REG - Royal Bk Scot.Grp. - Annual Financial Report <Origin Href="QuoteRef">RBS.L</Origin> - Part 2
23/02/2018 07:05
- Part 2: For the preceding part double click ID:nRSW7514Fa
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 Group's capital position.
As the Group is unable to recognise any accounting surplus due to constraints
under IFRIC14, 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 Group's capital
position.
As a result, if any of these assumptions prove inaccurate, or if the Group
does not hold adequate capital in its management buffer to cover market risk
in the pension fund in a stressed scenario, the Group's capital position may
significantly deteriorate and fall below the minimum capital requirements
applicable to the Group or Group entities, 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 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 Group to manage its pension obligations
resulting in an adverse impact on the Group's CET1 capital.
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.
Risk factors continued
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 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 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 Group if such new processes, including
the algorithms used, are not carefully tested and integrated into 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 Group.
In addition, recent and future disposals and restructurings by the Group
relating to the implementation of non-customer facing elements of its
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.
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 Group, including
cybercrime;
· compromise of the confidentiality, integrity, or availability of the
Group's data, systems and services;
· failure to identify or maintain the Group's key data within the limits
of the Group's agreed risk appetite;
· failure to provide adequate data, or the inability to correctly
interpret poor quality data;
· failure of the Group's technology services due to loss of data, systems
or data centre failure as a result of the Group's actions or those actions
outside the Group's control, or failure by third parties to restore services;
· failure to appropriately or accurately manage the Group's operations,
transactions or security;
· incorrect specification of models used by the Group or implementing or
using such models incorrectly;
· failure to effectively design, execute or deliver the Group's
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 Group to embed new
ways of working and values; or
· incomplete, inaccurate or untimely statutory, regulatory or management
reporting.
Operational risks 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 its transformation programme, including 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.
Risk factors continued
The Group's business performance and financial position could be adversely
affected if its capital is not managed effectively or if it is unable to meet
its prudential regulatory requirements, or if it is deemed prudent to increase
the amount of any management buffer that it requires. Effective management of
the Group's capital is critical to its ability to operate its businesses,
comply with its regulatory obligations, pursue its transformation programme
and current strategies, resume dividend payments on its ordinary shares,
maintain discretionary payments and pursue its strategic opportunities.
The Group is required by regulators in the UK, the EU and other jurisdictions
in which it undertakes regulated activities to maintain adequate capital
resources. Adequate capital also gives the Group financial flexibility in the
face of continuing turbulence and uncertainty in the global economy and
specifically in its core UK and European markets.
The Group currently targets a CET1 ratio at or above 13% throughout the period
until completion of its restructuring. On a fully loaded basis, the Group's
CET1 ratio was 15.9% at 31 December 2017, compared with 13.4% at 31 December
2016.
The Group's target capital ratio is based on its expected regulatory
requirements and internal modelling, including stress scenarios. However, the
Group's ability to achieve such targets depends on a number of factors,
including the implementation of its transformation programme and any of the
factors described below.
A shortage of capital, which could in turn affect the Group's capital ratio
and ability to resume dividend payments, could arise from:
· a depletion of the Group'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 Group's subsidiaries as a
result of the Bank of England's approach to setting the minimum requirements
for own funds and eligible liabilities ('MREL') within groups, requiring
sub-groups 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
Group's regulatory requirements, including as a result of changes to the
actual level of risk faced by the Group, factors influencing the Group's
regulator's determination of the firm-specific Pillar 2B buffer applicable to
the 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 Group, including countercyclical
buffers, increases in risk-weighted assets or in the risk weighting of
existing asset classes, or an increase in the Group's view of any management
buffer it needs, taking account of, for example, the capital levels or capital
targets of the Group's peer banks and criteria set by the credit rating
agencies;
· the implementation of the Group's transformation programme, including
in response to implementation of the UK ring-fencing regime, certain
intragroup funding arrangements will be limited and may no longer be permitted
and the Group may need to increasingly manage funding and liquidity at an
individual Group entity level, which could result in the Group being required
to maintain higher levels of capital in order to meet the Group's regulatory
requirements than would otherwise be the case, as may be the case if the Bank
of England were to identify impediments to the Group's resolvability resulting
from new funding and liquidity management strategies.
