Governance A letter from our Chairman 65 Board of Directors 66 Group Executive Committee 68 Corporate governance report 70
I am also pleased to welcome two new independent Non-Executive Directors to the Board; Sarah Legg, who became a member of the Audit and Board Risk Committee in December 2019 and Catherine Woods who will join us in March 2020. Catherine will join the Board Risk and Remuneration Committees.
Given our clear UK focus, our performance is inextricably linked to the health of the UK economy. During 2019, UK economic performance has remained resilient in the face of significant political and economic uncertainty, supported by record employment, low interest rates and rising real wages. Although uncertainty remains given the ongoing negotiation of international trade agreements, there is now a clearer sense of direction and we remain well placed to Help Britain Prosper, support our customers and deliver strong and sustainable returns for shareholders.
In addition, the Group has paid £2.9 billion tax in 2019 and we are proud to be the largest corporate tax payer in the UK.
Economic profit, a measure of profit taking into account expected losses, tax and a charge for equity utilisation. Economic profit in 2019 was impacted by lower net income received in the year.
We have made strong progress since we launched the Plan in 2014. In 2019, we achieved 20 out of 22 targets, helping to address some of the social, economic and environmental challenges the UK faces. Find out more on page 27.
The combination of heightened expectations and increasing levels of competition has resulted in greater levels of investment in technology across the sector, with banks placing increasing importance on delivering innovative new features for customers as well as continually upgrading and modernising back-office infrastructure. Banks are also regularly adopting new technologies such as machine learning and artificial intelligence to increase the effectiveness and efficiency with which more routine tasks are performed, while also using greater data driven insight to deliver an improved customer experience.
In February 2018, we launched our three year strategy to transform the Group for success in a digital world. Our simple, low risk customer focused strategy builds on our purpose of Helping Britain Prosper and our distinctive strengths.
Indirect engagement Board members are keen to be aware of shareholder sentiment and ensure follow up actions are taken as appropriate. As such all institutional shareholder letters are registered and discussed at the Group Nomination and Governance Committee.
In June 2019, the Group People and Productivity Director, presented to the Board on people and transforming ways of working, providing them with an update on the Group’s people strategy, read more on page 19. The Board also receives regular updates on culture, read more on page 74.
Our Remuneration Committee Chair consulted with shareholders representing over 30 per cent of our issued share capital on initial proposals and continued the dialogue as the policy evolved
Indirect engagement The Group’s Helping Britain Prosper Plan is reviewed and approved annually by the Board to ensure it focuses on what matters most to people, businesses and communities in the UK.
Our response to regulator and government priorities The Board are committed to complying with all relevant legislation, in particular that relating to prudential and conduct regulation. Appropriate regulation is considered in all Board decision making.
Supporting vulnerable customers Vulnerability for our customers exists in many forms, from a specific life event to something long-term. That’s why the Group is committed to raising awareness, fighting stigma and providing meaningful support across a range of challenging issues. Whether supporting our customers’ financial worries following a cancer diagnosis, with our partners at Macmillan, or working with Hope for Justice to provide bank accounts for modern slavery survivors, the Group continues to create innovative solutions for our customers.
Launched in 2014 and reviewed annually, the Plan focuses on the areas where we believe we can make the biggest difference. In 2018, as part of its inclusion in the Group Balanced Scorecard, we set specific targets across seven areas of focus aligned to our three year strategy, including environmental sustainability and progress is outlined below.
Real estate and mortgages will include loans and advances supported by assets which have a full range of Energy Performance Certificate (EPC) ratings including energy efficient properties
Governance Given the strategic importance of our sustainability ambitions, our governance structure provides clear oversight and ownership of the sustainability strategy. This includes: Lloyds Banking Group Board
In addition, existing customers whose overall operations include coal mining and coal power generation or who supply equipment or services to the sector will be expected to explain how they plan to reduce their reliance on revenue from coal fired power stations and/or coal mines. This includes reducing such revenue to less than 30 per cent by 2025 and, where relevant, to eliminate UK coal power generation in line with UK Government commitments.
Sustainability is now a mandatory part of credit applications in Commercial Banking for facilities greater than £500,000, and we continue to develop sector specific guidance to help relationship managers identify climate risks. We will review climate risk as part of the 2020 annual refresh of the Group’s Risk Appetite.
In early 2019 the Chairman paid a personal visit to the charity to meet the staff and experience the developments for himself.
