Although the precise nature of the UK’s future relationship with Europe remains unclear and the economic outlook is therefore uncertain, the economy has been resilient with low unemployment, stable house prices, record employment and GDP growth of 1.8 per cent.
As a result of significant strategic progress in 2017, we have reported increased statutory and underlying profits, strong capital generation and have announced an increased ordinary dividend and our intention to implement a share buyback.
Our leading cost position, combined with our simple business model, provides us with the operational flexibility to compete effectively. However, we must go further to respond to these threats.
Ensuring we have the right people and culture to meet evolving customer needs
We will look to build upon these strong foundations in the next phase of our strategy, thereby creating new competitive strengths. Implementation will ensure we can compete effectively and create value in a digital world.
For more about our 2018 – 2020 strategic priorities see pages 15–17
OUR BUSINESS MODEL Digitised, simple, low risk, customer focused, UK financial services provider
Why this is important Our market leading cost position and customer franchise are sources of competitive advantage. However, we must not be complacent and must further digitise the Group to drive additional operational efficiencies, improve the experience of our customers and colleagues and allow us to invest more for the future. In addition, we must continue to simplify and progressively transform our IT architecture in order to use data more efficiently, enhance our multi-channel customer engagement and create a scalable and resilient infrastructure.
Governance Good governance requires an effective structure and the combined effort of engaged and well-informed colleagues. It is essential that it is embedded into the processes, planning and delivery of the Group’s objectives and strategy.
Stakeholder engagement We know that engaging with different stakeholder groups is extremely important. It enables us to understand the issues they face, and their expectations from the Group. Their contributions influence our strategic thinking and also help us to shape our corporate reporting.
As a UK focused retail and commercial bank, we are inextricably linked to the British economy. Our success is the British economy’s success and we are fully committed to help people, businesses and communities in Britain prosper. António Horta-Osório Group Chief Executive
Supported c.6,800 clients in 2017 to export for the first time and helped clients break into new markets through the International Trade Portal.
Workplace, planning and retirement customer assets under administration increased by 15 per cent to £43 billion reflecting net inflows and positive market movements.
Example A deterioration in either the Group’s or the UK’s credit rating, or a sudden and significant withdrawal of customer deposits, would adversely impact our funding and liquidity position.
Pro forma CET1 ratio pre dividend and share buyback1 15.5% 14.1% 1.4pp
Pro forma CET1 ratio pre dividend and share buyback3 15.5% 14.1% 1.4pp
Total number of employees 67,905 70,433 1 Restated. See page 181.
External appointments: Interim Chairman of Provident Financial Plc with effect from 2 February 2018 (previously Senior Independent Director) and Chair of their Risk Advisory Committee, Senior Independent Director and Chair of Risk at QBE Insurance (Europe) Limited.
Skills and experience: Malcolm was previously General Counsel and Company Secretary of Standard Life after a career as a corporate lawyer in private practice in London and Edinburgh. He has a wealth of experience in governance, policy and regulation. He is a Fellow of the Institute of Chartered Secretaries and Administrators and a Member of the Corporate Governance Council and the GC100. Malcolm is an attendee of the Group Executive Committee.
Jakob was appointed Group Director, Community Banking in September 2017. From 2015 to 2017 he was Chief Operating Officer for the Retail Bank and prior to this he was Managing Director of Asset Finance. Other previous roles include Chief Operating Officer for Wealth & International, Managing Director International Retail and International Banking and Wholesale Banking Operations Director. Jakob joined the Group in 2004 having spent six years with McKinsey & Co, in their London office. Prior to McKinsey, Jakob spent time with Goldman Sachs and Oliver Wyman. He has a PhD in Theoretical Physics from Oxford University.
Investor Relations has primary responsibility for managing and developing the Group’s external relationships with existing and potential institutional equity investors and analysts. With support from senior management, they achieved this through a combination of more than 800 meetings and various presentations in 2017. The presentations were primarily aligned to results and included content on strategic progress and financial and operational performance. In addition to this direct shareholder engagement, Investor Relations provides regular reports to the executive team and Board on key market issues and shareholder concerns.
Update to be provided to both the Nomination and Governance Committee and the Board detailing progress against the agreed actions.
1 Aside from assisting with senior recruitment, benchmarking and succession planning, JCA Group has no other connection to the Company.
E2. Use of General Meetings The 2018 AGM will be held on 24 May 2018. The whole Board is expected to attend and will be available to answer shareholders’ questions.
To facilitate shareholder participation, electronic proxy voting and voting through the CREST proxy appointment service are available. All votes are taken by way of a poll to include all shareholder votes cast.
As detailed in last year’s annual report and following our announcement in February 2017, Nick Luff and Anthony Watson left the Board in May 2017. These departures resulted in the positions of Senior Independent Director and Audit Committee Chairman becoming vacant. The Committee reviewed both internal and external candidates for the position of Senior Independent Director. It was subsequently agreed that Anita Frew would become the Senior Independent Director and Simon Henry would become the Chairman of the Audit Committee. Further details in respect of both of these appointments are provided below.