The Group'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 Group's capital plan, a depletion of its 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 it needs to hold (including as a
result of the reasons described above), would adversely impact the Group's
ability to meet its capital targets or requirements and achieve its capital
strategy during the restructuring period.
If the Group is determined to have a shortage of capital, including as a
result of any of the circumstances described above, the Group 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 Group
being subject to regulatory interventions and sanctions. The Group's
regulators may also request that the Group carry out certain capital
management actions or, in an extreme scenario, this may also trigger the
implementation of its recovery plans. Such actions may, in turn, affect, among
other things, the Group's product offering, ability to operate its businesses,
comply with its regulatory obligations, pursue its transformation programme
and current strategies, resume dividend payments on its ordinary shares,
maintain discretionary payments on capital instruments and pursue strategic
opportunities, affecting the underlying profitability of the Group and future
growth potential.
If, in response to such shortage, certain regulatory capital instruments are
converted into equity or the Group raises additional capital through the
issuance of share capital or regulatory capital instruments, existing
shareholders may experience a dilution of their holdings. The success of such
issuances will also be dependent on favourable market conditions and the Group
may not be able to raise the amount of capital required or on satisfactory
terms. Separately, the Group may address a shortage of capital by taking
action to reduce leverage and/or risk-weighted assets, by modifying the
Group's legal entity structure or by asset or business disposals. Such actions
may affect the underlying profitability of the Group.
Risk factors continued
RBSG and the Group entities' ability to meet their obligations, including
funding commitments, depends on their ability to access sources of liquidity
and funding. If the Group or any Group entity is unable to raise funds
through deposits and/or 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.
Liquidity risk is the risk that a bank will be unable to meet its obligations,
including funding commitments, as they fall due. This risk is inherent in
banking operations and can be heightened by a number of factors, including an
over-reliance on a particular source of wholesale funding (including, for
example, short-term and overnight funding), changes in credit ratings or
market-wide phenomena such as market dislocation and major disasters.
The Group's funding may also be impacted at the Group entity level as a result
of ongoing restructuring efforts and strategy planning, including in response
to implementation of the UK ring-fencing regime, planning around Brexit and
the implementation of the Alternative Remedies Package, amongst others. For
example, where the Group's funding strategy depends on intragroup funding
arrangements between Group entities, as a result of the implementation of the
UK ring-fencing regime, such arrangements will be limited and may no longer be
permitted if they are provided between RFB and entities outside the RFB and,
as a result, the cost of funding may increase for certain Group entities,
which will be required to manage their own funding and liquidity strategy.
As a result of these and other restructuring changes that could result in the
Group's need to manage funding and liquidity at an individual entity level,
the Group may be required to maintain higher levels of funding and liquidity
than would otherwise be the case.
The Group relies on retail and wholesale deposits to meet a considerable
portion of its funding. The level of deposits may fluctuate due to factors
outside the Group's control, such as a loss of confidence (including in
individual Group entities), increasing competitive pressures for retail
customer deposits or the repatriation of deposits by foreign wholesale
depositors, which could result in a significant outflow of deposits within a
short period of time.
An inability to grow, or any material decrease in, the Group's deposits could,
particularly if accompanied by one of the other factors described above, have
a material adverse impact on the Group's ability to satisfy its liquidity
needs. Increases in the cost of retail deposit funding may impact the Group's
margins and profitability.
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.