As a result of our focus on the issue, we exceeded our 2020 target delivering 10.2 per cent of roles held by BAME colleagues, and increased the senior roles held by BAME colleagues to 6.7 per cent, working towards our stretching target of 8 per cent by 2020.
Impairment increased 21 per cent, with some weakening in used car prices, methodology refinements and lower cash recoveries following prior year debt sales, while underlying drivers remain strong, particularly in the mortgage book
Operating costs of £2,081 million reduced 5 per cent, as increased investment in the business was more than offset by continued focus on efficiency savings
Financial performance Strong growth in life and pensions sales, up 22 per cent, driven by increases in new members in existing workplace schemes, increased auto enrolment workplace contributions and bulk annuities. On track to achieve 15 per cent market share of workplace business by end of 2020 compared to 10 per cent market share at start of 2018
We are committed to better addressing our customers’ banking needs through consistent, fair and responsible credit risk decisions, aligned to customers’ circumstances, whilst staying within prudent risk appetite
Funding risk is the risk that we do not have sufficiently stable and diverse sources of funding or the funding structure is inefficient. Liquidity risk is the risk that we do not have sufficient financial resources to meet our commitments when they fall due, or can only secure them at excessive cost.
Our models play a vital role in supporting our Group strategy to ensure profitable growth in targeted segments and the drive toward automation and digital solutions to enhance customer outcomes. Model risk management helps ensure these models are implemented in a controlled and safe manner for both ourselves and customers.
The Group’s emerging risks are shown on pages 133 to 134 and a full analysis of the Group’s risk categories is on pages 129 to 187.
Anwyl Homes, founded in 1930, builds high quality houses across North Wales and the North West of England. Lloyds Bank has worked with Anwyl Homes for more than 70 years, providing the firm with the funding and working capital support it’s needed to expand. During the last five-year expansion plan the firm has built 754 new homes, completing developments across North Wales, Shropshire, Staffordshire, Cheshire, Merseyside and Lancashire. As a result of expansion, the firm has also been able to create a number of new jobs within the local area, boosting its workforce by 24 per cent over the same period.
The Group’s market-leading cost:income ratio continues to provide a competitive advantage and further strengthened to 48.5 per cent with positive jaws of 1 per cent.
The Board recognises the importance of meeting the Group’s responsibilities and duties both to shareholders and the communities we serve across the UK. Lord Blackwell Chairman
Group Director Retail and Consumer Finance, responsible for the Lloyds, Halifax, Bank of Scotland, Lex Autolease and Black Horse Brands including the retail branch networks, customer products and telephone banking, in addition to Retail Business Banking and UK Wealth businesses. David is a Fellow of the Chartered Institute of Bankers. He is also Group Executive Sponsor for Disability.
Non-Executive Directors see attendance at Board and Committee meetings as only one part of their role. In addition to the annual schedule of Board and Committee meetings, the Non-Executive Directors undertake a full programme of activities and engagements each year, please see pages 20 to 25 for more information.
The Board held joint discussions with Scottish Widows Group Limited in April and Lloyds Bank Corporate Markets plc in September. These meetings are important in respect of both governance and the sharing of best practice. They also provide the opportunity for in-depth focus on both insurance and corporate markets matters. Performance and business updates are also provided, and, in the case of Lloyds Bank Corporate Markets plc, updates on key milestones in respect of the development of this new bank.
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Considered reviews of Chairman’s fee (without Chairman present) and NonExecutive Directors’ fees (with NonExecutive Directors abstaining)
2019 evaluation of the Board’s performance The 2019 evaluation was conducted internally between October 2019 and January 2020 by the Company Secretary, and was overseen by the Nomination and Governance Committee.
Board focus Board agenda to become less rooted in regulatory compliance and risk mitigation
Lloyds Banking Group Annual Report and Accounts 2019 79 Lloyds Banking Group Annual Report and Accounts 2019 79 Strateg ic rep ort
The Committee concluded that the provision for PPI redress and the Group’s external disclosures were appropriate. The disclosures relating to PPI are set out in note 38: ‘Other provisions’ of the financial statements.
The Committee was satisfied that internal controls over financial reporting were appropriately designed and operating effectively.
As the most senior risk committee in the Group, the Committee interacts with other related risk committees, including the executive Group Risk Committee. Such interaction assists with the agenda planning process, where in addition to annual agenda planning, matters considered by the Group Risk Committee are reviewed to ensure escalation of all relevant matters to the Committee.
Conclusion: The Group’s EU exit contingency plans continue to be closely monitored by the Committee via specific regular updates, covering both operational status and external developments, a suite of early warning indicators and corresponding risk mitigation plans.
