Form 6-K ROYAL BANK OF SCOTLAND For: Feb 23
FORM 6-K
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
Report of Foreign Private Issuer
Pursuant to Rule 13a-16 or 15d-16
of the Securities Exchange Act of 1934
For
February 23, 2018
Commission
File Number: 001-34718
The
Royal Bank of Scotland plc
RBS,
Gogarburn, PO Box 1000
Edinburgh
EH12 1HQ
(Address
of principal executive offices)
Indicate
by check mark whether the registrant files or will file annual
reports under cover of Form 20-F or Form 40-F.
Form
20-F X Form 40-F
___
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by check mark if the registrant is submitting the Form 6-K in paper
as permitted by Regulation S-T Rule 101(b)(1):_________
Indicate
by check mark if the registrant is submitting the Form 6-K in paper
as permitted by Regulation S-T Rule 101(b)(7):_________
Indicate
by check mark whether the registrant by furnishing the information
contained in this Form is also thereby furnishing the information
to the Commission pursuant to Rule 12g3-2(b) under the Securities
Exchange Act of 1934.
Yes ___
No X
If
"Yes" is marked, indicate below the file number assigned to the
registrant in connection with Rule 12g3-2(b): 82-
________
|
The
following information was issued as Company announcements in
London, England and is furnished pursuant to General Instruction B
to the General Instructions to Form 6-K:
|
The Royal Bank of Scotland plc
23 February 2018
Annual Report and Accounts 2017
A copy of the Annual Report and Accounts 2017 for The Royal Bank of
Scotland plc has been submitted to the National Storage Mechanism
and will shortly be available for inspection at
http://www.morningstar.co.uk/uk/NSM
The document will be available on The Royal Bank
of Scotland Group plc's website at www.rbs.com/reports
For further information, please contact:RBS
Media Relations
+44 (0) 131 523 4205
Investors
Matt Waymark
Investor Relations
+44 (0) 207 672 1758
For the purpose of compliance with the Disclosure Guidance and
Transparency Rules, this announcement also contains risk factors
extracted from the Annual Report and Accounts 2017 in full unedited
text. Page references in the text refer to page numbers in the
Annual Report and Accounts 2017.
Risk factors
Set out
below are certain risk factors that could adversely affect the
Group’s future results, its financial condition and prospects
and cause them to be materially different from what is expected.
The Group is currently the principal operating subsidiary of The
Royal Bank of Scotland Group plc (‘RBSG’ and, together
with its subsidiaries, the RBS Group’). Throughout 2018, the
Group will go through a period of significant corporate change as
it implements its UK ring-fencing compliant structure. Following
the effective date of the first Ring-Fencing Transfer Scheme in
April 2018, the Bank will be renamed ‘NatWest Markets
Plc’ and will primarily comprise the current core NatWest
Markets franchise serving UK and Western European corporate
customers and global financial institutions. NatWest Markets Plc
will services its customers through its trading and sales
operations in London, Singapore and Stamford and sales offices in
Dublin, Hong Kong and Tokyo (See – Report of the
Directors on page 61).
Accordingly,
there will be changes to the risks to which the Group and its
business are or will be exposed during this period and certain of
the risks below will be more or less significant to NatWest Markets
Plc following the implementation of the Group’s UK
ring-fencing compliant structure. In addition, a number of the risk
factors described below which relate to RBSG and the RBS Group will
also be applicable to the Bank and the Group and the occurrence of
any such risks could have a material adverse effect on the
Group’s business, reputation, results of operations,
financial condition, cash flows or future prospects. The factors
discussed below and elsewhere in this report should not be regarded
as a complete and comprehensive statement of all potential risks
and uncertainties facing the Group.
The viability of the Bank (to be renamed as NatWest Markets Plc)
depends on its ability to access sources of liquidity and funding.
If the Bank is unable to raise adequate funds in the capital
markets, its liquidity position could be adversely affected which
may require unencumbered assets to be liquidated or it may result
in higher funding costs which may impact the Group’s margins
and profitability.
The
Group currently relies on retail and wholesale deposits to meet a
considerable portion of its funding. Pursuant to the first
Ring-Fencing Transfer Scheme in April 2018, the majority of retail
and wholesale deposits will transfer to and be held by Adam &
Company PLC (to be renamed The Royal Bank of Scotland plc )
requiring the Group to diversify its sources of funding and
capital.
The
implementation of the UK ring-fencing regime will also impact the
Group’s funding strategy which is currently managed centrally
by the RBS Group insofar as the Group also depends on intragroup
funding arrangements entered into with other RBS Group entities. As
a result of the implementation of the UK ring-fencing regime, such
arrangements may no longer, or only to a limited extent, be
permitted if they are provided to the Group by an entity in the RFB
once a ring-fence compliant structure is established. As a result
the cost of funding may increase for certain Group entities,
including the Bank, which will be required to manage their own
funding and liquidity strategy.
The
Bank will be required to access the debt capital markets with
issuance plans for £2-4 billion in senior unsecured funding in
2018. This will require frequent access to the global capital
markets and entails execution risk. Should its access to the global
capital markets be limited or if it is not able to access markets
at all or on acceptable terms, or if it is not able to reduce its
risk weighted assets (RWAs) in line with assumptions in its funding
plans, it may experience a shortfall in its funding requirements
which would have a material adverse impact on the
Group.
Risk factors continued
The
market view of bank credit risk has changed radically as a result
of the financial crisis and banks perceived by the market to be
riskier have had to issue debt at significantly higher costs.
Although conditions have improved, there have been recent periods
where corporate and financial institution counterparties have
reduced their credit exposures to banks and other financial
institutions, limiting the availability of these sources of
funding. The ability of the Bank of England to resolve the RBS
Group in an orderly manner may also increase investors’
perception of risk and hence affect the availability and cost of
funding for the RBS Group and the Group. Any uncertainty relating
to the credit risk of financial institutions generally or the Group
in particular may lead to reductions in levels of interbank lending
or may restrict the Group’s access to traditional sources of
funding or increase the costs or collateral requirements for
accessing such funding.
In
addition, the RBS Group is subject to certain regulatory
requirements with respect to liquidity coverage, including a
liquidity coverage ratio set by the PRA in the UK. This requirement
was phased in at 90% from 1 January 2017 and increased to 100% in
January 2018 (as required by the Capital Requirements Regulation).
The PRA may also impose additional liquidity requirements on the
RBS Group to reflect risks not captured in the liquidity coverage
ratio by way of Pillar 2 add-ons, which may increase and/or
decrease from time to time and require the RBS Group to obtain
additional funding or diversify its sources of funding. Current
proposals by the Financial Stability Board (‘FSB’) and
the European Commission also seek to introduce certain liquidity
requirements for financial institutions, including the introduction
of a net stable funding ratio (NSFR). Under the European Commission
November 2016 proposals, the NSFR would be calculated as the ratio
of an institution’s available stable funding relative to the
required stable funding it needs over a one-year
horizon.
The
NSFR would be expressed as a percentage and set at a minimum level
of 100%, which indicates that an institution holds sufficient
stable funding to meet its funding needs during a one-year period
under both normal and stressed conditions. If an
institution’s NSFR were to fall below the 100% level, the
institution would be required to take the measures laid down in the
CRD IV Regulation for a timely restoration to the minimum level.
Competent authorities would assess the reasons for non-compliance
with the NSFR requirement before deciding on any potential
supervisory measures.
These
proposals are currently being considered and negotiated among the
European Commission, the European Parliament and the European
Council and, in light of Brexit, there is considerable uncertainty
as to the extent to which such rules will apply to the RBS
Group.
If the
RBS Group or the Group are unable to raise sufficient funds through
deposits or in the capital markets, the liquidity position of the
RBS Group or the Group could be adversely affected and they might
be unable to meet deposit withdrawals on demand or at their
contractual maturity, to repay borrowings as they mature, to meet
their obligations under committed financing facilities, to comply
with regulatory funding requirements, to undertake certain capital
and/or debt management activities or to fund new loans, investments
and businesses. The RBS Group or the Group may need to liquidate
unencumbered assets to meet their liabilities, including disposals
of assets not previously identified for disposal to reduce their
funding commitments. In a time of reduced liquidity, the RBS Group
or the Group may be unable to sell some of their assets, may be
unable to maintain the run-down and sale of certain legacy
portfolios, or may need to sell assets at depressed prices, which
in either case could have a material adverse effect on the
Group’s financial condition and results of
operations.
The RBS Group and the Group are subject to a number of legal,
regulatory and governmental actions and investigations.
Unfavourable outcomes in such actions and investigations could have
a material adverse effect on the Group’s operations,
operating results, reputation, financial position and future
prospects
The RBS
Group’s and the Group’s operations remain diverse and
complex and they operate in legal and regulatory environments that
expose them to potentially significant legal and regulatory
actions, including litigation claims and proceedings and civil and
criminal regulatory and governmental investigations, and other
regulatory risk. The RBS Group and the Group have settled a number
of legal and regulatory actions over the past several years but the
RBS Group and the Group continue to be, and may in the future be,
involved in a number of legal and regulatory actions in the US, the
UK, Europe and other jurisdictions.
The
legal and regulatory actions specifically referred to below are, in
the RBS Group’s view, the most significant legal and
regulatory actions to which the RBS Group, including the Group, are
currently exposed. However, the RBS Group and the Group are
also subject to a number of additional claims, proceedings and
investigations, the adverse resolution of which may also have a
material adverse impact on the Group and which include ongoing
reviews, investigations and proceedings (both formal and informal)
by governmental law enforcement and other agencies and litigation
proceedings (including class action litigation), relating to, among
other matters, the offering of securities, including residential
mortgage-backed securities (RMBS), conduct in the foreign exchange
market, the setting of benchmark rates such as LIBOR and related
derivatives trading, the issuance, underwriting, and sales and
trading of fixed-income securities (including government
securities), product mis-selling, customer mistreatment, anti-money
laundering, sanctions, antitrust and various other compliance
issues.
See
‘Litigation, investigations and reviews’ of note 29 on
the consolidated accounts on pages 156 to 168 for details for these
matters. The RBS Group and the Group continue to cooperate with
governmental and regulatory authorities in relation to ongoing
informal and formal inquiries or investigations regarding these and
other matters.
Risk factors continued
Legal
and regulatory actions are subject to many uncertainties, and their
outcomes, including the timing, amount of fines or settlements or
the form of any settlements, which may be material, are often
difficult to predict, particularly
in the
early stages of a case or investigation. It is expected that the
RBS Group, including the Group will continue to have a material
exposure to legal and regulatory actions relating to legacy issues
in the medium term.
RMBS
In the
US, ongoing matters include certain matters relating to legacy RMBS
activities including investigations by the U.S. Department of
Justice (DOJ) and several state attorneys general and various civil
claims. A further provision of $650 million (£492 million) was
recorded by the RBS Group in Q4 2017 in relation to the RBS
Group’s various RMBS investigations and litigation matters,
taking the charge for the year to $971 million (£714 million).
Total aggregate provisions at 31 December 2017 were $4.4 billion
(£3.2 billion).
The
duration and outcome of the DOJ’s investigations and other
RMBS matters remain uncertain, including in respect of whether
settlements for all or any such matters may be reached and any
timing thereof. Further substantial provisions and costs may be
recognised.
Global Restructuring Group
As
announced on 8 November 2016, the RBS Group has taken steps,
including automatic refunds of certain complex fees and a
complaints process, overseen by an independent third party for
small and medium entity (SME) customers in the UK and the Republic
of Ireland that were in its Global Restructuring Group (GRG)
between 2008 and 2013. This complaints review process and the
automatic refund of complex fees was developed with the involvement
of the Financial Conduct Authority (FCA). The RBS Group booked a
provision of £400 million in Q4 2016, based on its estimates
of the costs associated with the complaints review process and the
automatic refund of complex fees for SME customers in GRG. On 23
October 2017, the FCA published an interim report incorporating a
summary of the Skilled Person’s report which stated that,
further to the general investigation announced in November 2016,
the FCA had decided to carry out a more focused investigation. The
FCA published its final summary of the Skilled Person’s
report on 28 November 2017. The UK House of Commons Treasury Select
Committee, seeking to rely on Parliamentary powers, published the
full version of the Skilled Person’s report on 20 February
2018. The FCA investigation is ongoing and fines or additional
redress commitments may be accepted by or imposed upon the RBS
Group as a result of this or any subsequent investigation or
enquiry, notwithstanding the steps the RBS Group has already
taken.
Payment protection insurance
To
date, the RBS Group has made provisions totaling £5.1 billion
with respect to payment protection insurance (PPI), including an
additional provision of £175 million in 2017. Of the £5.1
billion cumulative provision, £4.1 billion has been utilised
by 31 December 2017. In August 2017, the FCA’s new rules and
guidance on PPI complaints handling (Policy Statement (17/3)) came
into force. The Policy Statement introduced new so called
‘Plevin’ rules, under which customers may be eligible
for redress if the bank earned a high level of commission from the
sale of PPI, but did not disclose this detail at the point of sale.
The Policy Statement also introduced a two year PPI deadline, due
to expire in August 2019, before which new PPI complaints must be
made. The RBS Group is implementing the Policy
Statement.
The
number of claims received and the cost of the redress of such
claims may materially exceed the RBS Group’s estimates and
may entail additional material provisions and reputational
harm.
Settlements,
resolutions and outcomes in relation to ongoing legal or regulatory
actions may result in material financial fines or penalties,
non-monetary penalties, restrictions upon or revocation of
regulatory permissions and licenses and other collateral
consequences and may prejudice both contractual and legal rights
otherwise available to the Group. The costs of resolving these
legal and regulatory actions could individually or in aggregate
prove to be substantial and monetary penalties and other outcomes
could be materially in excess of provisions, if any, made by the
Group. New provisions or increases in existing provisions relating
to existing or future legal or regulatory actions may be
substantial and may have a material adverse effect on the
Group’s financial condition and results of operations as well
as its reputation.
The
outcome of on-going claims against the RBS Group and the Group may
give rise to additional legal claims being asserted against the
Group. Adverse outcomes or resolution of current or future legal or
regulatory actions could result in restrictions or limitations on
the Group’s operations, adversely impact the implementation
of the RBS Group’s current transformation programme as well
as the Group’s capital position and its ability to meet
regulatory capital adequacy requirements. The remediation
programmes or commitments which the RBS Group or the Group have
agreed to in connection with past settlements or investigations,
could require significant financial costs and personnel investment
for the Group and may result in changes in its operations or
product offerings, and failure to comply with undertakings made by
the Group to its regulators may result in additional measures or
penalties being taken against the Group.
Risk factors continued
The Group has been, and will remain, in a period of major business
transformation and structural change through to at least 2019 as it
implements its own transformation programme and seeks to comply
with UK ring-fencing and recovery and resolution requirements as
well as the Alternative Remedies Package. Additional structural
changes to the Group’s operations will also be required as a
result of Brexit. These various transformation and restructuring
activities are required to occur concurrently, which carries
significant execution and operational risks, and the Group may not
be a viable, competitive and profitable bank as a
result.
Since
early 2015, the RBS Group and the Group have been implementing a
major restructuring and transformation programme, articulated
around a strategy focused on the growth of strategic operations in
Personal & Business Banking (PBB) and Commercial & Private
Banking (CPB) and the further restructuring of the NatWest Markets
franchise, to focus mainly on UK and Western European corporate and
financial institutions.
Part of
the focus of this transformation programme is to downsize and
simplify the Group, reduce underlying costs and strengthen its
overall capital position. The transformation programme also aims to
improve customer experience and employee engagement, update its
operational and technological capabilities, strengthen governance
and control
frameworks
and better position the Group to operate in compliance with the UK
ring-fencing regime by 1 January
2019.
Together, these initiatives are referred to as the Group’s
‘transformation programme’.
This
transformation programme, including the restructuring of its
NatWest Markets franchise, is being completed at the same time as
the RBS Group is going through a period of very significant
structural reform to implement the requirements of the UK
ring-fencing regime and the requirements of the bank recovery and
resolution framework. It is complex and entails significant costs
and operational, legal and execution risks. See
‘Implementation of the ring-fencing regime in the UK which
began in 2015 and must be completed before 1 January 2019 will
result in material structural changes to the RBS Group and the
Group’s business, including with respect to the perimeter of
the Group’s activities and the assets, liabilities and
businesses that it holds. The steps required to implement the UK
ring-fencing regime are complex and entail significant costs and
operational, legal and execution risks, which risks may be
exacerbated by the Group’s other ongoing restructuring
efforts. The implementation of ring-fencing will fundamentally
reshape the Group’s business and operations.’ The RBS
Group is concurrently seeking to implement the Alternative Remedies
Package. See ‘The cost of implementing the Alternative
Remedies Package regarding the business previously described as
Williams & Glyn could be more onerous than anticipated and any
failure to comply with the terms of the Alternative Remedies
Package could result in the imposition of additional measures or
limitations on the RBS Group’s and the Group’s
operations.’
Due to
changes in the macro-economic and political and regulatory
environment in which it operates, in particular as a result of
Brexit, the Group has been required to reconsider certain aspects
of its current restructuring and transformation programme. In
anticipation of Brexit the Group has announced that it will be
re-purposing the RBS Group’s Dutch subsidiary, The Royal Bank
of Scotland N.V. (‘RBS N.V.’) for the NatWest Market
franchise’s European business and further structural changes
to Group’s Western European operations may also be required,
including in response to proposed changes to the European
prudential regulatory framework for banks and investment banks.
These proposals may result in additional prudential or structural
requirements being imposed on financial institutions based outside
the EU wishing to provide financial services within the EU and may
apply to the Group once the UK has formally exited the EU. The
ability of the RBS Group to successfully re-purpose and utilise RBS
N.V. as the platform for the NatWest Market franchise’s
European business following Brexit is subject to numerous
uncertainties, including those relating to Brexit negotiations. See
‘The Group is subject to political risks, including economic,
regulatory and political uncertainty arising from the referendum on
the UK’s membership of the European Union which could
adversely impact the Group’s business, results of operations,
financial condition and prospects.’
One
proposal made by the European Commission would impose a requirement
for any bank established outside the EU, which has an asset base
within the EU exceeding a certain size and has two or more
institutions within the EU, to establish a single intermediate
parent undertaking (‘IPU’) in the European Union under
which all EU entities within that group will operate.
The RBS
Group is currently taking steps to plan for how these proposals, if
adopted as currently proposed, may impact the RBS Group and its
current plans to implement the UK ring-fencing regime (which will
come into force on 1 January 2019 ahead of any IPU being required).
The impact of these proposals could be material given the
expectation that the Group would continue to carry out operations
in the EU. This could result in material additional capital
requirements and could have adverse tax implications.
The
scale and scope of the changes currently being implemented present
material operational, people and financial risks to the Group. The
Group’s transformation programme and structural reform agenda
comprise a large number of concurrent actions and initiatives, any
of which could fail to be implemented due to operational or
execution issues. Implementation of such actions and initiatives is
expected to result in significant costs, which could be materially
higher than currently contemplated, including due to material
uncertainties and factors outside of the Group’s control.
Furthermore it requires the implementation and application of
robust governance and controls frameworks and there is no guarantee
that the Group will be successful in doing so.
Risk factors continued
The
planning and execution of the various restructuring and
transformation activities is disruptive and will continue to divert
management resources from the conduct of the Group’s
operations and development of its business. Any additional
restructuring and transformation of the Group’s activities
would increase these risks and could result in further material
restructuring and transformation costs, jeopardise the delivery and
implementation of a number of other significant change projects,
impact the Group’s product offering or business model or
adversely impact the Group’s ability to deliver its strategy
and meet its targets and guidance, each of which could have a
material adverse impact on the Group’s results of operations,
financial condition and prospects.
There
can be no certainty that the Group will be able to successfully
complete its transformation programme and programmes for mandatory
structural reform, nor that the restructured Group will be a
viable, competitive or profitable banking business.
The Group’s ability to meet the targets and expectations
which accompany its own and the RBS Group’s transformation
programme, including with respect to its cost reduction programme
and its return to profitability and the timing thereof, are subject
to various internal and external risks and are based on a number of
key assumptions and judgments any of which may prove to be
inaccurate.
As part
of RBS Group’s and the Group’s transformation
programme, a number of financial, capital, operational and
diversity targets and expectations have been set by management for
the RBS Group and the Group, both for the short term and throughout
the transformation and restructuring period. These include (but are
not limited to) expectations relating to the RBS Group’s and
the Group’s return to profitability and the timing thereof,
one-off costs incurred in connection with material litigation and
conduct matters and the timing thereof, expected growth rates in
income, customer loans and advances and volumes and underlying
drivers and trends, cost:income ratio targets, expectations with
respect to reductions in operating costs, including remediation
costs, expectations relating to restructuring or transformation
costs and charges as well as impairment charges, disposal losses,
CET1 ratio targets and expectations regarding funding plans and
requirements, expectations with respect to reductions in
risk-weighted assets and the timing thereof, expectations with
respect to employees engagement and diversity targets.