Rules currently proposed by the Financial Stability Board ('FSB') and in the
EU in relation to the implementation of total loss-absorbing capacity ('TLAC')
and MREL may also limit the ability of certain large financial institutions to
hold debt instruments issued by other large financial institutions. The
ability of the Bank of England to resolve the Group in an orderly manner may
also increase investors' perception of risk and hence affect the availability
and cost of funding for the Group. Any uncertainty relating to the credit risk
of financial institutions 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.
The implementation of the UK ring-fencing regime may impact the Group's
funding strategy and the cost of funding may increase for certain Group
entities which will be required to manage their own funding and liquidity
strategy, in particular those entities outside the ring-fence which will no
longer be able to rely on retail deposit funding.
In addition, the 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 to
reflect risks not captured in the leverage coverage ratio by way of Pillar 2
add-ons, which may increase and/or decrease from time to time and require the
Group to obtain additional funding or diversify its sources of funding.
Current proposals by the 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 Group.
Risk factors continued
If the Group is unable to raise funds through deposits or in the capital
markets on acceptable terms or at all, its liquidity position could be
adversely affected and it might be unable to meet deposit withdrawals on
demand or at their contractual maturity, to repay borrowings as they mature,
to meet its 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
Group may need to liquidate unencumbered assets to meet its liabilities,
including disposals of assets not previously identified for disposal to reduce
its funding commitments. In a time of reduced liquidity, the Group may be
unable to sell some of its assets, 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.
Failure by the Group to comply with regulatory capital, funding, liquidity and
leverage requirements may result in intervention by its regulators and loss of
investor confidence, and may have a material adverse effect on its results of
operations, financial condition and reputation and may result in distribution
restrictions and adversely impact existing shareholders.
The Group is 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 Group is currently identified as a global systemically
important bank (G-SIB) by FSB and is therefore subject to more intensive
oversight and supervision by its regulators as well as additional capital
requirements, although the 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.
Under CRD IV, the Group is required 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 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 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 the 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). 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 FSB proposals and proposed
amendments to the CRD IV proposed by the European Commission in November
2016.
Risk factors continued
Most of the capital requirements which apply or will apply to the Group 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 Group's ability meet applicable CET1 capital requirements is
dependent on organic generation of CET1 through sustained profitability and/or
the Group's ability to issue ordinary shares, and there is no guarantee that
the Group may be able to generate CET1 capital through either of these
alternatives.
The amount of regulatory capital required to meet the Group's regulatory
capital requirements (and any additional management buffer), is determined by
reference to the amount of risk-weighted assets held by the Group. 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
Group's risk-weighted assets are subject to regulatory changes which may
impact the levels of regulatory capital required to be met by the Group.
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 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 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 Group, 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 '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 Group or its
subsidiaries. This uncertainty is compounded by Brexit which may result in
further changes to the prudential and regulatory framework applicable to the
Group.
If the Group is unable to raise the requisite amount of regulatory capital
(including loss absorbing capital in the form of MREL), or to otherwise meet
regulatory capital and leverage requirements, it may be exposed to increased
regulatory supervision or sanctions, loss of investor confidence, restrictions
on distributions and it may be required to reduce further the amount of its
risk-weighted assets or total assets and engage in the disposal of core and
other non-core businesses, which may not occur on a timely basis or achieve
prices which would otherwise be attractive to the Group.
This may also result in write-down or the conversion into equity of certain
regulatory capital instruments issued by the Group or the issue of additional
equity by the Group, each of which could result in - Part 2: For the preceding part double click ID:nRSW7514Fa
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 Group's capital position.
As the Group is unable to recognise any accounting surplus due to constraints
under IFRIC14, 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 Group's capital
position.
As a result, if any of these assumptions prove inaccurate, or if the Group
does not hold adequate capital in its management buffer to cover market risk
in the pension fund in a stressed scenario, the Group's capital position may
significantly deteriorate and fall below the minimum capital requirements
applicable to the Group or Group entities, 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 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 Group to manage its pension obligations
resulting in an adverse impact on the Group's CET1 capital.