The Committee also recognised significant strengthening of the Group’s intelligence capability to inform assessment of risk, for example the work to understand exposure to allegations of money laundering through Baltic banks; and cash-based money laundering through instant deposit machines.
1 Intensities have been restated for 2016-2017 and 2017-2018 to reflect changes to emissions data only, replacing estimated data with actuals; underlying income figures for those years have not changed.
– Vesting will be subject to a set of three financial underpins. – Remuneration Committee retains full discretion to amend the vesting levels from that determined should they not reflect performance.
Individual Performance Assessment and Committee Discretion Personal contribution and how performance has been achieved through leadership approach may be considered where it diverges from scorecard outcomes. Judgement may be applied in deciding whether personal contribution should alter the mechanical outcome provided by balanced scorecard metrics.
1 A measure of profit taking into account Expected Losses, tax and a charge for equity utilisation.
7 The changes in beneficial interests for António Horta-Osório (652 shares), Juan Colombás (568 shares) relate to ‘partnership’ and ‘matching’ shares acquired under the Lloyds Banking Group Share Incentive Plan between 31 December 2019 and 20 February 2020. There have been no other changes up to 20 February 2020.
Percentage change in remuneration levels Figures for ‘All employees’ are calculated using figures for all colleagues eligible for the GPS plan. This population is considered to be the most appropriate group of employees for these purposes because its remuneration structure is consistent with that of the GCE. For 2019, 66,216 colleagues were included in this category.
Gender Pay We have further reduced our gender pay gap in 2019 resulting in a 1.9 per cent improvement since 2017. At Lloyds Banking Group we are committed to promoting a diverse and inclusive working environment. Our focus is on improving the gender pay and bonus gaps by increasing the proportion of women in senior roles. In doing so, the gender gaps will reduce over time. We are committed to attracting and retaining the best talent and we are pleased that our 2019 mean gender pay and bonus gaps have reduced further this year.
The Committee applies its judgement to determine the payout level commensurate with business and/or individual performance or other factors as determined by the Committee. The Committee may reduce the level of award (including to zero), apply additional conditions to the vesting, or delay the vesting of deferred awards to a specified date or until conditions set by the Committee are satisfied, where it considers it appropriate. Awards may be subject to malus and clawback for a period of up to seven years after the date of award which may be extended to 10 years where there is an ongoing internal or regulatory investigation.
Guarantees, such as sign-on awards, may only be offered in exceptional circumstances to new hires for the first year of service and in accordance with regulatory requirements. Any awards made to new hires to compensate them for unvested variable remuneration they forfeit on leaving their previous employment (‘buy-out awards’) will be subject to appropriate retention, deferral, performance and clawback arrangements in accordance with applicable regulatory requirements.
The Group supports the recommendations made in the report 'Enhancing the Risk Disclosures of Banks' issued by the Enhanced Disclosure Task Force of the Financial Stability Board in October 2012.
The focus on these risks by key stakeholders including businesses, clients, shareholders, governments and regulators is increasing, aligned to the evolving societal, regulatory and political landscape.
– Credit applications and sector reviews include assessment of EU related risks. Initiatives in place to help clients effectively identify and mitigate or manage such risks.
– The Group will deepen insight into customer segments, their perception of brands and what they value.
Businesses assess the potential impacts of undertaking any change activity on their ability to execute effectively, and the potential consequences for the existing risk profiles
Exposures Ineffective operational resilience risk management could lead to vital services not being available to customers, and in extreme circumstances, bank failure could result. The Group has in place a transparent and effective operating model to identify and monitor critical business processes from a customer, Group and financial industry perspective. The failure to adequately build resilience into a critical business process may occur in a variety of ways, including: The Group being overly reliant on one location to deliver a critical business process
Measures such as expected credit loss (ECL), risk-weighted assets, observed credit performance, predicted credit quality (usually from predictive credit scoring models), collateral cover and quality, and other credit drivers (such as cash flow, affordability, leverage and indebtedness) are used to enable effective risk measurement across the Group.
Although not immune, credit portfolios are well positioned against an uncertain economic outlook and potential market volatility
The total notional principal amount of interest rate, exchange rate, credit derivative and equity and other contracts outstanding at 31 December 2019 and 31 December 2018 is shown in the table above. The notional principal amount does not, however, represent the Group’s credit risk exposure, which is limited to the current cost of replacing contracts with a positive value to the Group. Such amounts are reflected in note 53 on page 289.