The
successful implementation of the transformation programme and the
ability to meet associated targets and expectations, are subject to
various internal and external factors and risks, including those
described in this risk factor, the other risk factors included in
this section and the disclosure included in the rest of this
document. These include, but are not limited to, market,
regulatory, economic and political uncertainties, developments
relating to litigation, governmental actions and investigations and
regulatory matters, operational risks, risks relating to the RBS
Group’s and the Group’s business models and strategies
and delays or difficulties in implementing the transformation
programme, including the restructuring and funding of the NatWest
Markets franchise, the implementation of the UK ring-fencing regime
and compliance with the Alternative Remedies Package obligations. A
number of factors may also impact the RBS Group’s ability to
maintain its current CET1 ratio target at 13% throughout the
restructuring period, including conduct related costs, pension or
legacy charges, accounting impairments, including as a result of
the implementation of IFRS 9, or limited organic capital generation
through profits. In addition, the run-down of risk-weighted assets
may be accompanied by the recognition of disposal losses which may
be higher than anticipated, including due to a degraded economic
environment.
The RBS
Group’s and the Group’s ability to meet cost:income
ratio targets and the planned reductions in annual underlying costs
(excluding restructuring and conduct-related charges) may also be
impacted, and the focus on meeting cost reduction targets may
result in limited investment in other areas which could affect the
RBS Group’s or the Group’s long-term product offering
or competitive position.
More
generally, the targets and expectations which accompany the
transformation programme are based on management plans, projections
and models and are subject to a number of key assumptions and
judgments any of which may prove to be inaccurate. Among others,
the targets and expectations set as part of the transformation
programme assume that the RBS Group and the Group will be
successful in implementing their business models and strategies in
executing the transformation programme and in reducing the
complexity of their businesses and infrastructure, at the same time
that they will be implementing significant structural changes to
comply with the regulatory environment and that they will implement
and maintain robust control environments and effective cultures,
including with respect to risk management.
In
addition, the plans to deliver a UK ring-fencing compliant
structure across franchises and functions may impact the concurrent
transformation programme, which could result in delays to the
transformation programme portfolio deliveries which in turn could
result in delayed benefits therefrom. See ‘The Group has
been, and will remain, in a period of major business transformation
and structural change through to at least 2019 as it implements its
own transformation programme and seeks to comply with UK
ring-fencing and recovery and resolution requirements as well as
the Alternative Remedies Package. Additional structural changes to
the Group’s operations will also be required as a result of
Brexit.
Risk factors continued
These
various transformation and restructuring activities are required to
occur concurrently, which carries significant execution and
operational risks, and the Group may not be a viable, competitive
and profitable bank as a result.’
On
completion of the implementation of the transformation programme,
the further restructuring of the NatWest Markets franchise and the
UK ring-fencing regime, previously anticipated levels of Group
revenue and profitability may not be achieved in the timescale
envisaged or at any time, due to the changed nature of the
Group’s business model and revised scope of the Group’s
business. An adverse macroeconomic environment, including sustained
low interest rates, political and regulatory uncertainty, market
competition for margins and/or heightened litigation costs may also
pose significant headwinds to the profitability of the
Group.
As a
result, there can be no certainty that the implementation of the
transformation programme will prove to be a successful strategy,
that the RBS Group or the Group will meet its targets and
expectations during the restructuring period or that the
restructured RBS Group (including the Group) will be a viable,
competitive or profitable banking business.
Implementation of the ring-fencing regime in the UK which began in
2015 and must be completed before 1 January 2019 will result in
material structural changes to the RBS Group and the Group’s
business, including with respect to the perimeter of the
Group’s activities and the assets, liabilities and businesses
that it holds. The steps required to implement the UK ring-fencing
regime are complex and entail significant costs and operational,
legal and execution risks, which risks may be exacerbated by the
Group’s other ongoing restructuring efforts. The
implementation of ring-fencing will fundamentally reshape the
Group’s business and operations.
The
requirement for large UK banks taking deposits to
‘ring-fence’ retail banking operations was introduced
under the UK Financial Services (Banking Reform) Act 2013 (the
‘Banking Reform Act 2013’) and adopted through
secondary legislation (the ‘UK ring-fencing regime’).
These reforms form part of a broader range of structural reforms of
the banking industry seeking to improve the resilience and
resolvability of banks and which range from structural reforms
(including ring-fencing) to the implementation of a new recovery
and resolution framework (which in the UK will incorporate elements
of the ring-fencing regime). See ‘RBSG and its subsidiaries,
including the Bank, are subject to an evolving framework on
recovery and resolution, the impact of which remains uncertain, and
which may result in additional compliance challenges and
costs.’
By the
end of 2018, the RBS Group intends to have placed the majority of
its UK and Western European banking business in ring-fenced banking
entities organised as a sub-group (‘RFB’) under an
intermediate holding company named NatWest Holdings Limited, which
will ultimately be a direct subsidiary of RBSG and will own
National Westminster Bank Plc, Adam & Company PLC (to be
renamed The Royal Bank of Scotland plc) and Ulster Bank Ireland DAC
(Ulster Bank). As a result, National Westminster Bank Plc will no
longer be a subsidiary of the Bank. The Bank and the RBS
International businesses will sit outside the RFB.
As part
of this restructuring, the majority of existing personal, private,
business and commercial customers of the Bank is expected to be
transferred to the RFB during the second quarter of 2018,
specifically to Adam & Company PLC, which will be renamed The
Royal Bank of Scotland plc. Certain assets and liabilities
(including the covered bond programme, certain hedging positions
and parts of the liquid asset portfolio) will also be transferred
to National Westminster Bank Plc. At the same time, the Bank (which
will sit outside the RFB) will be renamed NatWest Markets Plc to
bring its legal name in line with the rebranding of the NatWest
Markets franchise which was initiated in December 2016, and will
continue to operate the NatWest Markets franchise as a direct
subsidiary of RBSG. The transfer, as described above, will be
effected principally by utilising a legal scheme entitled a
‘Ring-Fencing Transfer Scheme’ under Part VII of the
Financial Services and Markets Act 2000. The implementation of such
a scheme is subject to, amongst other considerations, regulatory
approval and the sanction of the Court of Session in Scotland,
Edinburgh (the ‘Court’). A hearing to seek the
Court’s approval of the scheme is expected to be held on 22
March 2018. The approval of the scheme by the Prudential Regulation
Authority (‘PRA’) is expected to be confirmed shortly
before that hearing date. If the scheme is duly approved by the
Court at the hearing expected to be held on 22 March 2018, it is
expected that the scheme will be implemented with effect from 30
April 2018 or any later date which the RBS Group may agree with the
PRA and the Financial Conduct Authority (‘FCA’).
It remains possible that
the court process described above may result in amendments being
required to be made to the RBS Group’s current plan and that
this may result in delays in the implementation of the UK
ring-fencing compliant structure, additional costs and/or changes
to the RBS Group’s and the Group’s
business.
In
addition, during the second half of 2018, it is proposed that
NatWest Holdings Limited, being the parent of the future
ring-fenced sub-group (which together with other entities is
intended to include National Westminster Bank Plc, Adam &
Company PLC (to be renamed The Royal Bank of Scotland plc) and
Ulster Bank Ireland DAC), will become a direct subsidiary of RBSG.
This is expected to occur through a capital reduction of The Royal
Bank of Scotland plc (to be renamed NatWest Markets Plc), which
will be satisfied by the transfer of the shares in NatWest Holdings
Limited currently held by The Royal Bank of Scotland plc to RBSG,
which will occur via a further and separate court process, which is
subject to the relevant Court and regulatory approvals.
It is possible that the
court process described above may result in amendments being
required to be made to the RBS Group’s current plan and that
this may result in delays in the implementation of the UK
ring-fencing compliant structure, additional costs and/or changes
to the RBS Group’s and the Group’s
business.
During the course of 2018, it is proposed that the RBS Group will
seek to implement a second, smaller ring-fencing transfer scheme as
part of its strategy to implement its future ring-fencing compliant
structure, which is proposed to transfer certain assets from
National Westminster Bank Plc to the Bank (by then renamed to
NatWest Markets Plc). Such a scheme would be subject to the same
reviews and approvals as described above in connection with the
first scheme.
Risk
factors continued
As a result of the implementation of the changes described above,
there will be a material impact on the composition of the
Group’s assets and liabilities and the businesses it operates
and will require a significant legal and organisational
restructuring of the RBS Group and the Group and the transfer of
large numbers of assets, liabilities, obligations, customers and
employees between legal entities within the RBS Group. As the Bank
is currently the principal operating subsidiary of RBSG and holds a
significant share of the RBS Group’s assets and businesses,
such changes, in conjunction with the concurrent restructuring of
the NatWest Markets franchise, will result in a significant
reduction of the perimeter of the Group’s activities as well
as the assets held by the Group as such businesses and assets will
be divested or transferred to other entities within the RBS Group,
which may adversely impact its security holders. The RBS
Group’s final ring-fenced legal structure and the actions
being taken to achieve it, remain subject to, amongst other
factors, additional regulatory, board and other approvals. In
particular, transfers of assets and liabilities by way of a
Ring-Fencing Transfer Scheme, as described above, must be reviewed
and reported on by an Independent Skilled Person appointed by the
RBS Group with the prior approval of the PRA (having consulted with
the FCA). The reports of the Skilled Person are made public and
form part of the court process described above.
The implementation of these changes involves a number of risks
related to both the revised RBS Group and Group structures and also
the process of transition to such new structures. Those risks
include the following:
●
As a result of ring-fencing, the Bank will have fewer customers as
certain customers will be moved from the Group to RFB entities, and
certain customers will also be required to deal with both the RFB
and other RBS Group entities outside the RFB (including the Bank),
in order to obtain the full range of products and services or to
take any affirmative steps in connection with the reorganisation.
The Group is unable to predict how some customers may react to
these and other required changes.
●
As a result of ring-fencing, subject to certain exceptions, the
Group will no longer be able to undertake retail or protected
activities, including the accepting of European Economic Area
retail deposits which must be carried out exclusively within the
RFB. This will require the transfer of certain of the current
Group’s activities to the RFB, leading to a loss of revenue
and assets for the Group. Such changes will alter the scope of the
Group’s activities. Such adjustments to the Group’s
activities and any related loss of customers may have a material
adverse effect on the Group’s business, financial condition
and results of operations.
●
As part of the establishment of the RFB, the RFB will need to
operate independently from other RBS Group entities outside the
RFB, including the Bank, and as a result, amendments will need to
be made to the RBS Group’s existing corporate governance
structure to ensure the RFB is independent of the Bank. This new
structure, which will also require the approval of the PRA, may
result in divergences between the various governance bodies within
the RBS Group and create operational challenges. In particular,
capital and funding requirements of the Bank and other RBS Group
entities outside the RFB will increasingly be managed at the level
of the Group as a result of these increasingly independent
governance structures and this may have an impact on the
availability and cost of funding for the Group.
●
The implementation of the UK ring-fencing regime will significantly
impact the management of the RBS Group’s treasury operations,
including internal and external funding arrangements. The changes
required may adversely impact the assessment made by credit rating
agencies, creditors and other stakeholders of the credit strength
of the Bank on a standalone basis and may heighten the cost of
capital and funding for the Bank and its subsidiaries. The ability
of the Bank to meet funding and capital prudential requirements may
be dependent on obtaining adequate credit ratings. There can be no
guarantee that such a credit rating will be obtained by the Bank.
The Group currently receives capital and funding support from RBS
Group entities, including those which will ultimately be
transferred to the RFB and which may no longer, or only to a
limited extent, provide capital and funding support to the Group
once a ring-fence compliant structure is established. Restrictions
or changes imposed on the ability of the RBS Group to provide
intra-group funding, capital or other support directly or
indirectly to the Bank or its subsidiaries, may result in funding
or capital pressures and liquidity stress for the Bank or its
subsidiaries.
●
The Group currently receives certain services from, and provides
other services to, entities within the RBS Group and has access to
the infrastructure of the RBS Group which the Group currently
requires in order to operate its business. In order to comply with
the requirements of the UK ring-fencing regime, the RBS Group will
need to revise its operations infrastructure so as to comply with
the shared services, independence and resolvability requirements
set out in the UK ring-fencing legislation and rules, including in
areas such as information technology (IT) infrastructure, human
resources and critical service providers which may involve
associated execution risk and may result in increased costs.
Arrangements between the RFB and other RBS Group entities outside
the RFB, including the Bank and its subsidiaries, will also need to
be reviewed in light of these requirements and the requirement that
all such transactions take place on an arm’s-length basis,
which may result in increased operational costs for the Group if it
duplicates certain infrastructure that, following implementation
are run from inside the RFB or rely on third party providers for
the provision of such services or infrastructure.
●
Once the UK ring-fencing regime is implemented, reliance on
intragroup exemptions in relation to the limits of risk-weighted
assets and large exposures will not be possible between the RFB and
other RBS Group entities outside the RFB (including the Bank) and
may result in risk-weighted assets inflation for the Bank and/or
the RBS Group.
●
From 2026 it will not be possible for the Group or other entities
outside the RFB to participate in the same defined benefit pension
scheme as RFB entities or their wholly-owned subsidiaries. As a
result, it will be necessary to restructure the RBS Group’s
defined benefit pension scheme (including The Royal Bank of
Scotland Group Pension Fund ( ‘Main scheme’) in which
the Group currently participates). This restructuring will be such
that either the Group or the RFB entities leave the current scheme.
The costs of separation may be material and may trigger certain
legal and regulatory obligations including possibly increased
contributions. Such restructuring may also result in additional or
increased cash contributions in the event the pension trustees
determine that the employer covenant has been weakened as a result
of such separation. See ‘The Group is subject to pension
risks and may be required to make additional contributions to cover
pension funding deficits as a result of degraded economic
conditions, any devaluation in the asset portfolio held by the
pension trustee, or as a result of the restructuring of its pension
schemes in relation to the implementation of the UK ring-fencing
regime.’
Risk factors continued
●
The restructuring and planned transfers
may also result in accounting consequences for the Bank. Although a
number of transfers will be made at book value between fully owned
RBS Group entities, certain transfers will be made at fair value
which may result in a profit or loss being recognised by the
Bank. In addition,
transfers of assets that have related hedging arrangements may
result in adverse operational, financial or accounting consequences
if the transfer is not consistent with the unaffected continuation
of such hedging arrangements.
●
In addition, the proposed transfers may have tax costs, or may
impact the tax attributes of the Bank and the ability to transfer
tax losses.
The steps required to implement the UK ring-fencing regime within
the RBS Group (including with respect to the Group) to comply with
the relevant rules and regulations are complex and require an
extended period of time to plan, execute and implement and entail
significant costs and operational, legal and execution risks, which
risks may be exacerbated by the RBS Group’s other ongoing
restructuring efforts (many of which impact or will impact the
Group). External or internal factors including new and developing
legal requirements relating to the regulatory framework for the
banking industry and the evolving regulatory and economic landscape
resulting from Brexit, as well as further political developments or
changes to the RBS Group’s current strategy, may require the
RBS Group to further restructure its operations (including certain
Group operations in the UK and Western Europe) and may in turn
require further changes to be made to the RBS Group’s
ring-fencing plans (including the planned structure of the RBS
Group post implementation).
The completion of ring-fencing will substantially reconfigure the
way RBSG holds its businesses and the legal entities within the RBS
Group, including fundamentally reshaping the Group. There is no
certainty that the RBS Group will be able to complete the legal
restructuring and migration of customers’ assets and
liabilities by the 1 January 2019 deadline or in accordance with
future rules and the consequences of non-compliance are currently
uncertain. Conducting the RBS Group’s operations in
accordance with the new rules may result in additional costs
(transitional and recurring) following implementation and impact
the RBS Group’s and/or the Group’s profitability. As a
result, the implementation of the UK ring-fencing regime could have
a material adverse effect on the Group’s reputation, results
of operations, financial condition and prospects.
In July 2018 the RBS Group plans to
reorganise the capital structure of the Bank by way of a Court
approved capital reduction. While the impact on the Bank’s
capital will depend on number of factors, including the potential
resolution of outstanding litigation and conduct matters, the
reduction is expected to be a material change to the Bank’s
absolute level of capital.
Following
the transfer of certain assets and liabilities out of the Bank (to
be renamed NatWest Markets Plc) to Adam & Company PLC (to be
renamed The Royal Bank of Scotland plc) at the end of April 2018
pursuant to the proposed first Ring-Fencing Transfer Scheme, in
July 2018 the RBS Group plans to reorganise the capital structure
of the Bank by way of a Court approved capital reduction. As part
of that Court process, the Bank’s shareholding in NatWest
Holdings Limited, as the parent of the RFB, will be distributed to
RBSG thereby separating the RFB from the remainder of the RBS
Group’s activities. The capital reduction will be a material
change to the Bank’s absolute level of equity while
establishing it with capital intended to be commensurate with its
ongoing activities. The extent of the reduction will depend on
number of factors, including the potential resolution of
outstanding litigation and conduct matters.
The
Group’s capital requirements and needs could vary
significantly over time, including as a result of the changes to
the Group’s business following the implementation of the
ring-fencing regime and may also be affected by general economic
conditions, industry trends, performance and many other factors not
within the Group’s control and the Group may be required to
raise additional capital.
The Group’s borrowing costs, its access to the debt capital
markets and its sources of liquidity depend significantly on its
and the RBS Group’s credit ratings and, to a lesser extent,
on the UK sovereign ratings.
The
credit ratings of RBSG, the Bank and other RBS Group entities
directly affect the cost of funding and capital instruments issued
by those entities, as well as secondary market liquidity in those
instruments. The implementation of ring-fencing is expected to
change the funding strategy of the RBS Group and the
Group.
A
number of UK and other European financial institutions, including
RBSG, the Bank and other RBS Group entities, have been downgraded
multiple times in recent years in connection with rating
methodology changes and credit rating agencies’ revised
outlook relating to regulatory developments, macroeconomic trends
and a financial institution’s capital position and financial
prospects.
The
senior unsecured long-term and short-term credit ratings of RBSG
and the Bank are investment grade by Moody’s, S&P and
Fitch. The outlook for RBSG is currently stable for S&P, Fitch
and Moody’s and the outlook for the Bank is currently stable
for S&P and Fitch and under review for downgrade for
Moody’s. This outlook is consistent with previous statements
made by Moody’s that the implementation of the ring-fencing
regime is likely to lead to downgrades in the ratings of the Bank.
Moody’s has not given an indication of the extent of the
potential downgrade. Therefore, there is a risk that any such
downgrade could be one or more notches.
Risk factors continued
Rating
agencies regularly review the RBSG and RBS Group entity credit
ratings, including those of RBSG, the Bank and other RBS Group
entities, and their ratings of long-term debt are based on a number
of factors, such as the RBS Group’s financial strength as
well as factors not within the Group’s control, including
political developments, conditions affecting the financial services
industry generally and other macroeconomic and political
developments, including in light of the outcome of the negotiations
relating to the form and timing of Brexit. In addition, the rating
agencies may further review the RBSG, the Bank and other RBS Group
entity ratings, as a result of the implementation of the UK
ring-fencing regime and related reorganisation as well as pension
and litigation/regulatory investigation risk, including potential
fines relating to investigations relating to legacy conduct issues.
A challenging macroeconomic environment, a delayed return to
satisfactory profitability and greater market uncertainty could
negatively impact the RBS Group’s (and in particular, the
Bank’s) credit ratings and potentially lead to ratings
downgrades which could adversely impact the RBS Group’s (and
in particular, the Bank’s) ability to fund, and the cost of
that funding, if any. As a result, the Bank’s ability to
access capital markets on acceptable terms and hence the ability to
raise the amount of funding required, and the RBS Group’s
ability to meet its regulatory requirements and targets, including
those relating to loss-absorbing instruments to be issued by the
RBS Group, could be affected. See ‘Implementation of the
ring-fencing regime in the UK which began in 2015 and must be
completed before 1 January 2019 will result in material structural
changes to the RBS Group and the Group’s business, including
with respect to the perimeter of the Group’s activities and
the assets, liabilities and businesses that it holds. The steps
required to implement the UK ring-fencing regime are complex and
entail significant costs and operational, legal and execution
risks, which risks may be exacerbated by the Group’s other
ongoing restructuring efforts. The implementation of ring-fencing
will fundamentally reshape the Group’s business and
operations.
Any
reductions in the long-term or short-term credit ratings of RBSG
and, in particular, the Bank, including downgrades below investment
grade, could adversely affect the Group’s issuance capacity
in the financial markets, increase the funding and borrowing costs
of the Group and, in particular, the Bank, require the Group and,
in particular, the Bank, to replace funding lost due to the
downgrade, which may include the loss of customer deposits and may
limit the Group’s and, in particular, the Bank’s access
to capital and money markets and trigger additional collateral or
other requirements in derivatives contracts and other secured
funding arrangements or the need to amend such arrangements, limit
the range of counterparties and clients willing to enter into
transactions with the Group and, in particular, the Bank, and
adversely affect its competitive position, all of which could have
a material adverse impact on the Group’s earnings, and in
particular, the Bank’s cash flow and financial
condition.