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.
Risk factors continued
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 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 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 Group if such new processes, including
the algorithms used, are not carefully tested and integrated into 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 Group.
In addition, recent and future disposals and restructurings by the Group
relating to the implementation of non-customer facing elements of its
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.
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 Group, including
cybercrime;
· compromise of the confidentiality, integrity, or availability of
the Group's data, systems and services;
· failure to identify or maintain the Group's key data within the
limits of the Group's agreed risk appetite;
· failure to provide adequate data, or the inability to correctly
interpret poor quality data;
· failure of the Group's technology services due to loss of data,
systems or data centre failure as a result of the Group's actions or those
actions outside the Group's control, or failure by third parties to restore
services;
· failure to appropriately or accurately manage the Group's
operations, transactions or security;
· incorrect specification of models used by the Group or
implementing or using such models incorrectly;
· failure to effectively design, execute or deliver the Group's
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 Group to embed
new ways of working and values; or
· incomplete, inaccurate or untimely statutory, regulatory or
management reporting.
Operational risks 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 its transformation programme, including 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.
Risk factors continued
The Group's business performance and financial position could be adversely
affected if its capital is not managed effectively or if it is unable to meet
its prudential regulatory requirements, or if it is deemed prudent to increase
the amount of any management buffer that it requires. Effective management
of the Group's capital is critical to its ability to operate its businesses,
comply with its regulatory obligations, pursue its transformation programme
and current strategies, resume dividend payments on its ordinary shares,
maintain discretionary payments and pursue its strategic opportunities.
The Group is required by regulators in the UK, the EU and other jurisdictions
in which it undertakes regulated activities to maintain adequate capital
resources. Adequate capital also gives the Group financial flexibility in the
face of continuing turbulence and uncertainty in the global economy and
specifically in its core UK and European markets.
The Group currently targets a CET1 ratio at or above 13% throughout the period
until completion of its restructuring. On a fully loaded basis, the Group's
CET1 ratio was 15.9% at 31 December 2017, compared with 13.4% at 31 December
2016.
The Group's target capital ratio is based on its expected regulatory
requirements and internal modelling, including stress scenarios. However, the
Group's ability to achieve such targets depends on a number of factors,
including the implementation of its transformation programme and any of the
factors described below.
A shortage of capital, which could in turn affect the Group's capital ratio
and ability to resume dividend payments, could arise from:
· a depletion of the Group'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 Group's subsidiaries as
a result of the Bank of England's approach to setting the minimum requirements
for own funds and eligible liabilities ('MREL') within groups, requiring
sub-groups 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
Group's regulatory requirements, including as a result of changes to the
actual level of risk faced by the Group, factors influencing the Group's
regulator's determination of the firm-specific Pillar 2B buffer applicable to
the 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 Group, including countercyclical
buffers, increases in risk-weighted assets or in the risk weighting of
existing asset classes, or an increase in the Group's view of any management
buffer it needs, taking account of, for example, the capital levels or capital
targets of the Group's peer banks and criteria set by the credit rating
agencies;
· the implementation of the Group's transformation programme,
including in response to implementation of the UK ring-fencing regime, certain
intragroup funding arrangements will be limited and may no longer be permitted
and the Group may need to increasingly manage funding and liquidity at an
individual Group entity level, which could result in the Group being required
to maintain higher levels of capital in order to meet the Group's regulatory
requirements than would otherwise be the case, as may be the case if the Bank
of England were to identify impediments to the Group's resolvability resulting
from new funding and liquidity management strategies.
The Group'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 Group's capital plan, a depletion of its 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 it needs to hold (including as a
result of the reasons described above), would adversely impact the Group's
ability to meet its capital targets or requirements and achieve its capital
strategy during the restructuring period.