Monitoring Material risks are managed through the relevant divisional-level committees, with review and escalation through Group level committees where appropriate, including the escalation of any material regulatory breaches or material legal incidents.
Poor governance of colleagues’ incentives and rewards and approval of schemes which drive unfair customer outcomes
Exposures The Group’s management of material people risks is critical to its capacity to deliver against its strategic objectives and to be the best bank for customers, particularly in the context of increasing volumes of organisational, political and external market change and increasing digitisation. The Group is exposed to the following key people risks: Failure to recruit, develop and retain colleagues, including ineffective management of succession planning or failure to identify appropriate talent pipeline
Measurement The Group maintains capital levels commensurate with a prudent level of solvency and aims to deliver consistent and high quality returns to shareholders. To support this the capital risk appetite is calibrated by taking into consideration both an internal view of the amount of capital the Group should hold as well as recognising external regulatory requirements.
In the short to medium term the IFRS 9 transitional arrangements for capital, which the Group has adopted, will provide some stability in capital requirements against the increased provisioning, measurement uncertainty and volatility introduced by IFRS 9.
Mitigation The Group manages and monitors liquidity risks and ensures that liquidity risk management systems and arrangements are adequate with regard to the internal risk appetite, Group strategy and regulatory requirements. Liquidity policies and procedures are subject to independent internal oversight by Risk. Overseas branches and subsidiaries of the Group may also be required to meet the liquidity requirements of the entity’s domestic country. Management of liquidity requirements is performed by the overseas branch or subsidiary in line with Group policy. Liquidity risk of the Insurance business is actively managed and monitored within the Insurance business. The Group plans funding requirements over the life of the funding plan, combining business as usual and stressed conditions. The Group manages its liquidity position both with regard to its internal risk appetite and the Liquidity Coverage Ratio (LCR) as required by the PRA and Capital Requirements Directive and Regulation (CRD IV) liquidity requirements.
Funding and liquidity management in 2019 The Group has maintained its strong funding and liquidity position with a stable loan to deposit ratio of 107 per cent.
1 per cent of total assets but limited to the overall Group materiality.
Total comprehensive income attributable to other equity holders 466 433 415
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Adjustment on adoption of IFRS 9 and IFRS 15 – (262) (929) (1,191) – – (1,191)
Remeasurements, comprising actuarial gains and losses, the return on plan assets (excluding amounts included in net interest expense (income) and net of the cost of managing the plan assets) , and the effect of changes to the asset ceiling (if applicable) are reflected immediately in the balance sheet with a charge or credit recognised in other comprehensive income in the period in which they occur. Remeasurements recognised in other comprehensive income are reflected immediately in retained profits and will not subsequently be reclassified to profit or loss.
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) .
The key UK economic assumptions made by the Group averaged over a five-year period are shown below: At 31 December 2019 At 31 December 2018
The table below shows the impact on the Group’s ECL resulting from a decrease/increase in Loss Given Default for a 10 percentage point (pp) increase/ decrease in the UK House Price Index (HPI) .
The valuation techniques for level 2 and level 3 financial instruments involve management judgement and estimates the extent of which depends on the complexity of the instrument and the availability of market observable information. In addition, in line with market practice, the Group applies credit, debit and funding valuation adjustments in determining the fair value of its uncollateralised derivative positions. A description of these adjustments is set out in note 50. Further details of the Group’s level 3 financial instruments and the sensitivity of their valuation including the effect of applying reasonably possible alternative assumptions in determining their fair value are also set out in note 50. Details about sensitivities to market risk arising from trading assets and other treasury positions can be found in the risk management section on page 187.
During 2019, the Group transferred Cardnet, its card payment acceptance service, from Retail into Commercial Banking and also transferred certain equity business from Commercial Banking into Central items. Comparative figures have been restated accordingly.
Net (expense) income arising on assets and liabilities designated at fair value through profit or loss (214) (156) (144)
Note 9: Other operating income 2019 £m 2018 £m 2017 £m
Loans and advances to banks 513 1,886 2,399 848 2,178 3,026
Exchange rate contracts: Interest rate contracts: Total derivative assets/liabilities – trading and other 6,492,038 25,133 24,674 5,464,658 22,032 20,265
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Total loans and advances to customers 257,020 16,654 1,384 13,572 288,630 1 Exchange and other adjustments includes certain adjustments, prescribed by IFRS 9, in respect of purchased or originated credit-impaired financial assets.