At
31 December 2017, a simultaneous one-notch long-term and associated
short-term downgrade in the credit rating of RBS plc by the three
main ratings agencies would have required RBS plc to post estimated
additional collateral of £1.4 billion, without taking account
of mitigating action by management. Individual credit ratings of
RBS plc, RBS N.V., RBS International, RBS Securities Inc., National
Westminster Bank Plc, Ulster Bank Ltd, Ulster Bank Ireland DAC and
Adam & Company PLC are also important to the RBS Group when
competing in certain markets such as corporate deposits and
over-the-counter derivatives. As discussed above, the success of
the implementation of the UK ring-fencing regime and the
restructuring of the Group, is in part dependent upon the Bank (to
be renamed NatWest Markets Plc) maintaining a sustainable
investment grade credit rating and being able to satisfy their
funding needs. A failure to maintain such a rating, or any
subsequent downgrades may threaten the ability of the Bank or other
entities outside of the RFB to satisfy their funding
needs.
The
major credit rating agencies downgraded and changed their outlook
to negative on the UK’s sovereign credit rating in June 2016
and September 2017 following the UK’s decision to leave the
EU. Any further downgrade in the UK Government’s credit
ratings could adversely affect the credit ratings of RBS Group
entities (including the Bank) and may result in the effects noted
above. Further political developments, including in relation to the
UK’s exit from the EU or the outcome of any further Scottish
referendum could negatively impact the credit ratings of the UK
Government and result in a downgrade of the credit ratings of RBSG,
the Bank and other RBS Group entities.
The Group is subject to political risks, including economic,
regulatory and political uncertainty arising from the referendum on
the UK’s membership of the European Union which could
adversely impact the Group’s business, results of operations,
financial condition and prospects.
In a
referendum held in the UK on 23 June 2016 (the ‘EU
Referendum’), a majority voted for the UK to leave the
European Union (‘EU’). On 29 March 2017 the UK
Government triggered the exit process contemplated under Article 50
of the Treaty on European Union.
This
provides for a maximum two year period of negotiation to determine
the terms of the UK’s exit from the EU (also known as
‘Brexit’) and set the framework for the UK’s new
relationship with the EU.
After
this period its EU membership and all associated treaties will
cease to apply, unless some form of transitional agreement
encompassing those associated treaties is agreed or there is
unanimous agreement by the European Council with the UK to extend
the negotiation period defined under Article 50. There is
no certainty that negotiations relating to the terms of the
UK’s relationship with the EU will be completed within the
two-year period designated by Article 50. Such negotiations may
well extend beyond 29 March 2019, into any transitional period, the
terms and duration of which are currently uncertain. Furthermore,
the government has introduced the European Union (Withdrawal) Bill
(the ‘Withdrawal Bill’) to the UK Parliament, which
aims to repeal the European Communities Act of 1972 and to
transpose EU law relevant to the UK into national law upon Brexit.
However, the precise terms of the Withdrawal Bill, if enacted by
the UK Parliament, are uncertain and it remains unclear how the
Withdrawal Bill will impact the legal and regulatory landscape in
the UK after it becomes effective. In addition, it is possible
(although of low likelihood) that a disorderly termination of the
Article 50 process could occur, resulting in the UK leaving the EU
before 29 March 2019. The consequences of such an early termination
of the Article 50 process are uncertain and adverse impacts could
crystallise rapidly should this occur.
Risk factors continued
This
prevailing uncertainty relates to the timing of Brexit, as well as
to the negotiation and form of the UK’s relationships with
the EU, with other multilateral organisations and with individual
countries at the time of exit and beyond. The timing of, and
process for, such negotiations and the resulting terms of the
UK’s future economic, trading and legal relationships with
both the EU and other counterparties could impact the RBS
Group’s and the Group’s financial condition, results of
operations and prospects. The direct and indirect effects of Brexit
are expected to affect many aspects of the RBS Group’s and
the Group’s business and operating environment, including as
described elsewhere in these risk factors, and may be
material.
The
longer term effects of Brexit on the RBS Group’s and the
Group’s operating environment are difficult to predict, and
are subject to wider global macro-economic trends and events, but
may significantly impact the RBS Group and the Group and their
customers and counterparties who are themselves dependent on
trading with the EU or personnel from the EU and may result in
periodic financial volatility and slower economic growth, in the UK
in particular, but also in Republic of Ireland, Europe and
potentially the global economy. Until the bilateral and
multilateral trading and economic relationships between the UK, the
EU, members of the World Trade Organisation and other key trading
partners are agreed, implemented and settled, the longer-term
effects of this uncertainty are likely to endure and their severity
increase in the absence of such agreements.
There
is related uncertainty as to the respective legal and regulatory
arrangements under which the RBS Group and its subsidiaries
(including the Group) will operate when the UK is no longer a
member of the EU. The RBS Group and its counterparties may no
longer be able to rely on the EU passporting framework for
financial services and could be required to apply for authorisation
in multiple jurisdictions in the EU. The cost and timing of that
authorisation process is uncertain.
The RBS
Group has already announced plans to re-purpose its Dutch banking
subsidiary, RBS N.V., to conduct the NatWest Market
franchise’s European business and further changes to the RBS
Group’s business operations may be required. The ability of
the Bank (to be renamed NatWest Markets Plc) to utilise RBS N.V. as
a platform for its European business is subject to uncertainty and
there is no guarantee that the use of such platform will be
successful. The RBS Group is also monitoring proposed amendments to
the prudential framework for non-EU banks operating within in the
EU. These and any other restructuring or commercial actions as well
as new or amended rules, could have a significant impact on the RBS
Group’s operations and/or legal entity structure, including
attendant restructuring costs, capital requirements and tax
implications and as a result adversely impact the RBS Group’s
and the Group’s profitability, business model and product
offering. These impacts would potentially be greater in the event
of a disorderly termination of the Article 50 process and early
Brexit. See ‘The Group has been, and will remain, in a period
of major business transformation and structural change through to
at least 2019 as it implements its own transformation programme and
seeks to comply with UK ring-fencing and recovery and resolution
requirements as well as the Alternative Remedies Package.
Additional structural changes to the Group’s operations will
also be required as a result of Brexit. These various
transformation and restructuring activities are required to occur
concurrently, which carries significant execution and operational
risks, and the Group may not be a viable, competitive and
profitable bank as a result.’
The RBS
Group and the Group face additional political uncertainty as to how
the Scottish parliamentary process may impact the negotiations
relating to Brexit. RBSG and the Bank are each headquartered and
incorporated in Scotland. Any changes to Scotland’s
relationship with the UK or the EU (as an indirect result of Brexit
or other developments) would impact the environment in which the
RBS Group and its subsidiaries (including the Group) operate, and
may require further changes to be made to the RBS Group’s or
the Group’s structure, independently or in conjunction with
other mandatory or strategic structural and organisational changes
and as a result could adversely impact the RBS Group and the
Group.
The
Group is currently subject to increased political risks as a result
of the UK Government’s majority ownership stake in RBSG. The
UK Government in its November 2017 Autumn Budget indicated its
intention to recommence the process for the privatisation of RBSG
before the end of 2018-2019, although there can be no certainty as
to the commencement of any sell-downs or the timing or extent
thereof.
See
‘HM Treasury (or UKFI on its behalf) may be able to exercise
a significant degree of influence over the RBS Group, including
indirectly on the Group, and any further offer or sale of its
interests may affect the price of securities issued by the RBS
Group.’ Were there to be a change of UK government as a
result of a general election, the Group may face new risks as a
result of a change in government policy. In its 2017 manifesto, for
example, the Labour Party announced its intention to launch a
consultation on breaking up the RBS Group to create new local
public banks, a move that could impact the Group.
In
addition to the political risks described above, the RBS Group
remains exposed to risks arising out of geopolitical events, such
as the imposition of trade barriers, the implementation of exchange
controls and other measures taken by sovereign governments that can
hinder economic or financial activity levels.
Risk factors continued
Operational risks are inherent in the Group’s businesses and
these risks are heightened as the Group implements its
transformation programme, including significant cost reductions,
the UK ring-fencing regime and implementation of the Alternative
Remedies Package, against the backdrop of legal and regulatory
changes.
Operational
risk is the risk of loss resulting from inadequate or failed
internal processes, people or systems, or from external events,
including legal risks. The Group has complex and diverse operations
and operational risks or losses can result from a number of
internal or external factors, including:
●
internal and
external fraud and theft from the RBS Group or the Group, including
cybercrime;
●
compromise of the
confidentiality, integrity, or availability of the RBS
Group’s or the Group’s data, systems and
services;
●
failure to identify
or maintain the RBS Group’s or the Group’s key data
within the limits of their agreed risk appetite;
●
failure to provide
adequate data, or the inability to correctly interpret poor quality
data;
●
failure of the RBS
Group’s or the Group’s technology services due to loss
of data, systems or data centre failure as a result of the
Group’s actions or actions outside the Group’s control,
or failure by third parties to restore services;
●
failure to
appropriately or accurately manage the RBS Group’s or the
Group’s operations, transactions or security;
●
incorrect
specification of models used by the RBS Group or the Group or
implementing or using such models incorrectly;
●
failure to
effectively execute or deliver the transformation
programme;
●
failure to attract,
retain or engage staff;
●
insufficient
resources to deliver change and business-as-usual
activity;
●
decreasing employee
engagement or failure by the RBS Group or the Group to embed new
ways of working and values; or
●
incomplete,
inaccurate or untimely statutory, regulatory or management
reporting.
Operational
risks for the Group are and will continue to be heightened as a
result of the number of initiatives being concurrently implemented
by the Group, in particular the implementation of the Group’s
transformation programme, its cost-reduction programme, the
implementation of the UK ring-fencing regime and implementation of
the Alternative Remedies Package. Individually, these initiatives
carry significant execution and delivery risk and such risks are
heightened as their implementation is often highly correlated and
dependent on the successful implementation of interdependent
initiatives.
These
initiatives are being delivered against the backdrop of ongoing
cost challenges and increasing legal and regulatory uncertainty and
will put significant pressure on the Group’s ability to
maintain effective internal controls and governance frameworks.
Although the Group has implemented risk controls and loss
mitigation actions and significant resources and planning have been
devoted to mitigate operational risk, it is not possible to be
certain that such actions have been or will be effective in
controlling each of the operational risks faced by the Group.
Ineffective management of such risks could have a material adverse
effect on the Group’s business, financial condition and
results of operations.
The Group’s operations are highly dependent on its and the
RBS Group’s IT systems. A failure of its or the RBS
Group’s IT systems, including as a result of the lack of or
untimely investments, could adversely affect its operations,
competitive position and investor and customer confidence and
expose the RBS Group or the Group to regulatory
sanctions.
The RBS
Group’s and the Group’s operations are dependent on the
ability to process a very large number of transactions efficiently
and accurately while complying with applicable laws and regulations
where it does business. The proper functioning of the RBS
Group’s and the Group’s payment systems, financial and
sanctions controls, risk management, credit analysis and reporting,
accounting, customer service and other IT systems, as well as the
communication networks between its branches and main data
processing centres, are critical to the RBS Group’s and the
Group’s operations.
The
vulnerabilities of the RBS Group’s and the Group’s IT
systems are in part due to their complexity, which is attributable
to overlapping multiple dated systems that result from the RBS
Group’s historical acquisitions and insufficient investment
prior to 2013 to keep the IT applications and infrastructure
up-to-date. Within a complex IT estate, the risk of disruption due
to end-of-life hardware and software may create challenges in
recovering from system breakdowns. In 2017, the Group made progress
to remediate or replace out of date systems, reducing the overall
risk of disruption.
However,
some risk remains, and will require continued focus and investment
on an on-going basis to limit any IT failures which may adversely
affect the RBS Group’s or the Group’s relationship with
their customers and their reputation, and which may also lead to
regulatory investigations and redress.
The RBS
Group’s and the Group’s regulators in the UK, continue
to actively monitor progress being made by banks in the UK to
modernise, manage and secure their IT infrastructure and
environment, in order to prevent future failures affecting
customers. Any critical system failure, any prolonged loss of
service availability or any material breach of data security could
cause serious damage to the RBS Group’s or the Group’s
ability to provide service to their customers, which could result
in significant compensation costs or fines resulting from
regulatory investigations and could breach regulations under which
the RBS Group and the Group operate.
In
particular, failures or breaches resulting in the loss or
publication of confidential customer data could cause long-term
damage to the RBS Group’s and/or the Group’s
reputation, business and brands, which could undermine its ability
to attract and keep customers.
Risk factors continued
The RBS
Group and the Group currently are implementing a number of complex
change initiatives, including their transformation programme, the
UK ring-fencing regime and the restructuring of the NatWest Markets
franchise. A failure to safely and timely implement one or several
of these initiatives could lead to disruptions of the RBS
Group’s or the Group’s IT infrastructure or loss or
publication of confidential customer data and in turn could cause
long-term damage to the RBS Group’s and the Group’s
reputation, brands, results of operations and financial position.
In addition, recent or future regulatory changes, such as the EU
General Data Protection Regulation and the CMA’s Open Banking
standard, increase the risks relating to the RBS Group’s and
the Group’s ability to comply with rules that impact its IT
infrastructure. Any non-compliance with such regulations could
result in regulatory proceedings or the imposition of fines or
penalties and consequently could have a material adverse effect on
the RBS Group’s and the Group’s business, reputation,
financial condition and future prospects.
The RBS
Group has made, and will continue to make, considerable investments
in its (including the Group’s) IT systems and technology to
further simplify, upgrade and improve its capabilities to make them
more cost-effective and improve controls, procedures, strengthen
cyber security defences, enhance the digital services provided to
bank customers and improve the RBS Group’s and the
Group’s competitive position, which is designed to reduce the
potential for system failures which adversely affect their
relationship with their customers and reputation, which may lead to
regulatory investigations and redress. However, the RBS
Group’s and Group’s current focus on cost-saving
measures, as part of their transformation programme, may impact the
resources available to implement further improvements to the RBS
Group’s and the Group’s IT infrastructure and
technology or limit the resources available for investments in
technological developments and/or innovation.
Should
such investment and rationalisation initiatives fail to achieve the
expected results, or prove to be insufficient, it could have a
material adverse impact on the Group’s operations, its
ability to retain or grow its customer business or its competitive
position and could negatively impact the Group’s financial
position.
The RBS Group and the Group are exposed to cyberattacks and a
failure to prevent or defend against such attacks and, provide, as
appropriate, notification of them, could have a material adverse
effect on the Group’s operations, results of operations or
reputation.
The RBS
Group and the Group are subject to regular cybersecurity attacks
and related threats, which have targeted financial institutions,
corporates, governments and other institutions across all
industries. The RBS Group and the Group are increasingly reliant on
technology which is vulnerable to attacks and these attacks
continue to increase in frequency, sophistication and severity and
could have a material adverse effect on the Group’s
operations, customers and reputation.
The RBS
Group and the Group rely on the effectiveness of their internal
policies, controls, procedures and capabilities to protect the
confidentiality, integrity and availability of information held on
their computer systems, networks and devices, and also on the
computer systems, networks and devices of third parties with whom
the RBS Group and the Group interact. In connection with the
implementation of the UK ring-fencing regime, certain systems,
networks or devices may be migrated from the Bank level to the
entities within the RFB, which may cause disruption or impact the
effectiveness of such systems, networks or devices.
The RBS
Group and the Group take appropriate measures to prevent, detect
and minimise attacks that could disrupt the delivery of critical
business processes to their customers. Because financial
institutions such as the Group operate with complex legacy
infrastructure, they may be even more susceptible to attack due to
the increased number of potential entry points and weaknesses. In
addition, the increasing sophistication of cyber criminals may
increase the risk of a security breach of the RBS Group’s and
the Group’s systems and as security threats continue to
evolve the RBS Group and the Group may be required to invest
additional resources to modify the security of their systems, which
could have a material adverse effect on the RBS Group’s and
the Group’s results of operations.
Failure
to protect the Group’s operations from cyberattacks or to
continuously review and update current processes and controls in
response to new or existing threats could result in the loss of
customer data or other sensitive information as well as instances
of denial of service for the Group’s customers and
staff.
The RBS
Group and the Group’s systems, and those of third parties
suppliers, are often subject to cyberattacks which have to date
been immaterial to the RBS Group’s and the Group’s
operations. In 2017, the RBS Group experienced 11 distributed
denial of service (DDOS) attacks against customer-facing websites,
one of which caused minimal customer impacts for a short period of
time.
This
represents a decrease from 26 attacks against the RBS Group in
2016, but a recent surge of activity in the fourth quarter of 2017
points towards an increasing trend of such attacks into 2018. The
Group’s DDOS mitigation controls have recently been
strengthened and will continue to be strengthened further in 2018.
However, there can be no assurance that those and the RBS Group and
the Group’s other strategies to defend against cyberattacks,
including future DDOS attacks, will be successful and avoid the
potential adverse effects of cyberattacks on the RBS Group or the
Group.
The
Bank of England, the FCA and HM Treasury in the UK and regulators
in the US and in Europe continue to recognise cybersecurity as a
systemic risk to the financial sector and have highlighted the need
for financial institutions to improve resilience to cyberattacks
and provide timely notification of them, as appropriate. The RBS
Group expects greater regulatory engagement, supervision and
enforcement on cybersecurity in the future. The RBS Group and the
Group continue to participate in initiatives led by the Bank of
England and other regulators designed to share best practice and to
test how major firms respond to significant
cyberattacks.
Risk factors continued
The
outputs of this collaboration along with other regulatory and
industry-led initiatives are continually incorporated into the RBS
Group’s and the Group’s on-going IT priorities and
improvement measures. However, the Group continues to expect that
it and the RBS Group will be targeted regularly in the future but
there can be no certainty that the Group will not be materially
impacted by a future attack.
Any
failure in the RBS Group’s or the Group’s cybersecurity
policies, procedures or controls, could lead to the Group suffering
financial losses, reputational damage, a loss of customers,
additional costs (including costs of notification of consumers,
credit monitoring or card reissuance), regulatory investigations or
sanctions being imposed and could have a material adverse effect on
the Group’s results of operations, financial condition or
future prospects.
The Group’s business and results of operations may be
adversely affected by increasing competitive pressures and
technology disruption in the markets in which it
operates.
The
markets for UK financial services, and the other markets within
which the Group operates, are very competitive, and management
expects such competition to continue or intensify in response to
customer behaviour, technological changes (including the growth of
digital banking), competitor behaviour, new entrants to the market
(including non-traditional financial services providers such as
large retail or technology conglomerates), new lending models (such
as peer-to-peer lending), industry trends resulting in increased
disaggregation or unbundling of financial services or conversely
the re-intermediation of traditional banking services, and the
impact of regulatory actions and other factors. In particular,
developments in the financial sector resulting from new banking,
lending and payment solutions offered by rapidly evolving
incumbents, challengers and new entrants, in particular with
respect to payment services and products, and the introduction of
disruptive technology may impede the Group’s ability to grow
or retain its market share and impact its revenues and
profitability, particularly in its key UK retail banking
segment.
These
trends may be catalysed by various regulatory and competition
policy interventions, particularly as a result of the Open Banking
initiative and other remedies imposed by the Competition and
Markets Authority (CMA) which are designed to further promote
competition within retail banking.
Increasingly
many of the products and services offered by the Group are, and
will become, technology intensive and the Group’s ability to
develop such services has become increasingly important to
retaining and growing the Group’s customer business in the
UK.
There
can be no certainty that the Group’s investment in its IT
capability intended to address the material increase in customer
use of online and mobile technology for banking will be successful
or that it will allow the Group to continue to grow such services
in the future. Certain of the Group’s current or future
competitors may have more efficient operations, including better IT
systems allowing them to implement innovative technologies for
delivering services to their customers.
Furthermore,
the Group’s competitors may be better able to attract and
retain customers and key employees and may have access to lower
cost funding and/or be able to attract deposits on more favourable
terms than the Group. Although the Group invests in new
technologies and participates in industry and research led
initiatives aimed at developing new technologies, such investments
may be insufficient, especially given the RBS Group’s focus
on its cost savings targets, which may limit additional investment
in areas such as financial innovation and therefore could affect
the Group’s offering of innovative products and its
competitive position.
The
Group may also fail to identify future opportunities or derive
benefits from disruptive technologies in the context of rapid
technological innovation, changing customer behaviour and growing
regulatory demands, including the UK initiative on Open Banking
(PSD2), resulting in increased competition from both traditional
banking businesses as well as new providers of financial services,
including technology companies with strong brand recognition, that
may be able to develop financial services at a lower cost base. If
the Group is unable to offer competitive, attractive and innovative
products that are also profitable, it will lose market share, incur
losses on some or all of its activities and lose opportunities for
growth.