If the Group is determined to have a shortage of capital, including as a
result of any of the circumstances described above, the Group 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 Group
being subject to regulatory interventions and sanctions. The Group's
regulators may also request that the Group carry out certain capital
management actions or, in an extreme scenario, this may also trigger the
implementation of its recovery plans. Such actions may, in turn, affect, among
other things, the Group's product offering, ability to operate its businesses,
comply with its regulatory obligations, pursue its transformation programme
and current strategies, resume dividend payments on its ordinary shares,
maintain discretionary payments on capital instruments and pursue strategic
opportunities, affecting the underlying profitability of the Group and future
growth potential.
If, in response to such shortage, certain regulatory capital instruments are
converted into equity or the Group raises additional capital through the
issuance of share capital or regulatory capital instruments, existing
shareholders may experience a dilution of their holdings. The success of such
issuances will also be dependent on favourable market conditions and the Group
may not be able to raise the amount of capital required or on satisfactory
terms. Separately, the Group may address a shortage of capital by taking
action to reduce leverage and/or risk-weighted assets, by modifying the
Group's legal entity structure or by asset or business disposals. Such actions
may affect the underlying profitability of the Group.
Risk factors continued
RBSG and the Group entities' ability to meet their obligations, including
funding commitments, depends on their ability to access sources of liquidity
and funding. If the Group or any Group entity is unable to raise funds
through deposits and/or 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.
Liquidity risk is the risk that a bank will be unable to meet its obligations,
including funding commitments, as they fall due. This risk is inherent in
banking operations and can be heightened by a number of factors, including an
over-reliance on a particular source of wholesale funding (including, for
example, short-term and overnight funding), changes in credit ratings or
market-wide phenomena such as market dislocation and major disasters.
The Group's funding may also be impacted at the Group entity level as a result
of ongoing restructuring efforts and strategy planning, including in response
to implementation of the UK ring-fencing regime, planning around Brexit and
the implementation of the Alternative Remedies Package, amongst others. For
example, where the Group's funding strategy depends on intragroup funding
arrangements between Group entities, as a result of the implementation of the
UK ring-fencing regime, such arrangements will be limited and may no longer be
permitted if they are provided between RFB and entities outside the RFB and,
as a result, the cost of funding may increase for certain Group entities,
which will be required to manage their own funding and liquidity strategy.
As a result of these and other restructuring changes that could result in the
Group's need to manage funding and liquidity at an individual entity level,
the Group may be required to maintain higher levels of funding and liquidity
than would otherwise be the case.
The Group relies on retail and wholesale deposits to meet a considerable
portion of its funding. The level of deposits may fluctuate due to factors
outside the Group's control, such as a loss of confidence (including in
individual Group entities), increasing competitive pressures for retail
customer deposits or the repatriation of deposits by foreign wholesale
depositors, which could result in a significant outflow of deposits within a
short period of time.
An inability to grow, or any material decrease in, the Group's deposits could,
particularly if accompanied by one of the other factors described above, have
a material adverse impact on the Group's ability to satisfy its liquidity
needs. Increases in the cost of retail deposit funding may impact the Group's
margins and profitability.
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 havethe dilution of the Group's
existing shareholders. A breach of the Group's applicable capital or leverage
requirements may also trigger the application of the Group's recovery plan to
remediate a deficient capital position.
Failure by the Group to comply with its capital requirements or to maintain
sufficient distributable reserves may result in the application of
restrictions on its ability to make discretionary distributions, including the
payment of dividends to its ordinary shareholders and coupons on certain
capital instruments.
In accordance with the provisions of CRD IV, a minimum level of capital
adequacy is required to be met by the Group in order for it to be entitled to
make certain discretionary payments.