Note 21: Financial assets at fair value through other comprehensive income 2019 £m 2018 £m
The acquisition is intended to enhance Scottish Widows' offering and broaden its participation in the financial planning and retirement segment whilst delivering a modern, flexible workplace savings platform.
Change in liabilities charged to the income statement (2,596) (1,969) (4,565) (153) (4,718)
Pension schemes Defined benefit schemes (i) Characteristics of and risks associated with the Group’s schemes The Group has established a number of defined benefit pension schemes in the UK and overseas. All significant schemes are based in the UK, with the three most significant being the main section of the Lloyds Bank Pension Schemes No. 1, the Lloyds Bank Pension Scheme No. 2 and the HBOS Final Salary Pension Scheme. At 31 December 2019, these schemes represented 94 per cent of the Group’s total gross defined benefit pension assets (2018: 94 per cent) . These schemes provide retirement benefits calculated as a percentage of final pensionable salary depending upon the length of service; the minimum retirement age under the rules of the schemes at 31 December 2019 is generally 55 although certain categories of member are deemed to have a contractual right to retire at 50.
On 20 February 2019 the Group announced the launch of a share buyback programme to repurchase outstanding ordinary shares and the programme commenced on 1 March 2019; the Group bought back and cancelled 1,887 million shares under the programme, for a total consideration, including expenses, of £1,095 million. Upon cancellation £189 million, being the nominal value of the shares repurchased, was transferred to the capital redemption reserve.
Certain Group companies are also named as defendants in (i) UK based claims; and (ii) two Dutch class actions, 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.
All lending assets and debt securities held by the Group in Cancara are restricted in use, as they are held by the collateral agent for the benefit of the commercial paper investors and the liquidity providers only. The Group provides liquidity facilities to Cancara under terms that are usual and customary for standard lending activities in the normal course of the Group’s banking activities. During 2019 there have continued to be planned drawdowns on certain liquidity facilities for balance sheet management purposes, supporting the programme to provide funding alongside the proceeds of the asset-backed commercial paper issuance. The Group could be asked to provide support under the contractual terms of these arrangements including, for example, if Cancara experienced a shortfall in external funding, which may occur in the event of market disruption.
Liabilities designated at fair value through profit or loss – 7,085 11 7,096
Note 52: Offsetting of financial assets and liabilities The following information relates to financial assets and liabilities which have been offset in the balance sheet and those which have not been offset but for which the Group has enforceable master netting agreements or collateral arrangements in place with counterparties.
Note 53: Financial risk management As a bancassurer, financial instruments are fundamental to the Group’s activities and, as a consequence, the risks associated with financial instruments represent a significant component of the risks faced by the Group.
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Total loans and advances to customers 123 64 6 – 193
Financial assets at fair value through other comprehensive income (excluding equity shares) An analysis of the Group’s financial assets at fair value through other comprehensive income is included in note 19. The credit quality of the Group’s financial assets at fair value through other comprehensive income (excluding equity shares) is set out below: Investment grade1 £m Other2 £m Total £m
Financial assets at fair value through profit or loss 5,857 5,837
Less: amounts with a maturity of three months or more (3,805) (3,169) (3,193)
Adjustment on adoption of IFRS 9 – – – (2) (2) – (2)
Issue of ordinary shares 107 – – – 107 – 107
Alternative performance measures As described on page 56, the Group analyses its performance on an underlying basis. The Group also calculates a number of metrics that are used throughout the banking and insurance industries on an underlying basis as these provide management with a relevant and consistent view of these measures from period to period. A description of the Group’s alternative performance measures and their calculation is set out below.
Addo Food Group (Holdings) Ltd 76.85% Queens Drive, Nottingham, NG2 1LU i & Addison Social Housing Ltd 20% 35 Great St Helen’s, London, EC3A 6AP Adler & Allan Group Ltd 89% 80 Station Parade, Harrogate, HG1 1HQ i & Archer Topco Ltd 99% c/o Crestbridge Limited, 47 Esplanade, St Helier, Jersey JE1 0BD xvi & Aghoco 1472 Ltd 89.25% 58 Evans Road, Liverpool, L24 9PB i & Airline Services And Components Group Ltd 94.45% Squire Patton Boggs (UK) LLP (Ref: Csu) Rutland House 148 Edmund Street Birmingham B3 2JR i & Allan Water Homes (Heartlands) Ltd 50% 24B Kenilworth Road, Bridge Of Allan, Stirling, Scotland, FK9 4DU i Angus International Safety Group Ltd 67.03%