For
example, companies in the financial services industry are
increasingly using artificial intelligence and/or automated
processes to enhance their output and performance. As part of this
broader trend, the RBS Group is in the early stages of automating
certain of its solutions and interactions within its
customer-facing businesses. Such developments may result in
unintended consequences or conduct risk for the RBS Group and the
Group if such new processes, including the algorithms used, are not
carefully tested and integrated into the RBS Group’s and the
Group’s current solutions. In addition to such reputational
risks, the development of automated solutions will require
investment in technology and will likely result in increased costs
for the RBS Group and the Group.
In
addition, recent and future disposals and restructurings by the
Group relating to the implementation of non-customer facing
elements of the transformation programme and the UK ring-fencing
regime, or required by the Group’s regulators, as well as
constraints imposed on the Group’s ability to compensate its
employees at the same level as its competitors, may also have an
impact on its ability to compete effectively. Intensified
competition from incumbents, challengers and new entrants in the
Group’s core markets could lead to greater pressure on the
Group to maintain returns and may lead to unsustainable growth
decisions. These and other changes in the Group’s competitive
environment could have a material adverse effect on the
Group’s business, margins, profitability, financial condition
and prospects.
Risk factors continued
The Group is reliant on the RBS Group for capital, liquidity and
funding support and expects to continue to be reliant, at least
during its transition to becoming a standalone sub-group to comply
with the UK ring-fencing requirements.
The
Group currently receives capital, liquidity and funding support
from the RBS Group, including from RBS Group entities which will
ultimately be situated inside of the RFB.
Although
the Group is transitioning to becoming a standalone sub-group of
the RBS Group that will be independent of the RFB to operate in
compliance with the UK ring-fencing regime by 1 January 2019, the
Group is expected to continue to rely on the RBS Group for capital,
liquidity and funding support, at least during the transition
period and such reliance may be necessary for a longer
period.
The
Group will likely be required to hold securities that are compliant
with the minimum requirements for own funds and eligible
liabilities (‘MREL’) on an internal basis and in
compliance with the capital requirements for a ‘material
subsidiary’ as set forth by the Bank of England. RBSG
is the only entity that is able to issue MREL securities
externally. As a result, the Group’s ability to meet
its internal MREL is substantially reliant on RBSG’s ability
to issue sufficient amounts of external MREL securities and
downstream the proceeds to the Group. If RBSG is unable to
issue adequate levels of MREL securities such that it is unable to
downstream sufficient amounts to the Group, this could lead to a
failure of the Group to meet its own individual internal MREL
requirements as well as the internal MREL requirements of
subsidiaries within the Group. See ‘Failure by the RBS
Group or the Group to comply with regulatory capital, funding,
liquidity and leverage requirements may result in intervention by
their regulators and loss of investor confidence, and may have a
material adverse effect on the Group’s results of operations,
financial condition and reputation and may result in distribution
restrictions and adversely impact existing shareholders.’ and
‘As a result of extensive reforms being implemented relating
to the resolution of financial institutions within the UK, the EU
and globally, material additional requirements will arise to ensure
that financial institutions maintain sufficient loss-absorbing
capacity. Such changes to the funding and regulatory capital
framework may require the RBS Group to meet higher capital levels
than anticipated within the RBS Group’s strategic plans and
affect the RBS Group’s and the Group’s funding
costs.’
In
addition, the RBS Group has historically held and managed its
liquidity portfolio centrally, via a single liquidity sub-group
(‘UK DoLSub’) comprising the RBS Group’s five
licensed deposit-taking UK banks: The Royal Bank of Scotland plc,
National Westminster Bank Plc, Ulster Bank Limited, Coutts & Co
and Adam & Company PLC. Following the legal entity
restructuring in response to the UK government’s ring-fencing
legislation, the Bank will separately hold and manage its own
liquidity portfolio. It will therefore cease to form part of
the UK DoLSub at a point in time in the second half of 2018
(subject to regulatory agreement). As a result of the Bank
(to be renamed NatWest Markets Plc) leaving the UK DoLSub, the
Bank’s liquidity position could be adversely affected, which
may require unencumbered assets to be liquidated or may result in
higher funding costs which may impact the Group’s margins and
profitability. See ‘The viability of Bank (to be
renamed as NatWest Markets Plc) depends on its ability to access
sources of liquidity and funding. If the Bank is unable to raise
adequate funds in the capital markets, its liquidity position could
be adversely affected which may require unencumbered assets to be
liquidated or it may result in higher funding costs which may
impact the Group’s margins and
profitability.’
The
planned transfers of a substantial part of the Group’s
operations will result in a loss of customers and related revenue
as the majority of existing personal, private, business and
commercial customers will be moved into the RFB. The Group’s
funding and liquidity needs will be particularly challenging during
this time, in particular if the RBS Group is not able to
successfully complete its transformation programme and if the Group
is not able to adapt its business models following the
implementation of the ring-fencing regime to become a viable,
competitive and profitable banking business. See
‘Implementation of the ring-fencing regime in the UK which
began in 2015 and must be completed before 1 January 2019 will
result in material structural changes to the RBS Group and the
Group’s business, including with respect to the perimeter of
the Group’s activities and the assets, liabilities and
businesses that it holds. The steps required to implement the UK
ring-fencing regime are complex and entail significant costs and
operational, legal and execution risks, which risks may be
exacerbated by the Group’s other ongoing restructuring
efforts. The implementation of ring-fencing will fundamentally
reshape the Group’s business and
operations.’
In
addition, the Group currently also receives capital, liquidity and
funding support from RBS Group entities which will ultimately be
transferred to the RFB and which may no longer, or only to a
limited extent, provide capital and funding support to the Group
once a ring-fence compliant structure is established. The reduction
or cessation of the ability of the RBS Group to provide capital
injections, liquidity or other financial support directly or
indirectly to the Group may result in funding or capital pressures
and liquidity stress for the Group and may have a material adverse
effect on the operations, financial condition and results of
operations of the Group. See ‘The Group’s borrowing
costs, its access to the debt capital markets and its sources of
liquidity depend significantly on its and the RBS Group’s
credit ratings and, to a lesser extent, on the UK sovereign
ratings.’ and ‘The viability of Bank (to be renamed as
NatWest Markets Plc) depends on its ability to access sources of
liquidity and funding.
Risk factors continued
If
the Bank is unable to raise adequate funds in the capital markets,
its liquidity position could be adversely affected which may
require unencumbered assets to be liquidated or it may result in
higher funding costs which may impact the Group’s margins and
profitability.’
The Group’s business performance and financial position could
be adversely affected if its or the RBS Group’s capital is
not managed effectively or if it or the RBS Group is unable to meet
their prudential regulatory requirements, including their capital
targets. Effective management of the RBS Group’s and the
Group’s capital is critical to their ability to operate their
businesses, comply with regulatory obligations, pursue their
transformation programmes and current strategies resume dividend
payments on RBSG ordinary shares, maintain discretionary payments
and pursue their strategic opportunities.
The RBS
Group and the Bank (on a standalone basis) are required by
regulators in the UK, the EU and other jurisdictions in which they
undertake regulated activities to maintain adequate capital
resources. Adequate capital also gives the RBS Group and the Bank
financial flexibility in the face of continuing turbulence and
uncertainty in the global economy and specifically in their core UK
and European markets.
The RBS
Group currently targets a CET1 ratio at or above 13% throughout the
period until completion of its restructuring. On the PRA
transitional basis, the RBS Group’s and the Bank’s CET1
ratio were 15.9% and 14.7%, respectively, at 31 December 2017,
compared with 13.4% and 13.1%, respectively, at 31 December
2016.
The RBS
Group’s target capital ratio for the RBS Group and the RBS
Group entities, including the Bank, is based on its expected
regulatory requirements and internal modelling, including stress
scenarios. However, the ability of the RBS Group or the Bank to
achieve such targets depends on a number of factors, including the
implementation of the RBS Group’s and the Bank’s
transformation programme and any of the factors described below. A
shortage of capital, which could in turn affect the Group’s
capital ratio, could arise from:
●
a depletion of the
RBS Group’s or the Bank’s capital resources through
increased costs or liabilities (including pension, conduct and
litigation costs), reduced profits or increased losses (which would
in turn impact retained earnings), sustained periods of low or
lower interest rates, reduced asset values resulting in
write-downs, impairments or accounting charges;
●
reduced upstreaming
of dividends from the RBS Group’s subsidiaries as a result of
the Bank of England’s approach to setting MREL within groups,
requiring sub-groups, such as the Group, to hold internal MREL
resources sufficient to match both their own individual MREL as
well as the internal MREL of the subsidiaries constituting the
sub-group;
●
an increase in the
amount of capital that is required to meet the Bank’s
regulatory requirements, including as a result of changes to the
actual level of risk faced by the RBS Group or the Group, factors
influencing the RBS Group’s regulator’s determination
of the firm-specific Pillar 2B buffer applicable to the RBS Group
(PRA buffer), changes in the minimum levels of capital or liquidity
required by legislation or by the regulatory authorities or the
calibration of capital or leverage buffers applicable to the RBS
Group or the Bank, including countercyclical buffers, increases in
risk-weighted assets or in the risk weighting of existing asset
classes, or an increase in the RBS Group’s view of any
management buffer it needs, taking account of, for example, the
capital levels or capital targets of the RBS Group’s peer
banks and criteria set by the credit rating agencies;
●
the implementation
of the RBS Group’s transformation programme, including in
response to implementation of the UK ring-fencing regime, means
certain intragroup funding arrangements will be limited and may no
longer be permitted and the RBS Group entities, including the Bank,
may need to increasingly manage funding and liquidity at an
individual RBS Group or Group entity level, which could result in
the RBS Group and the Bank being required to maintain higher levels
of capital in order to meet their regulatory requirements than
would otherwise be the case, as may be the case if the Bank of
England were to identify impediments to the RBS Group’s
resolvability resulting from new funding and liquidity management
strategies. In addition, once the UK ring-fencing regime is
implemented, reliance on intragroup exemptions in relation to large
exposures and liquidity will not be possible between the RFB and
other RBS Group entities outside the RFB (including the Bank) and
may result in risk-weighted assets inflation.
In
addition, the RBS Group’s capital requirements, determined
either as a result of regulatory requirements, including in light
of the implementation of the UK ring-fencing regime and the
establishment of the RFB or management targets, may impact the
level of capital required to be held by the Group and as part of
its capital management strategy, the RBS Group may decide to impose
higher capital levels to be held by the Bank.
The RBS
Group’s and the Bank’s current capital strategy is
based on the expected accumulation of additional capital through
the accrual of profits over time and/or through the planned
reduction of its risk-weighted assets through disposals, natural
attrition and other capital management initiatives.
Further
losses or a failure to meet profitability targets or reduce
risk-weighted assets in accordance with or within the timeline
contemplated by the RBS Group’s capital plan, a depletion of
its or the Bank’s capital resources, earnings and capital
volatility resulting from the implementation of IFRS 9 as of 1
January 2018, or an increase in the amount of capital they need to
hold (including as a result of the reasons described above), would
adversely impact the RBS Group’s or the Bank’s ability
to meet their capital targets or requirements and achieve their
capital strategy during the restructuring period.
Risk factors continued
If the
RBS Group or the Bank are determined to have a shortage of capital,
including as a result of any of the circumstances described above,
the RBS Group and the Bank may suffer a loss of confidence in the
market with the result that access to liquidity and funding may
become constrained or more expensive or may result in the RBS Group
or the Bank being subject to regulatory interventions and
sanctions. The RBS Group’s regulators may also request that
the RBS Group carry out certain capital management actions, which
may impact the Group, or, in an extreme scenario, this may also
trigger the implementation of the RBS Group’s recovery plans.
Such actions may, in turn, affect, among other things, the RBS
Group’s and/or the Group’s product offering, ability to
operate their businesses, comply with their regulatory obligations,
pursue their transformation programme and current strategies,
resume dividend payments on RBSG ordinary shares, maintain
discretionary payments on capital instruments and pursue strategic
opportunities, affecting the underlying profitability of the RBS
Group and the Group and future growth potential.
If, in
response to such shortage, certain regulatory capital instruments
are converted into equity or the RBS Group raises additional
capital through the issuance of share capital or regulatory capital
instruments, existing RBSG shareholders may experience a dilution
of their holdings. The success of such issuances will also be
dependent on favourable market conditions and the RBS Group may not
be able to raise the amount of capital required or on satisfactory
terms. Separately, the RBS Group may address a shortage of capital
by taking action to reduce leverage and/or risk-weighted assets, by
modifying the RBS Group’s legal entity structure or by asset
or business disposals. Such actions may affect the underlying
profitability of the RBS Group and the Group.
Failure by the RBS Group or the Group to comply with regulatory
capital, funding, liquidity and leverage requirements may result in
intervention by their regulators and loss of investor confidence,
and may have a material adverse effect on the Group’s results
of operations, financial condition and reputation and may result in
distribution restrictions and adversely impact existing
shareholders.
The RBS
Group and, where applicable, RBS Group entities (including the
Group and the Bank, are subject to extensive regulatory supervision
in relation to the levels and quality of capital it is required to
hold in connection with its business, including as a result of the
transposition of the Basel Committee on Banking Supervision’s
regulatory capital framework (Basel III) in Europe by a Directive
and Regulation (collectively known as CRD IV).
In
addition, the RBS Group is currently identified as a global
systemically important bank (G-SIB) by the FSB and is therefore
subject to more intensive oversight and supervision by its
regulators as well as additional capital requirements, although the
RBS Group belongs to the last ‘bucket’ of the FSB G-SIB
list and is therefore subject to the lowest level of additional
loss-absorbing capacity requirements.
Each
business within the RBS Group is subject to performance metrics
which factor in underlying regulatory capital requirements for the
RBS Group and the Bank to ensure that business capital targets and
generation are aligned to the RBS Group’s overall risk
appetite.
Under
CRD IV, the RBS Group is required, on a consolidated basis, to hold
at all times a minimum amount of regulatory capital calculated as a
percentage of risk-weighted assets (Pillar 1 requirement). CRD IV
also introduced a number of new capital buffers that are in
addition to the Pillar 1 and Pillar 2A requirements (as described
below) that must be met with CET1 capital.
The
combination of the capital conservation buffer (which, subject to
transitional provisions, will be set at 2.5% from 2019), the
countercyclical capital buffer (of up to 2.5% which is currently
set at 1.0%, with binding effect from 28 November 2018 by the FPC
for UK banks) and the higher of (depending on the institution) the
systemic risk buffer, the global systemically important
institutions buffer (G-SIB Buffer) and the other systemically
important institutions buffer, is referred to as the
‘combined buffer requirement’.
These
rules entered into force on 1 May 2014 for the countercyclical
capital buffer and on 1 January 2016 for the capital conservation
buffer and the G-SIB Buffer. The G-SIB Buffer is currently set at
1.0% for the RBS Group (from 1 January 2017), and is being phased
in over the period to 1 January 2019. The systemic risk buffer will
be applicable from 1 January 2019.
The
Bank of England’s Financial Policy Committee (the FPC) was
responsible for setting the framework for the systemic risk buffer
and the PRA adopted in December 2016 a final statement of policy
implementing the FPC’s framework. In early 2019, the PRA is
expected to determine which institutions the systemic risk buffer
should apply to, and if so, how large the buffer should be up to a
maximum of 3% of a firm’s risk-weighted assets. The systemic
risk buffer will apply to ring-fenced entities only and not all
entities within a banking group. The systemic risk buffer is part
of the UK framework for identifying and setting higher capital
buffers for domestic systemically important banks (D-SIBs), which
are groups that, upon distress or failure, could have an important
impact on their domestic financial systems.
In
addition, national supervisory authorities may add extra capital
requirements (the Pillar 2A requirements) to cover risks that they
believe are not covered or insufficiently covered by Pillar 1
requirements. The RBS Group’s current Pillar 2A requirement
has been set by the PRA at an equivalent of 4.0% of risk-weighted
assets.
The PRA
has also introduced a firm-specific PRA buffer, which is a
forward-looking requirement set annually and based on various
factors including firm-specific stress test results and is to be
met with CET1 capital (in addition to any CET1 capital used to meet
any Pillar 1 or Pillar 2A requirements).
Risk factors continued
Where
appropriate, the PRA may require an increase in an
institution’s PRA buffer to reflect additional capital
required to be held to mitigate the risk of additional losses that
could be incurred as a result of risk management and governance
weaknesses, including with respect to the effectiveness of the
internal stress testing framework and control environment. UK banks
are required to meet the higher of the combined buffer requirement
or PRA buffer requirement. The FPC and PRA have expressed concerns
around potential systemic risk associated with recent increases in
UK consumer lending and the impact of consumer credit losses on
banks’ resilience in a stress scenario, which the PRA has
indicated that it will consider when setting capital buffers for
individual banks.
In
addition to capital requirements and buffers, the regulatory
framework adopted under CRD IV, as transposed in the UK, sets out
minimum leverage ratio requirements for financial institutions.
These include a minimum leverage requirement of 3.25% which applies
to major UK banks, as recalibrated in October 2017 in accordance
with the FPC’s recommendation to the PRA. In addition, the UK
leverage ratio framework provides for: (i) an additional leverage
ratio to be met by G-SIBs and ring-fenced institutions to be
calibrated at 35% of the relevant firm’s capital G-SIB Buffer
or systemic risk buffer and which is being phased in from 2016
(currently set at 0.75% from 1 January 2018) and (ii) a countercyclical
leverage ratio buffer for all firms subject to the minimum leverage
ratio requirements which is calibrated at 35% of a firm’s
countercyclical capital buffer. Further changes may be made to the
current leverage ratio framework as a result of future regulatory
reforms, including the FSB proposals and proposed amendments to the
CRD IV proposed by the European Commission in November
2016.
Most of
the capital requirements which apply or will apply to the RBS Group
or to the Group (directly or indirectly as a result of RBS Group
internal capital management) will need to be met in whole or in
part with CET1 capital.
CET1
capital broadly comprises retained earnings and equity instruments,
including ordinary shares. As a result, the RBS Group’s
ability meet applicable CET1 capital requirements is dependent on
organic generation of CET1 through sustained profitability and/or
the RBS Group’s ability to issue ordinary shares, and there
is no guarantee that the RBS Group may be able to generate CET1
capital through either of these alternatives.
The
amount of regulatory capital required to meet the RBS Group’s
and the Bank’s regulatory capital requirements (and any
additional management buffer), is determined by reference to the
amount of risk-weighted assets held by the RBS Group and the Bank.
The models and methodologies used to calculate applicable
risk-weightings are a combination of individual models, subject to
regulatory permissions, and more standardised approaches. The rules
are applicable to the calculation of the RBS Group’s and the
Bank’s risk-weighted assets are subject to regulatory changes
which may impact the levels of regulatory capital required to be
met by the RBS Group and the Bank.
On 7
December 2017, the Basel Committee on Banking Supervision published
revised standards intended to finalise the Basel III post-crisis
regulatory reforms. The revised standards include the following
elements: (i) a revised standardised approach for credit risk,
which will improve the robustness and risk sensitivity of the
existing approach; (ii) revisions to the internal ratings-based
approach for credit risk, where the use of the most advanced
internally modelled approaches for low-default portfolios will be
limited; (iii) revisions to the credit valuation adjustment (CVA)
framework, including the removal of the internally modelled
approach and the introduction of a revised standardised approach;
(iv) a revised standardised approach for operational risk, which
will replace the existing standardised approaches and the advanced
measurement approaches; (v) revisions to the measurement of the
leverage ratio and a leverage ratio buffer for global systemically
important banks (G-SIBs), which will take the form of a Tier 1
capital buffer set at 50% of a G-SIB’s risk-weighted capital
buffer; and (vi) an aggregate output floor, which will ensure that
banks' risk-weighted assets (RWAs) generated by internal models are
no lower than 72.5% of RWAs as calculated by the Basel III
framework’s standardised approaches.
The
revised Basel III standards will take effect from 1 January 2022
and will be phased in over five years. Although the revised Basel
III standards must be implemented through legislation in the EU and
UK, and precise estimates of their impact would be premature at
this time, the revised standards may result in higher levels of
risk-weighted assets and therefore higher levels of capital, and in
particular CET1 capital, required to be held by the RBS Group or
the Group under Pillar 1 requirements. Such requirements would be
separate from any further capital overlays required to be held as
part of the PRA’s determination of the RBS Group’s
Pillar 2A or PRA buffer requirements with respect to such
exposures.
In the
UK, the PRA also set revised expectations to the calculation of
risk-weighted capital requirements in relation to residential
mortgage portfolios which firms are expected to meet by the end of
2020. To this effect, firms should also submit amended models for
regulatory approval.
Although
the above provides an overview of the capital and leverage
requirements currently applicable to the RBS Group and the Bank,
such requirements are subject to ongoing amendments and revisions,
including as a result of final rules and recommendations adopted by
the FSB or by European or UK regulators. In particular, on 23
November 2016, the European Commission published a comprehensive
package of reforms including proposed amendments to CRD IV and the
EU Bank Recovery and Resolution Directive (the BRRD). Although such
proposals are currently being considered and discussed among the
European Commission, the European Parliament and the European
Council and their final form and the timetable for their
implementation are not known, such amendments may result in
increased or more stringent requirements applying to the RBS Group
or its subsidiaries (including the Bank).