The Committee challenged the economic and non-economic actuarial assumptions made by management which underpin the calculation of the VIF asset and the insurance liabilities. The most significant assumptions were in respect of annuitant mortality, workplace pension persistency and expenses. The annuitant mortality assumptions were updated to recognise recent experience and for the latest industry improvement model; the assumptions for workplace pension persistency were updated to reflect the introduction of new pension freedom; and the Group’s expense assumption was updated to reflect new outsourcing arrangements.
The Group’s effective management of risk helps underpin its low risk and customer focused business model.
Financial reporting risk Risk management and Financial instruments 108–156 and 226–237
The Committee proposes salary increases for the Group Chief Executive and the Chief Financial Officer set below the budget for the wider colleague population, at 2 per cent. Juan Colombás took on a new role of Chief Operating Officer (COO) in September 2017 and accordingly it is proposed he receive a salary increase of 3.4 per cent to reflect the fact that the COO role is larger than his previous role as the Chief Risk Officer.
I should like to draw attention to the following key messages: Underlying profit increased to £8,493 million in 2017, exceeding budget by 8.2 per cent. Taking into consideration this financial performance, the Committee agreed an overall Group Performance Share of 5.1 per cent of underlying profit. This was adjusted both positively and negatively to reflect strong performance against stretching Group strategic objectives and conduct provisions impacting negatively on profitability and shareholder returns. In reaching its decision, the Committee considered the impact on customers, conduct and the Group’s reputation. The overall outcome determined by the Committee was £414.7 million, approximately 5.5 per cent higher than the equivalent bonus outcome for 2016. The total overall outcome, following the adjustments applied above, is 4.7 per cent of underlying profit before tax which remains significantly lower than the funding limit of 10 per cent. Further detail is provided on page 89, including the detailed metrics in the Group’s balanced scorecard.
Deferred GPS awarded in 2017 1 The shares awarded in March 2014 vested on 6 March 2017. The closing market price of the Group’s ordinary shares on that date was 67.51 pence. Shares vested are subject to a further two-year holding period.
FCA total reportable complaints and Financial Ombudsman Service (FOS) uphold rate (excluding PPI)
FCA total reportable complaints and Financial Ombudsman Service (FOS) uphold rate
Performance adjustment is determined by the Remuneration Committee and/or Board Risk Committee and may result in a reduction of up to 100 per cent of the GPS and/or GOS opportunity for the relevant period. It can be applied on a collective or individual basis. When considering collective adjustment, the Senior Independent Performance Adjustment and Conduct Committee (SIPACC) submits a report to the Remuneration Committee and Board Risk Committee regarding any adjustments required to BSCs or the overall GPS and/or GOS outcome to reflect inyear or prior year risk matters.
Individual GPS awards are based upon individual contribution, overall Group financial results and Balanced Scorecard ratings over the past financial year. The Group’s total risk-adjusted GPS outcome is determined by the Remuneration Committee annually as a percentage of the Group’s underlying profit, modified for: – Group Balanced Scorecard performance – Collective and discretionary adjustments to reflect risk matters and/or other factors.
Financial reporting – the Group meets regulatory reporting and tax requirements in jurisdictions where it operates.
– Counterparty credit risk3 – 7.1 – – 0.8 7.9 1 As a separate regulated business, Insurance (excluding Wealth) maintains its own regulatory solvency requirements, including appropriate management buffers, and reports directly to the Insurance Board. Insurance does not hold any RWAs, as its assets are removed from the Banking Group's regulatory capital calculations. However, in accordance with Capital Requirements Directive and Regulation (CRD IV) rules, part of the Group's investment in Insurance is included in the calculation of threshold RWAs, while the remainder is taken as a capital deduction.
IT resilience and cyber: Increasing digitisation places greater reliance on the provision of resilient and secure services to customers. Continued increase in the volume and sophistication of cyber-attacks could disrupt service for customers, causing financial loss/reputational damage.
Risk mitigation: – Drive the development of potential actions and contingency plans to mitigate the impact of adverse scenarios. Stress testing also links directly to the Group’s recovery planning process.
Company Secretariat support senior and Board level committees, and support the Chairs in agenda planning. This gives a further line of escalation outside the three lines of defence.
In commercial portfolios the PD models also segment counterparties into a number of rating grades, with each grade representing a defined range of default probabilities. Counterparties migrate between rating grades if the assessment of the PD changes. The corporate (non-retail) master scale comprises of 19 non-default ratings and 4 default rating grades, and forms the basis on which internal reporting is completed.
Impact of acquisition of businesses 138 – – – 138 –
Commercial Banking UK Direct Real Estate LTV analysis – The Group classifies Direct Real Estate as exposure which is directly supported by cash flows from property activities (as opposed to trading activities, such as hotels, care homes and housebuilders). – Focus remains on the UK market, on good quality customers, with a proven track record in Real Estate and where cash flows are robust.