Risk factors continued
Pursuant to Article 141 (Restrictions on distribution) of the CRD IV
Directive, as transposed in the UK, institutions that fail to meet the
'combined buffer requirement' will be subject to restricted 'discretionary
payments' (which are defined broadly by CRD IV as payments relating to CET1
instruments (dividends), variable remuneration and coupon payments on
additional Tier 1 instruments). The resulting restrictions are scaled
according to the extent of the breach of the 'combined buffer requirement' and
calculated as a percentage of the profits of the institution since the last
distribution of profits or 'discretionary payment' which gives rise to a
maximum distributable amount (MDA) (if any) that the financial institution can
distribute through discretionary payments.
The EBA has clarified that the CET1 capital to be taken into account for the
MDA calculation should be limited to the amount not used to meet the Pillar 1
and Pillar 2 own funds requirements of the institution. In the event of a
breach of the combined buffer requirement, the Group will be required to
calculate its MDA, and as a consequence it may be necessary for the Group to
reduce or cease discretionary payments to the extent of the breach.
The ability of the Group to meet the combined buffer requirement will be
subject to the Group holding sufficient CET1 capital in excess of its minimum
Pillar 1 and Pillar 2 capital requirements. In addition, the interaction of
such restrictions on distributions with the capital requirements and buffers
applicable to the Group remains uncertain in many respects while the relevant
authorities in the EU and the UK consult on and develop their proposals and
guidance on the application of the rules. In particular, the proposals
published by the European Commission in November 2016 contain certain proposed
amendments to Article 141, including to introduce a 'stacking order' in the
calculation of the maximum distributable amount and establish certain
priorities in the payments which could be made in the event the restrictions
apply (with payments relating to additional Tier 1 instruments being required
to be made before payments on CET1 instruments (dividends) or other
discretionary payments). The treatment of MDA breaches under the European
Commission proposals differ from the proposed consequences set out in the
final PRA rules and may result in uncertainty in the application of these
rules.
In addition to these rules and the requirement for PRA approval, in order to
make distributions (including dividend payments) in the first place, RBSG is
required to have sufficient distributable reserves available. Furthermore,
coupon payments due on the additional Tier 1 instruments issued by RBSG must
be cancelled in the event that RBSG has insufficient 'distributable items' as
defined under CRD IV. Both distributable reserves and distributable items are
largely impacted by the Group's ability to generate and accumulate profits or
conversely by material losses (including losses resulting from conduct
related-costs, restructuring costs or impairments).
RBSG's distributable reserves and distributable items are sensitive to the
accounting impact of factors including the redemption of preference shares,
restructuring costs and impairment charges and the carrying value of its
investments in subsidiaries which are carried at the lower of cost and their
prevailing recoverable amount. Recoverable amounts depend on discounted future
cash flows which can be affected by restructurings, including the
restructuring required to implement the UK ring-fencing regime, or unforeseen
events.
The distributable reserves of RBSG also depend on the receipt of income from
subsidiaries, principally as dividends. The ability of subsidiaries to pay
dividends is subject to their performance and applicable local laws and other
restrictions, including their respective regulatory requirements and
distributable reserves. Any of these factors, including restructuring costs,
impairment charges and a reduction in the carrying value of RBSG subsidiaries
or a shortage of dividends from them could limit RBSG's ability to maintain
sufficient distributable reserves to be able to pay coupons on certain capital
instruments and dividends to its ordinary shareholders.
The Group may be required to recognise further impairments in the future if
the outlook for its subsidiaries were to worsen. Whilst this level of
distributable profits does not impact upon RBSG's ability to pay coupons on
existing securities, the Group implemented a capital reorganisation in 2017 in
order to increase RBSG's distributable reserves by approximately £30 billion,
providing greater flexibility for potential future distributions and
preference share redemptions (if any).
Failure by the Group to meet the combined buffer requirement or retain
sufficient distributable reserves or distributable items as a result of
reduced profitability or losses, or changes in regulation or taxes adversely
impacting distributable reserves or distributable items, may therefore result
in limitations on the Group's ability to make discretionary distributions
which may negatively impact the Group's shareholders, holders of additional
Tier 1 instruments, staff receiving variable compensation (such as bonuses)
and other stakeholders and impact its market valuation and investors' and
analysts' perception of its financial soundness.