Risk factors continued
This
uncertainty is compounded by Brexit which may result in further
changes to the prudential and regulatory framework applicable to
the RBS Group and the Bank.
If the
RBS Group is unable to raise the requisite amount of regulatory
capital (including loss absorbing capital in the form of MREL), or
if the RBS Group or the Bank otherwise fail to meet regulatory
capital and leverage requirements, they may be exposed to increased
regulatory supervision or sanctions, loss of investor confidence,
and restrictions on distributions or they may be required to reduce
further the amount of their risk-weighted assets or total assets
and engage in the disposal of core and other non-core businesses,
including businesses within the Group, which may not occur on a
timely basis or achieve prices which would otherwise be attractive
to the RBS Group or the Group.
This
may also result in write-down or the conversion into equity of
certain regulatory capital instruments issued by the RBS Group or
the issue of additional equity by the RBS Group, each of which
could result in the dilution of the RBS Group’s existing
shareholders. A breach of the RBS Group’s or the Bank’s
applicable capital or leverage requirements may also trigger the
application of the RBS Group’s recovery plan to remediate a
deficient capital position.
Any of
these developments, including the failure by the RBS Group to meet
its regulatory capital and leverage requirements, may have a
material adverse impact on the Group’s capital position,
operations, reputation or prospects.
As a result of extensive reforms being implemented relating to the
resolution of financial institutions within the UK, the EU and
globally, material additional requirements will arise to ensure
that financial institutions maintain sufficient loss-absorbing
capacity. Such changes to the funding and regulatory capital
framework may require the RBS Group to meet higher capital levels
than anticipated within the RBS Group’s strategic plans and
affect the RBS Group’s and the Group’s funding
costs.
In
addition to the prudential requirements applicable under CRD IV,
the BRRD introduces, among other things, a requirement for banks to
maintain at all times a sufficient aggregate amount of own funds
and ‘eligible liabilities’ (that is, liabilities that
can absorb loss and assist in recapitalising a firm in accordance
with a predetermined resolution strategy), known as MREL), designed
to ensure that the resolution of a financial institution may be
carried out, without public funds being exposed to the risk of loss
and in a way which ensures the continuity of critical economic
functions, maintains financial stability and protects
depositors.
In
November 2015, the FSB published a final term sheet setting out its
total loss-absorbing capacity (‘TLAC’) standards for
G-SIBs. The EBA was mandated to assess the implementation of MREL
in the EU and the consistency of MREL with the final TLAC standards
and published an interim report setting out the conclusions of its
review in July 2016 and its final report in December
2016.
On the
basis of the EBA’s work and its own assessment of CRD IV and
the BRRD, the European Commission published in November 2016 a
comprehensive set of proposals, seeking to make certain amendments
to the existing MREL framework. In particular, the proposals make a
number of amendments to the MREL requirements under the BRRD, in
part in order to transpose the FSB’s final TLAC term
sheet.
The UK
government is required to transpose the BRRD’s provisions
relating to MREL into law through further secondary legislation. In
November 2016, the Bank of England published its final rules
setting out its approach to setting MREL for UK banks. These final
rules (which were adopted on the basis of the current MREL
framework in force in the EU) do not take into account the European
Commission’s most recent proposals with respect to MREL and
differ in a number of respects. In addition, rules relating to a
number of specific issues under the framework remain to be
implemented. These include internal MREL requirements, in respect
of which the FSB published guiding principles in July 2017. The
Bank of England published a consultation paper in October 2017 but
has not yet published a final statement of policy on its approach
to setting internal MREL. The Bank of England has also stated that
it expects to set out policy proposals for MREL cross-holdings and
disclosure requirements once there is greater clarity as to the
timing and final content of related EU proposals.
The
Bank of England is responsible for setting the MREL requirements
for each UK bank, building society and certain investment firms in
consultation with the PRA and the FCA, and such requirement will be
set depending on the resolution strategy of the financial
institution. In its final rules, the Bank of England has set out a
staggered compliance timeline for UK banks, including with respect
to those requirements applicable to G-SIBs (including the RBS
Group).
Under
the revised timeline, G-SIBs will be expected to (i) meet the
minimum requirements set out in the FSB’s TLAC term sheet
from 1 January 2019 (i.e. the higher of 16% of risk-weighted assets
or 6% of leverage exposures), and (ii) meet the full MREL
requirements to be phased in from 1 January 2020, with the full
requirements applicable from 2 January 2022 (i.e. for G-SIBs two
times Pillar 1 plus Pillar 2A or the higher of two times the
applicable leverage ratio requirement or 6.75% of leverage
exposures). MREL requirements are expected to be set on
consolidated, sub-consolidated and individual bases, and are in
addition to regulatory capital requirements (so that there can be
no double counting of instruments qualifying for capital
requirements).
For
institutions, including the RBS Group, for which bail-in is the
required resolution strategy and which are structured to permit
single point of entry resolution due to their size and systemic
importance, the Bank of England has indicated that in order to
qualify as MREL, eligible liabilities must be issued by the
resolution entity (i.e. the holding company for the RBS Group) and
be structurally subordinated to operating and excluded liabilities
(which include insured deposits, short-term debt, derivatives,
structured notes and tax liabilities).
Risk factors continued
The
final rules set out a number of liabilities which cannot qualify as
MREL and are therefore ‘excluded liabilities’. As a
result, senior unsecured issuances by RBSG will need to be
subordinated to the excluded liabilities described
above.
The
proceeds from such issuances will be transferred to material
operating subsidiaries (as identified using criteria set in the
Bank of England’s final rules on internal MREL) in the form
of capital or another form of subordinated claim. In this way, MREL
resources will be ‘structurally subordinated’ to senior
liabilities of operating companies, allowing losses from operating
companies to be transferred to the holding company and - if
necessary - for resolution to occur at the holding company level,
without placing the operating companies into a resolution process.
The TLAC standard requires that the total amount of excluded
liabilities on RBSG’s balance sheet does not exceed 5% of its
external TLAC (i.e. the eligible liabilities RBSG has issued to
investors which meet the TLAC requirements) and the Bank of England
has adopted this criterion in its final rules. If the RBS Group
were to fail to comply with this ‘clean balance sheet’
requirement, it could disqualify otherwise eligible liabilities
from counting towards MREL and result in the RBS Group breaching
its MREL requirements.
The
purpose of internal MREL requirements is to provide for
loss-absorbing capacity to be appropriately distributed within a
banking group and to provide the mechanism by which losses can be
transferred from operating companies to the resolution entity. The
Bank of England proposes to set internal MREL requirements above
capital requirements for each ‘material subsidiary’ of
a banking group. The Bank of England will formally determine which
entities within the group represent material subsidiaries, with
reference to indicative criteria including such subsidiary’s
contribution to the RBS Group’s risk-weighted assets and
operating income.
It will
also set the internal MREL requirement, calibrated to be between
75% and 90% of the external MREL requirement that would otherwise
apply to a material subsidiary were it a resolution entity in its
own right. Such requirements must be met with internal MREL
resources which are subordinated to the operating liabilities of
the material subsidiary issuing them and must be capable of being
written down or converted to equity via a contractual trigger.
These liabilities, issued to other group entities (typically the
issuing entity’s immediate parent), must be priced on an
arm’s-length basis. The impact of these requirements on the
RBS Group and the Group, the cost of servicing these liabilities
and the implications for the RBS Group’s and the
Group’s funding plans cannot be assessed with certainty until
the Bank of England’s proposed internal MREL policy is
finalised and final rules
are published.
Compliance
with these and other future changes to capital adequacy and
loss-absorbency requirements in the EU and the UK by the relevant
deadline will require the RBS Group to restructure its balance
sheet and issue additional capital and other instruments compliant with
the rules, which may be costly, whilst certain existing Tier 1 and
Tier 2 securities and other senior, unsecured instruments issued by the
RBS Group will cease to count towards the RBS Group’s
loss-absorbing capacity for the purposes of meeting MREL/TLAC
requirements.
The RBS
Group’s resolution authority can impose an MREL requirement
over and above the regulatory minima and potentially higher than
the RBS Group’s peers, if it has concerns regarding the
resolvability of the RBS Group.
As a
result, the RBS Group may be required to issue additional
loss-absorbing instruments in the form of CET1 capital or
subordinated or senior unsecured debt instruments and may see an
increased risk of a breach of the RBS Group’s combined buffer
requirement triggering the restrictions relating to the MDA
described above.
There
remain some areas of uncertainty regarding the implementation of
outstanding regulatory requirements in the UK, the EU and globally,
and the final requirements to which the RBS Group will be subject,
and the RBS Group may therefore need to revise its capital plan
accordingly.
The Group’s businesses and performance can be negatively
affected by actual or perceived economic conditions in the UK and
globally and other global risks, including risks arising out of
geopolitical events and political developments and the Group will
be increasingly impacted by developments in the UK as its
operations become increasingly concentrated in the UK.
Actual
or perceived difficult global economic conditions can create
challenging economic and market conditions and a difficult
operating environment for the Group’s businesses and its
customers and counterparties. As part of its revised strategy, the
RBS Group has been refocusing its business in the UK, the ROI and
Western Europe and, accordingly is more exposed to the economic
conditions of the British economy as well as the Eurozone. In
particular, the longer term effects of Brexit are difficult to
predict and are subject to wider global macro-economic trends, but
may include periods of financial market volatility and slower
economic growth, in the UK in particular, but also in the ROI,
Europe and the global economy, at least in the short to medium
term.
See
‘The Group is subject to political risks, including economic,
regulatory and political uncertainty arising from the referendum on
the UK’s membership of the European Union which could
adversely impact the Group’s business, results of operations,
financial condition and prospects.’ and ‘The Group has
been, and will remain, in a period of major business transformation
and structural change through to at least 2019 as it implements its
own transformation programme and seeks to comply with UK
ring-fencing and recovery and resolution requirements as well as
the Alternative Remedies Package. Additional structural changes to
the Group’s operations will also be required as a result of
Brexit. These various transformation and restructuring activities
are required to occur concurrently, which carries significant
execution and operational risks, and the Group may not be a viable,
competitive and profitable bank as a result.’
The
outlook for the global economy over the medium-term remains
uncertain due to a number of factors including political
instability, an extended period of low inflation and low interest
rates, although monetary policy has begun the process of
normalisation in some countries.
Risk factors continued
The
normalisation of monetary policy in the USA may affect some
emerging market economies which may raise their domestic interest
rates in order to avoid capital outflows, with negative effects on
growth and trade. Such conditions could be worsened by a number of
factors including political uncertainty or macro-economic
deterioration in the Eurozone or the US, increased instability in
the global financial system and concerns relating to further
financial shocks or contagion, volatility in the value of the pound
sterling, new or extended economic sanctions, volatility in
commodity prices or concerns regarding sovereign debt. In
particular, concerns relating to emerging markets, including lower
economic growth or recession, concerns relating to the Chinese
economy and financial markets, reduced global trade in emerging
market economies to which the Group is exposed or increased
financing needs as existing debt matures, may give rise to further
instability and financial market volatility.
Any of
the above developments could impact the Group directly by resulting
in credit losses and indirectly by further impacting global
economic growth and financial markets.
Developments
relating to current economic conditions, including those discussed
above, could have a material adverse effect on the Group’s
business, financial condition, results of operations and prospects.
Any such developments may also adversely impact the financial
position of the Group’s pension schemes, which may result in
the Group being required to make additional contributions. See
‘The Group is subject to pension risks and may be required to
make additional contributions to cover pension funding deficits as
a result of degraded economic conditions, any devaluation in the
asset portfolio held by the pension trustee, or as a result of the
restructuring of its pension schemes in relation to the
implementation of the UK ring-fencing regime.’
In
addition, the Group is exposed to risks arising out of geopolitical
events or political developments, such as trade barriers, exchange
controls, sanctions and other measures taken by sovereign
governments that can hinder economic or financial activity
levels.
Furthermore,
unfavourable political, military or diplomatic events, including
secession movements or the exit of other Member States from the EU,
armed conflict, pandemics, state and privately sponsored cyber and
terrorist acts or threats, and the responses to them by
governments, could also adversely affect economic activity and have
an adverse effect upon the Group’s business, financial
condition and results of operations.
The financial performance of the RBS Group has been, and may
continue to be, materially affected by customer and counterparty
credit quality and deterioration in credit quality could arise due
to prevailing economic and market conditions and legal and
regulatory developments.
The RBS
Group has exposure to many different industries, customers and
counterparties, and risks arising from actual or perceived changes
in credit quality and the recoverability of monies due from
borrowers and other counterparties are inherent in a wide range of
the Group’s businesses. In particular, the Group has
significant exposure to certain individual customers and other
counterparties in weaker business sectors and geographic markets
and also has concentrated country exposure in the UK, the US and
across the rest of Europe principally Germany, the Netherlands,
Ireland and France.
At 31
December 2017, the RBS Group’s current exposure in the UK was
£363.0 billion, in the US was £18.4 billion and in
Western Europe (excluding the UK) was £60.0 billion); and
within certain business sectors, namely personal and financial
institutions (at 31 December 2016, personal lending amounted to
£176.6 billion, and lending to banks and other financial
institutions was £37.8 billion.
Provisions
held on loans in default have decreased in recent years due to
asset sales and the portfolio run-down in Ulster Bank Ireland DAC
and the NatWest Markets franchise’s legacy portfolios. If the
risk profile of these loans were to increase, including as a result
of a degradation of economic or market conditions, this could
result in an increase in the cost of risk and the Group may be
required to make additional provisions, which in turn would reduce
earnings and impact the Group’s profitability. The
Group’s lending strategy or processes may also fail to
identify or anticipate weaknesses or risks in a particular sector,
market or borrower category, which may result in an increase in
default rates, which may, in turn, impact the Group’s
profitability. Any adverse impact on the credit quality of the
Group’s customers and other counterparties, coupled with a
decline in collateral values, could lead to a reduction in
recoverability and value of the Group’s assets and higher
levels of impairment allowances, which could have an adverse effect
on the Group’s operations, financial position or
prospects.
The
credit quality of the Group’s borrowers and its other
counterparties is impacted by prevailing economic and market
conditions and by the legal and regulatory landscape in their
respective markets. Credit quality has improved in certain of the
Group’s core markets, in particular the UK and Ireland, as
these economies have improved. However, a further deterioration in
economic and market conditions or changes to legal or regulatory
landscapes could worsen borrower and counterparty credit quality
and also impact the Group’s ability to enforce contractual
security rights. In particular, developments relating to Brexit may
adversely impact credit quality in the UK.
In
addition, as the RBS Group continues to implement its strategy and
further reduces its scale and global footprint, the Group’s
relative exposure to the UK and to certain sectors and asset
classes in the UK will continue to increase as its business becomes
more concentrated in the UK as a result of the reduction in the
number of jurisdictions outside of the UK in which it operates. The
level of UK household indebtedness remains high and the ability of
some households to service their debts could be challenged by a
period of higher unemployment. Highly indebted households are
particularly vulnerable to shocks, such as falls in incomes or
increases in interest rates, which threaten their ability to
service their debts.
Risk factors continued
In
particular, in the UK the Group is at risk from downturns in the UK
economy and volatility in property prices in both the residential
and commercial sectors. With UK home loans currently representing
the most significant portion of the Group’s total loans and
advances to the retail sector, the Group has a large exposure to
adverse developments in the UK residential property sector. In the
UK commercial real estate market, activity has improved against
2016 but may be short-lived given continued political uncertainty
and progress of negotiations relating to the form and timing of
Brexit. There is a risk of further adjustment given the reliance of
the UK commercial real estate market in recent years on inflows of
foreign capital and, in some segments, stretched property
valuations. As a result, the continued house price weakness,
particularly in London and the South East of the UK, would be
likely to lead to higher impairment and negative capital impact as
loss given default rate increases. In addition, reduced
affordability of residential and commercial property in the UK, for
example, as a result of higher interest rates, inflation or
increased unemployment, could also lead to higher impairments on
loans held by the Group being recognised.
The
Group also remains exposed to certain counterparties operating in
certain industries which have been under pressure in recent years
and any further deterioration in the outlook the credit quality of
these counterparties may require the Group to make additional
provisions, which in turn would reduce earnings and impact the
Group’s profitability.
In
addition, the Group’s credit risk is exacerbated when the
collateral it holds cannot be realised as a result of market
conditions or regulatory intervention or is liquidated at prices
not sufficient to recover the full amount of the loan or derivative
exposure that is due to the Group, which is most likely to occur
during periods of illiquidity and depressed asset valuations, such
as those experienced in recent years. This has particularly been
the case with respect to large parts of the Group’s
commercial real estate portfolio. Any such deteriorations in the
Group’s recoveries on defaulting loans could have an adverse
effect on the Group’s results of operations and financial
condition.
Concerns
about, or a default by, one financial institution could lead to
significant liquidity problems and losses or defaults by other
financial institutions, as the commercial and financial soundness
of many financial institutions may be closely related as a result
of credit, trading, clearing and other relationships. Even the
perceived lack of creditworthiness of, or questions about, a
counterparty may lead to market-wide liquidity problems and losses
for, or defaults by, the RBS Group and/or the Group.
This
systemic risk may also adversely affect financial intermediaries,
such as clearing agencies, clearing houses, banks, securities firms
and exchanges with which the Group interacts on a daily
basis.
The
effectiveness of recent prudential reforms designed to contain
systemic risk in the EU and the UK is yet to be tested.
Counterparty risk within the financial system or failures of the
Group’s financial counterparties could have a material
adverse effect on the Group’s access to liquidity or could
result in losses which could have a material adverse effect on the
Group’s financial condition, results of operations and
prospects.
The
trends and risks affecting borrower and counterparty credit quality
have caused, and in the future may cause, the Group to experience
further and accelerated impairment charges, increased repurchase
demands, higher costs, additional write-downs and losses for the
Group and an inability to engage in routine funding
transactions.
The Group is subject to pension risks and will be required to make
additional contributions as a result of the restructuring of its
pension schemes in relation to the implementation of the UK
ring-fencing regime. In addition, the Group expects to make
additional contributions to cover pension funding deficits if there
are degraded economic conditions or if there is any devaluation in
the asset portfolio held by the pension trustee.
The
Group maintains a number of defined benefit pension schemes for
certain former and current employees. The UK ring-fencing regime
will require significant changes to the structure of the
Group’s existing defined benefit pension schemes because,
from 2026 it will not be possible for the Group or other entities
outside the RFB to participate in the same defined pension benefit
scheme as RFB entities or their wholly-owned subsidiaries. As a
result, RFB entities cannot be liable for debts to pension schemes
that might arise as a result of the failure of an entity that is
not a RFB or wholly owned subsidiary thereof after 1 January 2026.
The restructuring of the RBS Group and its defined benefit pension
scheme to implement the UK ring-fencing regime could also affect
assessments of the RBS Group’s pension scheme deficits or
result in the pension scheme trustees considering that the employer
covenant has been weakened and result in further additional
material contributions being required.
The RBS
Group is developing a strategy to meet these requirements. This
will require the agreement of the pension scheme trustee. The RBS
Group’s intention is for the Main Scheme to be supported by
the RFB. Discussions with the pension scheme trustee are ongoing
and will be influenced by the RBS Group’s overall ring-fence
strategy and its pension funding and investment
strategies.
If
agreement is not reached with the pension trustee, alternative
options less favourable to the RBS Group or the Group may need to
be developed to meet the requirements of the pension
regulations.
The
costs associated with the restructuring of the Group’s
existing defined benefit pension schemes could be material and
could result in higher levels of additional contributions than
those described above and currently agreed with the pension trustee
which could have a material adverse effect on the Group’s
results of operations, financial position and
prospects.
Risk factors continued
Pension
risk also includes the risk that the assets of the RBS
Group’s various defined benefit pension schemes, including
those in which the Group participates, do not fully match the
timing and amount of the schemes’ liabilities, as a result of
which the RBS Group and/or the Group are required or chooses to
make additional contributions to address deficits that may emerge.
Risk arises from the schemes because the value of the asset
portfolios may be less than expected, or may have reduced in value
relative to the pension liabilities it supports, and because there
may be greater than expected increases in the estimated value of
the schemes’ liabilities and additional future contributions
to the schemes may be required. Pension regulations may also change
in a manner adverse to the RBS Group or the Group.
The
value of pension scheme liabilities varies with changes to
long-term interest rates (including prolonged periods of low
interest rates as is currently the case), inflation, monetary
policy, pensionable salaries and the longevity of scheme members,
as well as changes in applicable legislation.
Given
economic and financial market difficulties and volatility, the low
interest rate environment and the risk that such conditions may
occur again over the near and medium term, some of the RBS
Group’s pension schemes have experienced increased pension
deficits.