Exposures Whilst the Group has a zero risk appetite for material regulatory breaches or material legal incidents, the Group remains exposed to material regulatory breaches and material legal incidents outside of its risk appetite. Exposure is driven by significant ongoing and new legislation, regulation and court proceedings in the UK and overseas which in each case needs to be interpreted, implemented and embedded into day-to-day operational and business practices across the Group.
Monitoring Monitoring and reporting is undertaken at Board, Group and business area committees. As part of the reporting of CRAMs, a robust outcomes testing regime for both sales and complaints processes is in place to test performance of customer critical activities.
The table below summarises the consolidated capital position of the Group. The Group’s Pillar 3 report will provide a comprehensive analysis of the own funds of the Group.
Available-for-sale financial assets – – 19,526 19,526 – 21,514 – 1,058 22,572 42,098
Trading market risk measures are applied to all of the Group’s regulatory trading books and they include daily VaR (table 1.49), sensitivity based measures, and stress testing calculations.
For significant provisions made, we understood and challenged the provisioning methodologies and underlying assumptions used by management. For example, we challenged the basis that management used for forecasting the number of PPI complaints that will be received in the future. We considered regulatory developments and management’s interactions with regulators.
As noted in the directors’ statement, the directors have concluded that it is appropriate to adopt the going concern basis in preparing the financial statements. In drawing this conclusion the directors have considered: – the regulatory capital position of the Group which is critical to the market maintaining confidence in the Group’s ability to absorb losses that it may incur in a market stress; and – the funding and liquidity position of the Group to be able to meet its liabilities as they fall due, including in a market stress.
Items that may subsequently be reclassified to profit or loss: Movements in revaluation reserve in respect of available-for-sale financial assets: Adjustment on transfer from held-to-maturity portfolio – 1,544 –
Changes in non-controlling interests – – – – – (242) (242)
– Insurance and participating investment contracts in the Group’s with-profit funds Liabilities of the Group’s with-profit funds, including guarantees and options embedded within products written by these funds, are stated at their realistic values in accordance with the Prudential Regulation Authority’s realistic capital regime, except that projected transfers out of the funds into other Group funds are recorded in the unallocated surplus (see below).
Fees payable for other services: Audit of the Company’s subsidiaries pursuant to legislation 18.6 14.7 14.9
UK corporation tax: Current tax on profit for the year (1,342) (1,010) (485)
Gross investment in finance leases, receivable: Not later than 1 year 680 551
Benefits expected to be paid between 1 and 2 years 1,235 1,180
For the principal post-retirement healthcare scheme, the latest actuarial valuation of the liability was carried out at 31 December 2017 by qualified independent actuaries. The principal assumptions used were as set out above, except that the rate of increase in healthcare premiums has been assumed at 6.81 per cent (2016: 6.84 per cent).
Note 36: Deferred tax The Group’s deferred tax assets and liabilities are as follows: Statutory position £m £m Tax disclosure £m £m
(2) Issued and fully paid share capital 2017 Number of shares 2016 Number of shares 2015 Number of shares 2017 £m 2016 £m 2015 £m
The number of shares awarded relating to matching shares in 2017 was 32,025,497 (2016: 35,956,224), with an average fair value of £0.67 (2016: £0.61), based on market prices at the date of award.
Certain Group companies are also named as defendants in: (i) UK based claims; and (ii) in a Dutch class action, each raising LIBOR manipulation allegations. A number of the claims against the Group in relation to the alleged mis-sale of Interest Rate Hedging Products also include allegations of LIBOR manipulation.
Derivative financial instruments 1,881 23,953 – – – – – 25,834
A one per cent rise in the CDS spread would lead to an increase in the DVA of £96 million to £133 million.
Asset-backed securities: Corporate and other debt securities 17,343 2,124 19,467 17,445 2,163 19,608
Debt securities held as loans and receivables 10 29 – – 7 350 2,775 472 3,643
Share of post-tax results of associates and joint ventures (6) 1 3
Liabilities arising from insurance contracts and participating investment contracts – – (3,828)
IFRS 9 Financial Instruments IFRS 9 replaces IAS 39 ‘Financial Instruments: Recognition and Measurement’ and is effective for annual periods beginning on or after 1 January 2018. The Group has chosen 1 January 2018 as its initial application date of IFRS 9 and has not restated comparative periods.
Common equity tier 1 capital/Core tier 1 capital 14.1 13.6 12.8 12.8 14.0 1 Annual dividends comprise both interim and final dividend payments. Under IFRS, the total dividend for the year represents the interim dividend paid during the year and the final dividend which will be paid and accounted for during the following year.
Chester Asset Securitisation Holdings No.2 Limited 63 Clerical Medical Non Sterling Arts FSA 65 Clerical Medical Non Sterling Arts LSA 65 Clerical Medical Non Sterling Guadalix Hold Co BV 66 Clerical Medical Non Sterling Guadalix Spanish
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