The
last triennial valuation of the Main scheme, which covers certain
of the Group’s current or former employees and to which the
Group contributes, had an effective date of 31 December 2015. This
valuation was concluded with the acceleration of the nominal value
of all committed contributions in respect of past service
(£4.2 billion), which was paid in the first quarter of
2016. The next
triennial period valuation will take place in the fourth quarter of
2018 and the Main scheme pension trustee agreed that it would not
seek a new valuation prior to that date, except where a material
change arises. The 2018 triennial valuation is expected to result
in a significant increase in the regular annual contributions in
respect of the ongoing accrual of benefits. Notwithstanding the
2016 accelerated payment and any additional contributions that may
be required beforehand as a result of a material change, the RBS
Group expects to have to agree to additional contributions, to
which the Group may be required to contribute over and above the
existing committed past service contributions, as a result of the
next triennial valuation. Under current legislation, such agreement
would need to be reached no later than the first quarter of 2020.
The cost of such additional contributions could be material and any
additional contributions that are committed to the Main scheme
following new actuarial valuations would trigger the recognition of
a significant additional liability on the balance sheet of the
Group and/or an increase in any pension surplus derecognised, which
in turn could have a material adverse effect on the Group’s
results of operations, financial position and
prospects.
Pension risk and changes to the RBS Group’s funding of its
pension schemes may have a significant impact on the RBS
Group’s and/or the Group’s capital
position.
The RBS
Group’s capital position is influenced by pension risk in
several respects: Pillar 1 capital is impacted by the requirement
that net pension assets are deducted from capital and that
actuarial gains/losses impact reserves and, by extension, CET1
capital; Pillar 2A requirements result in the RBS Group being
required to carry a capital add-on to absorb stress on the pension
fund and finally the risk of additional contributions to the RBS
Group’s pension fund is taken into account in the
Group’s capital framework plan. Changes to the RBS
Group’s capital position or capital requirements relating to
pension risks, are then reflected in the capital which the Group is
required to hold, in line with the RBS Group’s capital
strategy which requires Group entities, including the Group, to
maintain adequate capital at all times. In addition, an increase in
the pension risk to which the Group is exposed may result in
increased regulatory capital requirements applicable to the
Group.
The RBS
Group believes that the accelerated payment to the RBS
Group’s Main scheme pension fund made in the first quarter of
2016 improved the RBS Group’s and the Group’s capital
planning and resilience through the period to 2019 and provided the
Main Scheme pension trustee with more flexibility over its
investment strategy. This payment has resulted in a reduction in
prevailing Pillar 2A add-on. However, subsequent contributions
required in connection with the 2018 triennial valuation, or
otherwise, may adversely impact the RBS Group’s and the
Group’s capital position.
As the
RBS Group is unable to recognise any accounting surplus due to
constraints under IFRIC 14, any contributions made which increase
the accounting surplus, or contributions committed to which would
increase the accounting surplus when paid, would have a
corresponding negative impact on the RBS Group’s capital
position.
As a
result, if any of these assumptions proves inaccurate, the RBS
Group’s capital position may significantly deteriorate and
fall below the minimum capital requirements applicable to the RBS
Group or RBS Group entities (including the Bank), and in turn
result in increased regulatory supervision or sanctions,
restrictions on discretionary distributions or loss of investor
confidence, which could individually or in aggregate have a
material adverse effect on the RBS Group’s and/or the
Group’s results of operations, financial prospects or
reputation.
The
impact of the Group’s pension obligations on its results and
operations are also dependent on the regulatory environment in
which it operates. There is a risk that changes in prudential
regulation, pension regulation and accounting standards, or a lack
of coordination between such sets of rules, may make it more
challenging for the RBS Group to manage its pension obligations
resulting in an adverse impact on the RBS Group’s CET1
capital.
Risk factors continued
The Group’s businesses are exposed to the effect of
movements in currency rates, which could have a material adverse
effect on the results of operations, financial condition or
prospects of the Group.
The Group’s foreign exchange exposure arises from structural
foreign exchange risk, including capital deployed in the
Group’s foreign subsidiaries, branches and joint
arrangements, and non-trading foreign exchange risk, including
customer transactions and profits and losses that are in a currency
other than the functional currency of the transacting
entity.
The Group maintains policies and procedures to ensure the impact of
exposures to fluctuations in currency rates are minimised.
Nevertheless, changes in currency rates, particularly in the
sterling-US dollar and euro-sterling exchange rates, affect the
value of assets, liabilities, income and expenses denominated in
foreign currencies and the reported earnings of the Group’s
non-UK subsidiaries and may affect the Group’s reported
consolidated financial condition or its income from foreign
exchange dealing.
Changes in foreign exchange rates may result from the decisions of
the Bank of England, ECB, the US Federal Reserve and from political
or global market events outside the Group’s control and lead
to sharp and sudden variations in foreign exchange rates, such as
those seen in the sterling/US dollar exchange rates since the
occurrence of the EU Referendum. Throughout 2017, ongoing UK
negotiations to exit the EU have, amongst other factors, resulted
in continued volatility in the sterling exchange rate relative to
other major currencies. Continued or increasing volatility in
currency rates can materially affect the Group’s results of
operations, financial condition or prospects.
Continued low interest rates have significantly affected and will
continue to affect the Group’s business and results of
operations. A continued period of low interest rates, and yield
curves and spreads may affect net interest income, the effect of
which may be heightened during periods of liquidity
stress.
Interest
rate and foreign exchange risks, discussed below, are significant
for the Group. Monetary policy has been highly accommodative in
recent years, including as a result of certain policies implemented
by the Bank of England and HM Treasury such as the Term Funding
Scheme, which have helped to support demand at a time of very
pronounced fiscal tightening and balance sheet repair. In the UK,
the Bank of England lowered interest rates to 0.25% in August 2016
and raised them to 0.5% in November 2017. However, there remains
considerable uncertainty as to whether or when the Bank of England
and other central banks will further increase interest rates. While
the ECB has been conducting a quantitative easing programme since
January 2015 designed to improve confidence in the Eurozone and
encourage more private bank lending, there remains considerable
uncertainty as to whether such measures have been or will be
sufficient or successful and the extension of this programme until
the end of September 2018 (or beyond) may put additional pressure
on margins.
Continued
sustained low or negative interest rates or any divergences in
monetary policy approach between the Bank of England and other
major central banks could put further pressure on the Group’s
interest margins and adversely affect the Group’s
profitability and prospects. A continued period of low interest
rates and yield curves and spreads may affect the interest rate
margin realised between lending and borrowing costs, the effect of
which may be heightened during periods of liquidity
stress.
Conversely
while increases in interest rates may support the Group’s
income, sharp increases in interest rates could lead to generally
weaker than expected growth, or even contracting GDP, reduced
business confidence, higher levels of unemployment or
underemployment, adverse changes to levels of inflation,
potentially higher interest rates and falling property prices in
the markets in which the Group operates. In turn, this could cause
stress in the loan portfolio of the Group, particularly in relation
to non-investment grade lending or real estate loans and
consequently to an increase in delinquency rates and default rates
among customers, leading to the possibility of the Group incurring
higher impairment charges. Similar risks result from the
exceptionally low levels of inflation in developed economies, which
in Europe particularly could deteriorate into sustained deflation
if policy measures prove ineffective. Reduced monetary stimulus and
the actions and commercial soundness of other financial
institutions have the potential to impact market liquidity.
The cost of implementing the
Alternative Remedies Package regarding the business previously described as
Williams & Glyn could be more onerous than anticipated and any
failure to comply with the terms of the Alternative Remedies
Package could result in the imposition of additional measures or
limitations on the RBS Group’s and the Group’s
operations.
On 18 September 2017, the RBS Group received confirmation that an
alternative remedies package announced on 26 July 2017
(‘Alternative Remedies Package’), regarding the
business previously described as Williams & Glyn, had been
formally approved by the European Commission (‘EC’) in
the form proposed.
The Alternative Remedies Package replaced the existing requirement
to divest the business previously described as Williams & Glyn
by 31 December 2017. The Alternative Remedies Package focusses on
the following two remedies to promote competition in the market for
banking services to small and medium-sized enterprises
(‘SMEs’) in the UK: (i) a £425 million capability
and innovation fund that will grant funding to a range of eligible
competitors in the UK banking and financial technology sectors; and
(ii) a £275 million incentivised switching scheme which will
provide funding for eligible bodies to help them incentivise SME
customers of the business previously described as Williams &
Glyn to switch their primary accounts and loans from the RBS Group,
paid in the form of ‘dowries’ to business current
accounts at the receiving bank.
Risk factors continued
The RBS Group has also agreed to set aside up to a further £75
million in funding to cover certain costs customers may incur as a
result of switching under the incentivised switching scheme. In
addition, under the terms of the Alternative Remedies Package,
should the uptake within the incentivised switching scheme not be
sufficient, RBSG may be required to make a further contribution,
capped at £50 million.
An independent body (‘Independent Body’) is in the
process of being established to administer the Alternative Remedies
Package. However, the implementation of the Alternative Remedies
Package including but not limited to the funding commitments and
financial incentives envisaged to be provided under the plan.
Implementation of the Alternative Remedies Package could also
divert resources from the RBS Group’s and the Group’s
operations and jeopardise the delivery and implementation of other
significant plans and initiatives. In addition, under the terms of
the Alternative Remedies Package, the Independent Body can require
the RBS Group to modify certain aspects of the RBS Group’s
execution of the incentivised switching scheme, which could
increase the cost of implementation. Furthermore, should the uptake
within the incentivised switching scheme not be sufficient, the
Independent Body can extend the duration of the scheme by up to
twelve months and can compel the RBS Group to extend the customer
base to which the scheme applies which may result in prolonged
periods of disruption to a wider portion of the Group’s
business.
As a direct consequence of the incentivised switching scheme, the
Group will lose existing customers and deposits, which in turn will
have adverse impacts on the Group’s business and associated
revenues and margins. Furthermore, the capability and innovation
fund is intended to benefit eligible competitors and negatively
impact the Group’s competitive position.
To support the incentivised switching initiative, upon request by
an eligible bank, the RBS Group has also agreed to grant those
customers which have switched to eligible banks under the
incentivised switching scheme access to its branch network for cash
and cheque handling services, which may result in reputational and
financial exposure for the Group and impact customer service
quality for the Group’s own customers with consequent
competitive, financial and reputational implications. The
implementation of the incentivised switching scheme is also
dependent on the engagement of the eligible banks with the
incentivised switching scheme and the application of the eligible
banks to and approval by the Independent Body. The incentivised transfer of SME
customers to third party banks places reliance on those third
parties to achieve satisfactory customer outcomes which could give
rise to reputational damage if these are not
forthcoming.
A failure to comply with the terms of the Alternative Remedies
Package could result in the imposition of additional measures or
limitations on the RBS Group’s and the Group’s
operations, additional supervision by the RBS Group’s
regulators, and loss of investor or customer confidence, any of
which could have a material adverse impact on the RBS Group and the
Group. Delays in execution may also impact the RBS Group’s
and the Group’s ability to carry out their transformation
programme, including the implementation of cost saving initiatives
and mandatory regulatory requirements.
Such risks will increase in line with any delays.
The Group’s earnings and financial condition have been, and
its future earnings and financial condition may continue to be,
materially affected by depressed asset valuations resulting from
poor market conditions.
The
Group’s businesses and performance are affected by financial
market conditions. The performance and volatility of financial
markets affect bond and equity prices and have caused, and may in
the future cause, changes in the value of the Group’s
investment and trading portfolios. Financial markets have recently
experienced and may in the near term experience significant
volatility, including as a result of concerns about Brexit,
political and financial developments in the US and in Europe,
including as a result of general elections, geopolitical
developments and developments relating to trade agreements
volatility and instability in the Chinese and global stock markets,
expectations relating to or actions taken by central banks with
respect to monetary policy, and weakening fundamentals of the
Chinese economy, resulting in further short-term changes in the
valuation of certain of the Group’s assets. Uncertainty about
potential fines for past misconduct and concerns about the
longer-term viability of business models have also weighed heavily
on the valuations of some financial institutions in Europe and in
the UK, including the RBS Group.
Any
further deterioration in economic and financial market conditions
or weak economic growth could require the RBS Group to recognise
further significant write-downs and realise increased impairment
charges, all of which may have a material adverse effect on its
financial condition, results of operations and capital ratios. As
part of their transformation programme, the RBS Group and the Group
are executing the run-down and sale of certain legacy portfolios
and assets. Deteriorating market conditions could extend the time
line to achieve this.
Moreover,
market volatility and illiquidity (and the assumptions, judgements
and estimates in relation to such matters that may change over time
and may ultimately not turn out to be accurate) make it difficult
to value certain of the Group’s exposures. Valuations in
future periods reflecting, among other things, the then-prevailing
market conditions and changes in the credit ratings of certain of
the Group’s assets may result in significant changes in the
fair values of the Group’s exposures, such as credit market
exposures, and the value ultimately realised by the Group may be
materially different from the current or estimated fair value. As
part of its ongoing derivatives operations, the Group also faces
significant basis, volatility and correlation risks, the occurrence
of which are also impacted by the factors noted above.
In
addition, for accounting purposes, the Group carries some of its
issued debt, such as debt securities, at the current market price
on its balance sheet. Factors affecting the current market price
for such debt, such as the credit spreads of the Group, may result
in a change to the fair value of such debt, which is recognised in
the income statement as a profit or loss.
Risk factors continued
The Group’s businesses are subject to substantial regulation
and oversight. Significant regulatory developments and increased
scrutiny by the Group’s key regulators has had and is likely
to continue to increase compliance and conduct risks and could have
a material adverse effect on how the Group conducts its business
and on its results of operations and financial
condition.
The
Group is subject to extensive laws, regulations, corporate
governance requirements, administrative actions and policies in
each jurisdiction in which it operates. Many of these have been
introduced or amended recently and are subject to further material
changes. Among others, the implementation and strengthening of the
prudential and recovery and resolution framework applicable to
financial institutions in the UK, the EU and the US, and future
amendments to such rules, are considerably affecting the regulatory
landscape in which the Group operates and will operate in the
future, including as a result of the adoption of rules relating to
the UK ring-fencing regime, severe restrictions on proprietary
trading, CRD IV and the BRRD and certain other measures. Increased
regulatory focus in certain areas, including conduct, consumer
protection regimes, anti-money laundering, anti-tax evasion,
payment systems, and antiterrorism laws and regulations, have
resulted in the Group facing greater regulation and scrutiny in the
UK, the US and other countries in which it operates.
Recent
regulatory changes, proposed or future developments and heightened
levels of public and regulatory scrutiny in the UK, Europe and the
US have resulted in increased capital, funding and liquidity
requirements, changes in the competitive landscape, changes in
other regulatory requirements and increased operating costs, and
have impacted, and will continue to impact, product offerings and
business models.
Such
changes may also result in an increased number of regulatory
investigations and proceedings and have increased the risks
relating to the Group’s ability to comply with the applicable
body of rules and regulations in the manner and within the time
frames required.
Such
risks are currently exacerbated by Brexit and the unprecedented
degree of uncertainty as to the respective legal and regulatory
frameworks in which the RBS Group and the Group will operate when
the UK is no longer a member of the EU. For example, current
proposed changes to the European prudential regulatory framework
for banks and investment banks may result in additional prudential
or structural requirements being imposed on financial institutions
based outside the EU wishing to provide financial services within
the EU (which may apply to the Group once the UK has formally
exited the EU). See ‘The Group has been, and will remain, in
a period of major business transformation and structural change
through to at least 2019 as it implements its own transformation
programme and seeks to comply with UK ring-fencing and recovery and
resolution requirements as well as the Alternative Remedies
Package. Additional structural changes to the Group’s
operations will also be required as a result of Brexit. These
various transformation and restructuring activities are required to
occur concurrently, which carries significant execution and
operational risks, and the Group may not be a viable, competitive
and profitable bank as a result’.
In
addition, the RBS Group and its counterparties may no longer be
able to rely on the European passporting framework for financial
services and could be required to apply for authorisation in
multiple European jurisdictions, the costs, timing and viability of
which is uncertain.
Any of
these developments (including failures to comply with new rules and
regulations) could have a significant impact on how the Group
conduct its business, its authorisations and licenses, the products
and services it offers, its reputation and the value of its assets,
the Group’s operations or legal entity structure, including
attendant restructuring costs and consequently have a material
adverse effect on its business, funding costs, results of
operations, financial condition and prospects.
Areas
in which, and examples of where, governmental policies, regulatory
and accounting changes and increased public and regulatory scrutiny
could have an adverse impact (some of which could be material) on
the Group include, but are not limited to, those set out above as
well as the following:
●
amendments to the
framework or requirements relating to the quality and quantity of
regulatory capital as well as liquidity and leverage requirements,
either on a solo, consolidated or subgroup level (and taking into
account the new legal structure of the RBS Group and the Group
following the implementation of the UK ring-fencing regime),
including amendments to the rules relating to the calculation of
risk-weighted assets and reliance on internal models and credit
ratings as well as rules affecting the eligibility of deferred tax
assets;
●
the design and
implementation of national or supranational mandated recovery,
resolution or insolvency regimes or the implementation of
additional or conflicting loss-absorption requirements, including
those mandated under UK rules, BRRD, MREL or by the FSB’s
recommendations on TLAC;
●
new or amended
regulations or taxes that reduce profits attributable to
shareholders which may diminish, or restrict, the accumulation of
the distributable reserves or distributable items necessary to make
distributions or coupon payments or limit the circumstances in
which such distributions may be made or the extent
thereof;
●
the monetary,
fiscal, interest rate and other policies of central banks and other
governmental or regulatory bodies;
●
further
investigations, proceedings or fines either against the RBS Group
or the Group in isolation or together with other large financial
institutions with respect to market conduct
wrongdoing;
●
the imposition of
government-imposed requirements and/or related fines and sanctions
with respect to lending to the UK SME market and larger commercial
and corporate entities;
●
increased
regulatory scrutiny with respect to mortgage lending, including
through the implementation of the FCA’s UK mortgages market
study and other initiatives led by the Bank of England or European
regulators;
Risk factors continued
●
concerns expressed
by the FPC and PRA around potential systemic risk associated with
recent increases in UK consumer lending and the impact of consumer
credit losses on banks’ resilience in a stress scenario,
which the PRA has indicated that it will consider when setting
capital buffers for individual banks;
●
additional rules
and regulatory initiatives and review relating to customer
protection, including the FCA’s Treating Customers Fairly
regime and increased focus by regulators on how institutions
conduct business, particularly with regard to the delivery of fair
outcomes for customers and orderly/transparent
markets.
●
the imposition of
additional restrictions on the Group’s ability to compensate
its senior management and other employees and increased
responsibility and liability rules applicable to senior and key
employees;
●
rules and
regulations relating to, and enforcement of, anti-corruption,
anti-bribery, anti-money laundering, anti-terrorism, sanctions,
anti-tax evasion or other similar regimes;
●
investigations into
facilitation of tax evasion or avoidance or the creation of new
civil or criminal offences relating thereto;
●
rules relating to
foreign ownership, expropriation, nationalisation and confiscation
of assets;
●
changes to
financial reporting standards (including accounting standards or
guidance) and guidance or the timing of their
implementation;
●
changes to risk
aggregation and reporting standards;
●
changes to
corporate governance requirements, senior manager responsibility,
corporate structures and conduct of business rules;
●
competition reviews
and investigations relating to the retail banking sector in the UK,
including with respect to SME banking and PCAs;
●
financial market
infrastructure reforms establishing new rules applying to
investment services, short selling, market abuse, derivatives
markets and investment funds, including the European Market
Infrastructure Regulation and the Markets in Financial Instruments
Directive and Regulation in the EU and the Dodd Frank Wall Street
Reform Consumer Protection Act of 2010 in the US;
●
increased
regulatory scrutiny with respect to UK payment systems by the
Payments Systems Regulator and the FCA, including in relation to
banks’ policies and procedures for handling push payment
scams;
●
increased attention
to competition and innovation in UK payment systems and
developments relating to the UK initiative on Open Banking and the
European directive on payment services;
●
new or increased
regulations relating to customer data and privacy protection,
including the EU General Data Protection Regulation
(‘GDPR’);
●
restrictions on
proprietary trading and similar activities within a commercial bank
and/or a group;
●
the introduction
of, and changes to, taxes, levies or fees applicable to the RBS
Group’s or the Group’s operations, such as the
imposition of a financial transaction tax, changes in tax rates,
increases in the bank corporation tax surcharge in the UK,
restrictions on the tax deductibility of interest payments or
further restrictions imposed on the treatment of carry-forward tax
losses that reduce the value of deferred tax assets and require
increased payments of tax;
●
the regulation or
endorsement of credit ratings used in the EU (whether issued by
agencies in European member states or in other countries, such as
the US);
●
the Markets in
Financial Instruments Directive (‘MiFID’) regulating
the provision of ‘investment services and activities’
in relation to a range of customer-related areas and the revised
directive (‘MiFID II’) and new regulation (Markets in
Financial Instruments Regulation or ‘MiFIR’) replacing
and changing MiFID to include expanded supervisory powers that
include the ability to ban specific products, services and
practices;
●
the European
Commission’s proposal to impose a requirement for any bank
established outside the EU, which has an asset base of a certain
size and has two or more institutions within the EU, to establish a
single intermediate parent undertaking (‘IPU’) in the
European Union, under which all EU entities within that group would
operate; and
●
other requirements
or policies affecting the Group and its profitability or product
offering, including through the imposition of increased compliance
obligations or obligations which may lead to restrictions on
business growth, product offerings, or pricing.
Changes
in laws, rules or regulations, or in their interpretation or
enforcement, or the implementation of new laws, rules or
regulations, including contradictory laws, rules or regulations by
key regulators in different jurisdictions, or failure by the RBS
Group or the Group to comply with such laws, rules and regulations,
may have a material adverse effect on the Group’s business,
financial condition and results of operations. In addition,
uncertainty and lack of international regulatory coordination as
enhanced supervisory standards are developed and implemented may
adversely affect the Group’s ability to engage in effective
business, capital and risk management planning.
Risk factors continued
The RBS Group and the Group rely on valuation, capital and stress
test models to conduct their business, assess their risk exposure
and anticipate capital and funding requirements. Failure of these
models to provide accurate results or accurately reflect changes in
the micro-and macroeconomic environment in which the Group operates
or findings of deficiencies by the Group’s regulators
resulting in increased regulatory capital requirements could have a
material adverse effect on the Group’s business, capital and
results.
Given
the complexity of the RBS Group and the Group’s business,
strategy and capital requirements, the Group relies on analytical
models to manage its business, assess the value of its assets and
its risk exposure and anticipate capital and funding requirements,
including with stress testing. The Group’s valuation, capital
and stress test models and the parameters and assumptions on which
they are based, need to be periodically reviewed and updated to
maximise their accuracy.
Failure
of these models to accurately reflect changes in the environment in
which the Group operates or to be updated in line with the changes
in the RBS Group’s or the Group’s business model or
operations, or the failure to properly input any such changes could
have an adverse impact on the modelled results or could fail to
accurately capture the Group’s risk exposure or the risk
profile of the Group’s financial instruments or result in the
RBS Group being required to hold additional capital as a function
of the PRA buffer. For example, as the Group implements its
transformation programme, including the restructuring and funding
of its NatWest Markets franchise, the implementation of the UK
ring-fencing regime any impacted models would need to be correctly
identified and adapted in line with the implementation process. The
Group also uses valuation models that rely on market data inputs.
If incorrect market data is input into a valuation model, it may
result in incorrect valuations or valuations different to those
which were predicted and used by the Group in its forecasts or
decision making. Internal stress test models may also rely on
different, less severe, assumptions or take into account different
data points than those defined by the Group’s
regulators.
Some of
the analytical models used by the Group are predictive in nature.
In addition, a number of internal models used by the Group are
designed, managed and analysed by the RBS Group and may not
appropriately capture risks and exposures relating to the
Group’s portfolios. Some of the Group’s internal models
are subject to periodic review by its regulators and, if found
deficient, the Group may be required to make changes to such models
or may be precluded from using any such models, which could result
in an additional capital requirement which could have a material
impact on the Group’s capital position.
The
Group could face adverse consequences as a result of decisions
which may lead to actions by management based on models that are
poorly developed, implemented or used, or as a result of the
modelled outcome being misunderstood or such information being used
for purposes for which it was not designed. Risks arising from the
use of models could have a material adverse effect on the
Group’s business, financial condition and results of
operations, minimum capital requirements and
reputation.
The RBS Group is subject to stress tests mandated by its regulators
in the UK and in Europe which may result in additional capital
requirements or management actions which, in turn, may impact the
RBS Group’s and/or the Group’s financial condition,
results of operations and investor confidence or result in
restrictions on distributions.
The RBS
Group is subject to annual stress tests by its regulator in the UK
and also subject to stress tests by the European regulators with
respect to RBSG, RBS N.V. and Ulster Bank Ireland DAC. Stress tests
provide an estimate of the amount of capital banks might deplete in
a hypothetical stress scenario. In addition, if the stress tests
reveal that a bank’s existing regulatory capital buffers are
not sufficient to absorb the impact of the stress, it is possible
that it will need to take action to strengthen its capital
position.
There
is a strong expectation that the PRA would require a bank to take action
if, at any point during the stress, a bank were projected to breach
any of its minimum CET1 capital or leverage ratio requirements.
However, if a bank is projected to fail to meet its systemic
buffers, it will still be expected to strengthen its capital
position over time but the supervisory response is expected to be
less intensive than if it were projected to breach its minimum
capital requirements. The PRA will also use the annual stress test
results to inform its determination of whether individual
banks’ current capital positions are adequate or need
strengthening. For some banks, their individual stress-test results
might imply that the capital conservation buffer and
countercyclical rates set for all banks is not consistent with the
impact of the stress on them. In that case, the PRA can increase
regulatory capital buffers for individual banks by adjusting their
PRA buffers.
Under
the 2017 Bank of England stress tests, which were based on the
balance sheet of the RBS Group for the year ended 31 December 2016,
the RBS Group’s capital position before the impact of
strategic management actions that the PRA judged could
realistically be taken in the stress scenario remained below its
CET1 capital hurdle rate and above its Tier 1 leverage hurdle rate.
After the impact of strategic management actions the Group’s
capital position would have remained above its CET1 capital hurdle
rate, but the PRA judged that RBSG did not meet its systemic
reference point in this scenario. Given the steps RBSG had already
taken to strengthen its capital position during 2017, the PRA did
not require the RBS Group to submit a revised capital
plan.
Risk factors continued
Failure
by the RBS Group to meet the thresholds set as part of the stress
tests carried out by its regulators in the UK and elsewhere may
result in the RBS Group’s regulators requiring the RBS Group
to generate additional capital, increased supervision and/or
regulatory sanctions, restrictions on capital distributions and
loss of investor confidence, which may impact the Group’s
financial condition, results of operations and
prospects.
The Group’s operations entail inherent reputational risk,
i.e., the risk of brand damage and/or financial loss due to a
failure to meet stakeholders’ expectations of the
Group’s conduct, performance and business
profile.
Brand
damage can be detrimental to the business of the Group in a number
of ways, including its ability to build or sustain business
relationships with customers, low staff morale, regulatory censure
or reduced access to, or an increase in the cost of, funding. In
particular, negative public opinion resulting from the actual or
perceived manner in which the Group or any other member of the RBS
Group conducts or modifies its business activities and operations,
including as a result of the transformation programme or other
restructuring efforts, speculative or inaccurate media coverage,
financial performance, ongoing investigations and proceedings and
the settlement of any such investigations and proceedings, IT
failures or cyber-attacks resulting in the loss or publication of
confidential customer data or other sensitive information, the
level of direct and indirect government support, or the actual or
perceived strength or practices in the banking and financial
industry may adversely affect the Group’s ability to keep and
attract customers and, in particular, corporate and retail
depositors.
Modern
technologies, in particular online social networks and other
broadcast tools which facilitate communication with large audiences
in short time frames and with minimal costs, may also significantly
enhance and accelerate the impact of damaging information and
allegations.
Although
the RBS Group has implemented a Reputational Risk Policy across
customer-facing businesses (including those of the Group) to
improve the identification, assessment and management of customers,
transactions, products and issues which represent a reputational
risk, the Group cannot ensure that it will be successful in
avoiding damage to its business from reputational risk, which could
result in a material adverse effect on the Group’s business,
financial condition, results of operations and
prospects.
The reported results of the Group are sensitive to the accounting
policies, assumptions and estimates that underlie the preparation
of its financial statements. Its results in future periods may be
affected by changes to applicable accounting rules and
standards.
The
preparation of financial statements requires management to make
judgements, estimates and assumptions that affect the reported
amounts of assets, liabilities, income and expenses.
Due to
the inherent uncertainty in making estimates, results reported in
future periods may reflect amounts which differ from those
estimates. Estimates, judgements and assumptions take into account
historical experience and other factors, including market practice
and expectations of future events that are believed to be
reasonable under the circumstances.
The
accounting policies deemed critical to the Group’s results
and financial position, based upon materiality and significant
judgements and estimates, include goodwill, provisions for
liabilities, deferred tax, loan impairment provisions, fair value
of financial instruments, which are discussed in detail in
‘Critical accounting policies and key sources of estimation
uncertainty’ on pages 96 to 98. IFRS Standards and
Interpretations that have been issued by the International
Accounting Standards Board (the IASB) but which have not yet been
adopted by the Group are discussed in ‘Accounting
developments’ on pages 98 to 100. Changes in accounting
standards or guidance by accounting bodies or in the timing of
their implementation, whether mandatory or as a result of
recommended disclosure relating to the future implementation of
such standards could result in the Group having to recognise
additional liabilities on its balance sheet, or in further
write-downs or impairments and could also significantly impact the
financial results, condition and prospects of the
Group.
In July
2014, the IASB published a new accounting standard for financial
instruments (IFRS 9) effective for annual periods beginning on or
after 1 January 2018. It introduced a new framework for the
recognition and measurement of credit impairment, based on expected
credit losses, rather than the incurred loss model currently
applied under IAS 39. The inclusion of loss allowances with respect
to all financial assets that are not recorded at fair value tend to
result in an increase in overall impairment balances when compared
with the previous basis of measurement under IAS 39. The Group
expects IFRS 9 to increase earnings and capital volatility in 2018
and beyond.
The
valuation of financial instruments, including derivatives, measured
at fair value can be subjective, in particular where models are
used which include unobservable inputs. Generally, to establish the
fair value of these instruments, the Group relies on quoted market
prices or, where the market for a financial instrument is not
sufficiently active, internal valuation models that utilise
observable market data. In certain circumstances, the data for
individual financial instruments or classes of financial
instruments utilised by such valuation models may not be available
or may become unavailable due to prevailing market conditions. In
such circumstances, the Group’s internal valuation models
require the Group to make assumptions, judgements and estimates to
establish fair value, which are complex and often relate to matters
that are inherently uncertain. Resulting changes in the fair values
of the financial instruments has had and could continue to have a
material adverse effect on the Group’s earnings, financial
condition and capital position.
Risk factors continued
The Group is exposed to conduct risk which may adversely impact the
Group or its employees and may result in conduct having a
detrimental impact on the Group’s customers or
counterparties.
In
recent years, the RBS Group, including the Group, has sought to
refocus its culture on serving the needs of its customers and
continues to redesign many of its systems and processes to promote
this focus and strategy. However, the Group is exposed to various
forms of conduct risk in its operations. These include business and
strategic planning that does not adequately reflect the RBS
Group’s customers’ needs, ineffective management and
monitoring of products and distribution, actions taken that may not
conform to their customer-centric focus, outsourcing of customer
service and product delivery via third parties that do not have
appropriate levels of control, oversight and culture, the
possibility of alleged mis-selling of financial products or the
mishandling of complaints related to the sale of such product, or
poor governance of incentives and rewards. Some of these risks have
materialised in the past and ineffective management and oversight
of conduct issues may result in customers being poorly or unfairly
treated and may in the future lead to further remediation and
regulatory intervention/enforcement.
The
Group’s businesses are also exposed to risks from employee
misconduct including non-compliance with policies and regulatory
rules, negligence or fraud (including financial crimes), any of
which could result in regulatory fines or sanctions and serious
reputational or financial harm to the RBS Group and the Group. In
recent years, a number of multinational financial institutions,
including entities within the RBS Group, have suffered material
losses due to the actions of employees, including, for example, in
connection with the foreign exchange and LIBOR investigations the
Group may not succeed in protecting itself from such conduct in the
future. It is not always possible to timely detect or deter
employee misconduct and the precautions the RBS Group takes to
detect and prevent this activity may not always be
effective.
The RBS
Group and the Group have implemented a number of policies and
allocated new resources in order to help mitigate against these
risks. The RBS Group and the Group have also prioritised
initiatives to reinforce good conduct in their engagement with the
markets in which they operate, together with the development of
preventative and detective controls in order to positively
influence behaviour.
The RBS
Group’s and the Group’s transformation programme is
also intended to improve the control environment. Nonetheless, no
assurance can be given that the RBS Group’s and the
Group’s strategy and the control framework will be effective
and that conduct and financial crime issues will not have an
adverse effect on the Group’s results of operations,
financial condition or prospects.
The Group may be adversely impacted if its or the RBS Group’s
risk management is not effective and there may be significant
challenges in maintaining the effectiveness of the Group’s
risk management framework as a result of the number of strategic
and restructuring initiatives being carried out by the RBS Group
simultaneously.
The
management of risk is an integral part of all of the Group’s
activities. Risk management includes the definition and monitoring
of the RBS Group’s risk appetite and reporting of the RBS
Group’s and the Group’s exposure to uncertainty and the
consequent adverse effect on profitability or financial condition
arising from different sources of uncertainty and risks as
described throughout these risk factors.
Ineffective
risk management may arise from a wide variety of events and
behaviours, including lack of transparency or incomplete risk
reporting, unidentified conflicts or misaligned incentives, lack of
accountability control and governance, lack of consistency in risk
monitoring and management or insufficient challenges or assurance
processes.
Failure
to manage risks effectively could adversely impact the RBS
Group’s and/or the Group’s reputation or their
relationship with their customers, shareholders or other
stakeholders, which in turn could have a significant effect on the
Group’s business prospects, financial condition and results
of operations.
Risk
management is also strongly related to the use and effectiveness of
internal stress tests and models. See ‘The RBS Group and the
Group rely on valuation, capital and stress test models to conduct
their business, assess their risk exposure and anticipate capital
and funding requirements. Failure of these models to provide
accurate results or accurately reflect changes in the micro-and
macroeconomic environment in which the Group operates or findings
of deficiencies by the Group’s regulators resulting in
increased regulatory capital requirements could have a material
adverse effect on the Group’s business, capital and
results.’
A failure by the Group to embed a strong risk culture across the
organisation could adversely affect the ability of the RBS Group
and the Group to achieve their strategic objectives.
In
response to weaknesses identified in previous years, the RBS Group
is currently seeking to embed a strong risk culture within the RBS
Group (including the Group) based on a robust risk appetite and
governance framework.
A key
component of this approach is the three lines of defence model
designed to identify, manage and mitigate risk across all levels of
the organisation. This framework has been implemented and
improvements continue and will continue to be made to clarify and
improve the three lines of defence and internal risk
responsibilities and resources, including in response to feedback
from regulators. Notwithstanding the RBS Group’s efforts,
changing an organisation’s risk culture requires significant
time, investment and leadership, and such efforts may not insulate
the RBS Group or the Group from future instances of
misconduct.
Risk factors continued
A
failure by any of these three lines to carry out their
responsibilities or to effectively embed this culture could have a
material adverse effect on the RBS Group and/or the Group through
an inability to achieve their strategic objectives for their
customers, employees and wider stakeholders.
As a result of the commercial and regulatory environment in which
it operates, the Group may be unable to attract or retain senior
management (including members of the board) and other skilled
personnel of the appropriate qualification and competence. The
Group may also suffer if it does not maintain good employee
relations.
The
Group’s current and future success depend on its ability to
attract, retain and remunerate highly skilled and qualified
personnel, including senior management (which includes directors
and other key employees), in a highly competitive labour market.
This cannot be guaranteed, particularly in light of heightened
regulatory oversight of banks and the increasing scrutiny of, and
(in some cases) restrictions placed upon, employee compensation
arrangements, in particular those of banks in receipt of Government
support (such as the RBS Group), which may place the Group at a
competitive disadvantage. In addition, the market for skilled
personnel is increasingly competitive, thereby raising the cost of
hiring, training and retaining skilled personnel.
Certain
of the Group’s directors as well as members of its executive
committee and certain other senior managers and employees are also
subject to the new responsibility regime introduced under the
Banking Reform Act 2013 which introduces clearer accountability
rules for those within the new regime. The senior managers’
regime and certification regime took effect on 7 March 2016, whilst
the conduct rules were applied to the wider employee population
from 7 March 2017, with the exception of some transitional
provisions. The new regulatory regime may contribute to reduce the
pool of candidates for key management and non-executive roles,
including non-executive directors with the right skills, knowledge
and experience, or increase the number of departures of existing
employees, given concerns over the allocation of responsibilities
introduced by the new rules.
In
addition, in order to ensure the independence of the RFB as part of
the implementation of the UK ring-fencing regime, the RBS Group
will be required to recruit new independent directors and senior
members of management to sit on the boards of directors and board
committees of the RFB and other RBS Group entities, and there may
be a limited pool of competent candidates from which such
appointments can be made.
The RBS
Group’s evolving strategy has led to the departure of a large
number of experienced and capable employees, including Group
employees. The restructuring relating to the ongoing implementation
of the transformation programme and related cost-reduction targets
may cause experienced staff members to leave and prospective staff
members not to join the RBS Group, including the Group. The lack of
continuity of senior management and the loss of important personnel
coordinating certain or several aspects of the RBS Group’s
restructuring (including those which impact the Group) could have
an adverse impact on the Group’s business and future
success.
The
failure to attract or retain a sufficient number of appropriately
skilled personnel to manage the complex restructuring required to
implement the UK ring-fencing regime and the RBS Group’s and
the Group’s strategies could prevent the Group from
successfully maintaining its current standards of operation,
implementing its strategy and meeting regulatory commitments. This
could have a material adverse effect on the Group’s business,
financial condition and results of operations.
In
addition, many of the Group’s employees in the UK and other
jurisdictions in which the Group operates are represented by
employee representative bodies, including trade unions. Engagement
with its employees and such bodies is important to the Group and a
breakdown of these relationships could adversely affect the
Group’s business, reputation and results.
HM Treasury (or UKFI on its behalf) may be able to exercise a
significant degree of influence over the RBS Group, including
indirectly on the Group, and any further offer or sale of its
interests may affect the price of securities issued by the RBS
Group.
On 6
August 2015, the UK Government made its first sale of RBSG ordinary
shares since its original investment in 2009 and sold approximately
5.4% of its stake in RBSG. Following this initial sale, the UK
Government exercised its conversion rights under the B Shares on 14
October 2015 which resulted in HM Treasury holding 72.88% of the
ordinary share capital of RBSG, and which entity owns all of the
Bank’s share capital. The UK Government, through HM Treasury,
held 70.5% of the issued ordinary share capital of the RBS Group as
of 31 December 2017. The UK Government in its November 2017 Autumn
Budget indicated its intention to recommence the process for the
privatisation of the RBS Group before the end of 2018-2019 and to
carry out over the forecast period a programme of sales of RBSG
ordinary shares expected to sell down approximately two thirds of
HM Treasury’s current shareholding in the RBS Group, although
there can be no certainty as to the commencement of any sell-downs
or the timing or extent thereof.
Any
offers or sale, or expectations relating to the timing thereof, of
a substantial number of ordinary shares by HM Treasury, could
negatively affect prevailing market prices for the outstanding
ordinary shares of RBSG and other securities issued by the RBS
Group and lead to a period of increased price volatility for the
RBS Group’s securities. In addition, UKFI manages HM
Treasury’s shareholder relationship with the RBS Group and,
although HM Treasury has indicated that it intends to respect the
commercial decisions of the RBS Group and that the RBS Group
entities (including the Bank) will continue to have their own
independent board of directors and management team determining
their own strategies, its position as a majority shareholder (and
UKFI’s position as manager of this shareholding) means that
HM Treasury or UKFI might be able to exercise a significant degree
of influence over, among other things, the election of directors
and appointment of senior management, the RBS Group’s capital
strategy, dividend policy, remuneration policy or the conduct of
any RBS Group entities, including the Bank.
Risk factors continued
The
manner in which HM Treasury or UKFI exercises HM Treasury’s
rights as majority shareholder could give rise to conflicts between
the interests of HM Treasury and the interests of other
shareholders. The Board of RBSG has a duty to promote the success
of the RBS Group for the benefit of its members as a
whole.
The Group operates in markets that are subject to intense scrutiny
by the competition authorities and its business and results of
operations could be materially affected by competition decisions
and other regulatory interventions.
The
competitive landscape for banks and other financial institutions in
the UK, the rest of Europe and the US is changing rapidly. Recent
regulatory and legal changes have and may continue to result in new
market participants and changed competitive dynamics in certain key
areas, such as in retail and SME banking in the UK where the
introduction of new entrants is being actively encouraged by the UK
Government. The competitive landscape in the UK is also likely to
be affected by the UK Government’s implementation of the UK
ring-fencing regime and other customer protection measures
introduced by the Banking Reform Act 2013. The implementation of
these reforms may result in the consolidation of newly separated
businesses or assets of certain financial institutions with those
of other parties to realise new synergies or protect their
competitive position and is likely to increase competitive
pressures on the Group.
The UK
retail banking sector has been subjected to intense scrutiny by the
UK competition authorities and by other bodies, including the FCA,
in recent years, including with a number of reviews/inquiries being
carried out, including market reviews conducted by the CMA and its
predecessor the Office of Fair Trading regarding SME banking and
personal banking products and services, the Independent Commission
on Banking and the Parliamentary Commission on Banking
Standards. These reviews
raised significant concerns about the effectiveness of competition
in the retail banking sector.
The
CMA’s Retail Banking Market Investigation report sets out
measures primarily intended to make it easier for consumers and
businesses to compare PCA and SME bank products, increase the
transparency of price comparison between banks and amend PCA
overdraft charging. The CMA is working with HM Treasury and other
regulators to implement these remedies which are likely to impose
additional compliance requirements on the RBS Group and the Group
and could, in aggregate, adversely impact the Group’s
competitive position, product offering and revenues.
Adverse
findings resulting from current or future competition
investigations may result in the imposition of reforms or remedies
which may impact the competitive landscape in which the RBS Group
or the Group operate or result in restrictions on mergers and
consolidations within the UK financial sector.
The
impact of any such developments in the UK will become more
significant as the Group’s business becomes increasingly
concentrated in the UK retail sector.
These
and other changes to the competitive framework in which the Group
operates could have a material adverse effect on the Group’s
business, margins, profitability, financial condition and
prospects.
RBSG and its subsidiaries, including the Bank, are subject to an
evolving framework on recovery and resolution, the impact of which
remains uncertain, and which may result in additional compliance
challenges and costs.
In the
EU, the UK and the US, regulators have implemented or are in the
process of implementing recovery and resolution regimes designed to
prevent the failure of financial institutions and resolution tools
to ensure the timely and orderly resolution of financial
institutions without use of public funds. These initiatives have
been complemented by a broader set of initiatives to improve the
resilience of financial institutions and reduce systemic risk,
including the UK ring-fencing regime, the introduction of certain
prudential requirements and powers under CRD IV, and certain other
measures introduced under the BRRD, including the requirements
relating to loss absorbing capacity.
The
BRRD, which was implemented in the UK from January 2015, provides a
framework for the recovery and resolution of credit institutions
and investment firms, their subsidiaries and certain holding
companies in the EU, and the tools and powers introduced under the
BRRD include preparatory and preventive measures, early supervisory
intervention powers and resolution tools.
Implementation
of certain provisions of the BRRD remains subject to secondary
rulemaking as well as a review by the European Parliament and the
European Commission of certain topics mandated by the BRRD. In
November 2016, as a result of this review, the European Commission
published a package of proposals seeking to introduce certain
amendments to CRD IV and the BRRD. These proposals are now subject
to further discussions and negotiations among the European
institutions and it is not possible to anticipate their final
content. Further amendments to the BRRD or the implementing rules
in the EU or the UK may also be necessary to ensure continued
consistency with the FSB recommendations on key attributes of
national resolution regimes and resolution planning for G-SIBs,
including with respect to TLAC and MREL requirements.
In
light of these potential developments as well as the impact of
Brexit, there remains uncertainty as to the rules which may apply
to the RBS Group going forward.
Risk factors continued
In
addition, banks headquartered in countries which are members of the
Eurozone are now subject to the European banking union framework.
In November 2014, the ECB assumed direct supervisory responsibility
for RBS N.V. and Ulster Bank Ireland DAC under the Single
Supervisory Mechanism (SSM). As a result of the above, there
remains uncertainty as to how the relevant resolution regimes in
force in the UK, the Eurozone and other jurisdictions, would
interact in the event of a resolution of the RBS Group, although it
remains clear that the Bank of England, as UK resolution authority,
would be responsible for resolution of the RBS Group overall
(consistent with the RBS Group’s single point of entry
bail-in resolution strategy, as determined by the Bank of
England)
The
BRRD requires national resolution funds to raise ‘ex
ante’ contributions on banks and investment firms in
proportion to their liabilities and risk profiles and allow them to
raise additional ‘ex post’ funding contributions in the
event the ex-ante contributions do not cover the losses, costs or
other expenses incurred by use of the resolution fund. Although
receipts from the UK bank levy are currently being used to meet the
ex-ante and ex post funding requirements, the RBS Group may be
required to make additional contributions in the future. In
addition, RBS Group entities in countries subject to the European
banking union are required to pay supervisory fees towards the
funding of the SSM as well as contributions to the single
resolution fund.
The
recovery and resolution regime implementing the BRRD in the UK
places compliance and reporting obligations on the RBS Group and
the Group. These compliance and reporting obligations may result in
increased costs, including as a result of the RBS Group’s
mandatory participation in resolution funds, and heightened
compliance risks, and the RBS Group may not be in a position to
comply with all such requirements within the prescribed deadlines
or at all. In addition to the costs associated with the issuance of
MREL-eligible debt securities and compliance with internal MREL
requirements, further changes may be required for the RBS Group and
the Group to enhance their resolvability, in particular due to
regulatory requirements relating to operational continuity and
valuations capabilities in resolution.
In July
2016, the PRA adopted a new framework requiring financial
institutions to ensure the continuity of critical shared services
(provided by entities within the group or external providers) to
facilitate recovery action, orderly resolution and post-resolution
restructuring, which will apply from 1 January 2019.
The
application of such rules to the RBS Group requires the RBS Group
to restructure certain of its activities relating to the provision
of services from one legal entity to another within the RBS Group,
may limit the RBS Group’s ability to outsource certain
functions and/or may result in increased costs resulting from the
requirement to ensure the financial and operational resilience and
independent governance of such critical services. Any such
developments could have a material adverse impact on the
Group.
In
August 2017, the Bank of England published a consultation paper
setting out its preliminary views on the valuation capabilities
that firms should have in place prior to resolution. The Bank of
England has not yet published a final statement of policy in this
area. Achieving compliance with the expectations set out in any
such statement of policy, once finalised, may require changes to
the RBS Group’s existing valuation processes and/or the
development of additional capabilities, infrastructure and
processes. The RBS Group may incur costs in complying with such
obligations, which costs may increase if the Bank of England
determined that the RBS Group’s valuation capabilities
constitute an impediment to resolution and subsequently exercised
its statutory power to direct the RBS Group to take measures to
address such impediment.
In
addition, compliance by the RBS Group with this recovery and
resolution framework has required and is expected to continue to
require significant work and engagement with the RBS Group’s
regulators, including in order for the RBS Group to continue to
submit to the PRA an annual recovery plan assessed as meeting
regulatory requirements and to be assessed as resolvable by the
Bank of England. The outcome of this regulatory dialogue may impact
the operations or structure of the RBS Group or the Group, or
otherwise result in increased costs, including as a result of the
Bank of England’s power under section 3A of the Banking Act
to direct institutions to address impediments to
resolvability.
The RBS Group may become subject to
the application of stabilisation or resolution powers in certain
significant stress situations, which may result in various actions
being taken in relation to the RBS Group and any securities of the
RBS Group, including the Group, including the write-off, write-down
or conversion of securities issued by the RBS Group or the
Group.
The
Banking Act 2009, as amended to implement the BRRD (Banking Act)
confers substantial powers on relevant UK authorities designed to
enable them to take a range of actions in relation to UK banks or
investment firms and certain of their affiliates in the event a
bank or investment firm in the same group is considered to be
failing or likely to fail. Under the Banking Act, wide powers are
granted to the Bank of England (as the relevant resolution
authority), as appropriate as part of a special resolution regime
(the SRR). These powers enable the Bank of England to implement
resolution measures with respect to a UK bank or investment firm
and certain of its affiliates (including, for example, RBSG) (each
a relevant entity) in circumstances in which the relevant UK
resolution authorities are satisfied that the resolution conditions
are met. Under the applicable regulatory framework and pursuant to
guidance issued by the Bank of England, governmental financial
support, if any is provided, would only be used as a last resort
measure where a serious threat to financial stability cannot be
avoided by other measures (such as the stabilisation options
described below, including the UK bail-in power) and subject to the
limitations set out in the Banking Act.
Risk factors continued
Several
stabilisation options and tools are available to the Bank of
England under the SRR, where a resolution has been
triggered.
In
addition, the Bank of England may commence special administration
or liquidation procedures specifically applicable to banks. Where
stabilisation options are used which rely on the use of public
funds, such funds can only be used once there has been a
contribution to loss absorption and recapitalisation of at least 8%
of the total liabilities of the institution under resolution. The
Bank of England has indicated that among these options, the UK
bail-in tool (as described further below) would apply in the event
a resolution of the RBS Group were triggered.
Further,
the Banking Act grants broad powers to the Bank of England, the
application of which may adversely affect contractual arrangements
and which include the ability to (i) modify or cancel contractual
arrangements to which an entity in resolution is party, in certain
circumstances; (ii) suspend or override the enforcement provisions
or termination rights that might be invoked by counterparties
facing an entity in resolution, as a result of the exercise of the
resolution powers; and (iii) disapply or modify laws in the UK
(with possible retrospective effect) to enable the powers under the
Banking Act to be used effectively.
The
stabilisation options are intended to be applied prior to the point
at which any insolvency proceedings with respect to the relevant
entity would otherwise have been initiated. Accordingly, the
stabilisation options may be exercised if the relevant UK
resolution authority: (i) is satisfied that a UK bank or investment
firm is failing, or is likely to fail; (ii) determines that it is
not reasonably likely that (ignoring the stabilisation powers)
action will be taken by or in respect of a UK bank or investment
firm that will result in condition (i) above ceasing to be met;
(iii) considers the exercise of the stabilisation powers to be
necessary, having regard to certain public interest considerations
(such as the stability of the UK financial system, public
confidence in the UK banking system and the protection of
depositors, being some of the special resolution objectives) and
(iv) considers that the special resolution objectives would not be
met to the same extent by the winding-up of the UK bank or
investment firm.
In the
event that the Bank of England seeks to exercise its powers in
relation to a UK banking group company (such as RBSG), the relevant
UK resolution authority has to be satisfied that (A) the conditions
set out in (i) to (iv) above are met in respect of a UK bank or
investment firm in the same banking group (or, in respect of an EEA
or third country credit institution or investment firm in the same
banking group, the relevant EEA or third country resolution
authority is satisfied that the conditions for resolution
applicable in its jurisdiction are met) and (B) certain criteria
are met, such as the exercise of the powers in relation to such UK
banking group company being necessary having regard to public
interest considerations.
The use
of different stabilisation powers is also subject to further
‘specific conditions’ that vary according to the
relevant stabilisation power being used. Although the SRR sets out
the pre-conditions for determining whether an institution is
failing or likely to fail, it is uncertain how the relevant UK
resolution authority would assess such conditions in any particular
pre-insolvency scenario affecting RBSG and/or other members of the
RBS Group (including the Bank) and in deciding whether to exercise
a resolution power.
There
has been no application of the SRR powers in the UK to a large
financial institution, such as RBSG, to date, which could provide
an indication of the relevant UK resolution authority’s
approach to the exercise of the resolution powers, and even if such
examples existed, they may not be indicative of how such powers
would be applied to RBSG.
Therefore,
holders of shares and other securities issued by RBS Group entities
may not be able to anticipate a potential exercise of any such
powers.
The UK
bail-in tool is one of the powers available to the Bank of England
under the SRR and was introduced under the Banking Reform Act 2013.
The UK government amended the provisions of the Banking Act to
ensure the consistency of these provisions with the bail-in
provisions under the BRRD, which amendments came into effect on 1
January 2015. The UK bail-in tool includes both a power to
write-down or convert capital instruments and triggered at the
point of non-viability of a financial institution and a bail-in
tool applicable to eligible liabilities (including senior unsecured
debt securities issued by the RBS Group) and available in
resolution.
The
capital instruments write-down and conversion power may be
exercised independently of, or in combination with, the exercise of
a resolution tool, and it allows resolution authorities to cancel
all or a portion of the principal amount of capital instruments
and/or convert such capital instruments into common equity Tier 1
instruments when an institution is no longer viable. The point of
non-viability for such purposes is the point at which the Bank of
England or the PRA determines that the institution meets certain
conditions under the Banking Act, for example if the institution
will no longer be viable unless the relevant capital instruments
are written down or extraordinary public support is provided, and
without such support the appropriate authority determines that the
institution would no longer be viable. The Bank of England may
exercise the power to write down or convert capital instruments
without any further exercise of resolution tools, as may be the
case where the write-down or conversion of capital instruments is
sufficient to restore an institution to viability.
Where
the conditions for resolution exist and it is determined that a
stabilisation power may be exercised, the Bank of England may use
the bail-in tool (in combination with other resolution tools under
the Banking Act ) to, among other things, cancel or reduce all or a
portion of the principal amount of, or interest on, certain
unsecured liabilities of a failing financial institution and/or
convert certain debt claims into another security, including
ordinary shares of the surviving entity.
In
addition, the Bank of England may use the bail-in tool to, among
other things, replace or substitute the issuer as obligor in
respect of debt instruments, modify the terms of debt instruments
(including altering the maturity (if any) and/or the amount of
interest payable and/or imposing a temporary suspension on
payments) and discontinue the listing and admission to trading of
financial instruments. The exercise of the bail-in tool will be
determined by the Bank of England which will have discretion to
determine whether the institution has reached a point of
non-viability or whether the conditions for resolution are met, by
application of the relevant provisions of the Banking Act, and
involves decisions being taken by the PRA and the Bank of England,
in consultation with the FCA and HM Treasury. As a result, it will
be difficult to predict when, if at all, the exercise of the
bail-in power may occur.
The
potential impact of these powers and their prospective use may
include increased volatility in the market price of shares and
other securities issued by RBS Group entities, as well as increased
difficulties for RBSG or other RBS Group entities in issuing
securities in the capital markets and increased costs of raising
such funds.
If
these powers were to be exercised (or there is an increased risk of
exercise) in respect of the RBS Group or any entity within the RBS
Group (including the Bank), such exercise could result in a
material adverse effect on the rights or interests of RBSG
shareholders which would likely be extinguished or very heavily
diluted. Holders of debt securities (which may include holders of
RBSG senior unsecured debt), may see the conversion of part (or
all) of their claims into equity or written down in part or written
off entirely. In accordance with the rules of the Special
Resolution Regime, the losses imposed on holders of equity and debt
instruments through the exercise of bail-in powers would be subject
to the ‘no creditor worse off’ safeguard, which
requires losses (net of any compensation received) not to exceed
those which would be realised in an insolvency
counterfactual.
Although
the above represents the risks associated with the UK bail-in power
currently in force in the UK and applicable to the RBS Group,
changes to the scope of, or conditions for the exercise of the UK
bail-in power may be introduced as a result of further political or
regulatory developments. For example, the application of these
powers to internally-issued MREL instruments, issued by one group
entity and held solely by its parent entity, is currently being
consulted on by the Bank of England. In addition, further
political, legal or strategic developments may lead to structural
changes to the RBS Group, including at the holding company level.
Notwithstanding any such changes, the RBS Group expects that its
securities would remain subject to the exercise of a form of
bail-in power, either pursuant to the provisions of the Banking
Act, the BRRD or otherwise.
The value or effectiveness of any credit protection that the Group
has purchased depends on the value of the underlying assets and the
financial condition of the insurers and
counterparties.
The
Group has some remaining credit exposure arising from
over-the-counter derivative contracts, mainly credit default swaps
(CDSs), and other credit derivatives, each of which are carried at
fair value.
The
fair value of these CDSs, as well as the Group’s exposure to
the risk of default by the underlying counterparties, depends on
the valuation and the perceived credit risk of the instrument
against which protection has been bought. Many market
counterparties have been adversely affected by their exposure to
residential mortgage-linked and corporate credit products, whether
synthetic or otherwise, and their actual and perceived
creditworthiness may deteriorate rapidly. If the financial
condition of these counterparties or their actual or perceived
creditworthiness deteriorates, the Group may record further credit
valuation adjustments on the credit protection bought from these
counterparties under the CDSs. The Group also recognises any
fluctuations in the fair value of other credit
derivatives.
Any
such adjustments or fair value changes may have a material adverse
impact on the Group’s financial condition and results of
operations.
In the UK and in other jurisdictions, the RBS Group and the Group
are responsible for contributing to compensation schemes in respect
of banks and other authorised financial services firms that are
unable to meet their obligations to customers.
In the
UK, the Financial Services Compensation Scheme (‘FSCS’)
was established under the Financial Services and Markets Act 2000
and is the UK’s statutory fund of last resort for customers
of authorised financial services firms. The FSCS pays compensation
if a firm is unable to meet its obligations. The FSCS funds
compensation for customers by raising levies on the industry,
including the RBS Group and the Group. In relation to protected
deposits, each deposit-taking institution contributes towards these
levies in proportion to their share of total protected
deposits.
In the
event that the FSCS needs to raise additional and unexpected
funding, is required to raise funds more frequently or
significantly increases the levies to be paid by authorised firms,
the associated costs to the RBS Group or the Group may have an
adverse impact on the RBS Group’s and/or the Group’s
results of operations and financial condition.
To the
extent that other jurisdictions where the RBS Group operates have
introduced or plan to introduce similar compensation, contributory
or reimbursement schemes, the RBS Group and the Group may make
further provisions and may incur additional costs and liabilities,
which may have an adverse impact on the Group’s financial
condition and results of operations.
Risk factors continued
The Group intends to execute the run-down and/or the sale of
certain portfolios and assets. Failure by the Group to do so on
commercially favourable terms could have a material adverse effect
on the Group’s operations, operating results, financial
position and reputation.
The
Group’s ability to execute the run-down and/or sale of
certain portfolios and assets and the price achieved for such
disposals will be dependent on prevailing economic and market
conditions.
As a
result, there is no assurance that the Group will be able to sell
or run down these portfolios or assets either on favourable
economic terms to the Group or at all or that it may do so within
the intended timetable. Material tax or other contingent
liabilities could arise on the disposal or run-down of assets and
there is no assurance that any conditions precedent agreed will be
satisfied, or consents and approvals required will be obtained in a
timely manner or at all. The Group may be exposed to deteriorations
in the portfolios or assets being sold between the announcement of
the disposal and its completion, which period may span many
months.
In
addition, the Group may be exposed to certain risks, including
risks arising out of ongoing liabilities and obligations, breaches
of covenants, representations and warranties, indemnity claims,
transitional services arrangements and redundancy or other
transaction-related costs, and counterparty risk in respect of
buyers of assets being sold.
The
occurrence of any of the risks described above could have a
material adverse effect on the Group’s business, results of
operations, financial condition and capital position and
consequently may have the potential to impact the competitive
position of part or all of the Group’s business.
The Group’s results could be adversely affected in the event
of goodwill impairment.
The
Group capitalises goodwill, which is calculated as the excess of
the cost of an acquisition over the net fair value of the
identifiable assets, liabilities and contingent liabilities
acquired. Acquired goodwill is recognised initially at cost and
subsequently at cost less any accumulated impairment losses. As
required by IFRS Standards, the Group tests goodwill for impairment
annually, or more frequently when events or circumstances indicate
that it might be impaired. An impairment test involves comparing
the recoverable amount (the higher of the value in use and fair
value less cost to sell) of an individual cash generating unit with
its carrying value. At 31 December 2017, the Group carried goodwill
of £5.2 billion on its balance sheet. The value in use and
fair value of the Group’s cash-generating units are affected
by market conditions and the performance of the economies in which
the Group operates.
Where
the Group is required to recognise a goodwill impairment, it is
recorded in the Group’s income statement, but it has no
effect on the Group’s regulatory capital position. Further
impairments of the Group’s goodwill could have an adverse
effect on the Group’s results and financial
condition.
Changes in tax legislation or failure to generate future taxable
profits may impact the recoverability of certain deferred tax
assets recognised by the Group.
In
accordance with IFRS Standards, the Group has recognised deferred
tax assets on losses available to relieve future profits from tax
only to the extent it is probable that they will be recovered. The
deferred tax assets are quantified on the basis of current tax
legislation and accounting standards and are subject to change in
respect of the future rates of tax or the rules for computing
taxable profits and offsetting allowable losses.
Failure
to generate sufficient future taxable profits or further changes in
tax legislation (including rates of tax) or accounting standards
may reduce the recoverable amount of the recognised deferred tax
assets. Changes to the treatment of deferred tax assets may impact
the Group’s capital, for example by reducing further the
Group’s ability to recognise deferred tax
assets.
The
implementation of the rules relating to the UK ring-fencing regime
and the resulting restructuring of the Group may further restrict
the Group’s ability to recognise tax deferred tax assets in
respect of brought forward losses.
Legal Entity Identifier: RR3QWICWWIPCS8A4S074
Signatures
Pursuant
to the requirements of the Securities Exchange Act of 1934, the
registrant has duly caused this report to be signed on its behalf
by the undersigned, thereunto duly authorized.
Date: 23
February 2018
|
THE
ROYAL BANK OF SCOTLAND plc (Registrant)
|
|
|
|
By: /s/
Jan Cargill
|
|
|
|
Name:
Jan Cargill
|
|
Title:
Deputy Secretary
|
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