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 Group's operations.
On 18 September 2017, the 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.
Risk factors continued
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 Group paid in the
form of 'dowries' to business current accounts at the receiving bank. The
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 also entails additional
costs for the Group, 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
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 Group to
modify certain aspects of the 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 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 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 RBS'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 Group's
operations, additional supervision by the Group's regulators, and loss of
investor or customer confidence, any of which could have a material adverse
impact on the Group. Delays in execution may also impact the Group's ability
to carry out its transformation programme, including the implementation of
cost saving initiatives and mandatory regulatory requirements. Such risks will
increase in line with any delays.
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 Group to meet higher capital
levels than the Group anticipated within its strategic plans and affect 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 the minimum
requirements for 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 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.
Risk factors continued
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
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 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 Group) and
be structurally subordinated to operating and excluded liabilities (which
include insured deposits, short-term debt, derivatives, structured notes and
tax liabilities). Under the single point of entry (SPE) resolution model that
applies to the Group, losses that crystallise in the operating companies are
passed up the chain to RBSG through the write down of the holding company's
investments in the equity and debt of its operating companies. The
probability of the external MREL investors being bailed-in will depend on the
Group's overall going-concern capital resources, the extent of any losses in
the operating companies, and the extent to which those losses are passed up to
the investing entity (recognising that some operating company liabilities,
including obligations to pension schemes, are protected from bail-in).
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 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.
Rules currently proposed by the Financial Stability Board ('FSB') and in the
EU in relation to the implementation of total loss-absorbing capacity ('TLAC')
and MREL may also limit the ability of certain large financial institutions to
hold debt instruments issued by other large financial institutions. The
ability of the Bank of England to resolve the Group in an orderly manner may
also increase investors' perception of risk and hence affect the availability
and cost of funding for the Group. Any uncertainty relating to the credit risk
of financial institutions 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.
The implementation of the UK ring-fencing regime may impact the Group's
funding strategy and the cost of funding may increase for certain Group
entities which will be required to manage their own funding and liquidity
strategy, in particular those entities outside the ring-fence which will no
longer be able to rely on retail deposit funding.
In addition, the 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 to
reflect risks not captured in the leverage coverage ratio by way of Pillar 2
add-ons, which may increase and/or decrease from time to time and require the
Group to obtain additional funding or diversify its sources of funding.
Current proposals by the 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 Group.
Risk factors continued
If the Group is unable to raise funds through deposits or in the capital
markets on acceptable terms or at all, its liquidity position could be
adversely affected and it might be unable to meet deposit withdrawals on
demand or at their contractual maturity, to repay borrowings as they mature,
to meet its 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
Group may need to liquidate unencumbered assets to meet its liabilities,
including disposals of assets not previously identified for disposal to reduce
its funding commitments. In a time of reduced liquidity, the Group may be
unable to sell some of its assets, 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.
Failure by the Group to comply with regulatory capital, funding, liquidity and
leverage requirements may result in intervention by its regulators and loss of
investor confidence, and may have a material adverse effect on its results of
operations, financial condition and reputation and may result in distribution
restrictions and adversely impact existing shareholders.
The Group is 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 Group is currently identified as a global systemically
important bank (G-SIB) by FSB and is therefore subject to more intensive
oversight and supervision by its regulators as well as additional capital
requirements, although the 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.
Under CRD IV, the Group is required 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 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 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 the 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). 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 FSB proposals and proposed
amendments to the CRD IV proposed by the European Commission in November 2016.
Risk factors continued
Most of the capital requirements which apply or will apply to the Group 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 Group's ability meet applicable CET1 capital requirements is
dependent on organic generation of CET1 through sustained profitability and/or
the Group's ability to issue ordinary shares, and there is no guarantee that
the Group may be able to generate CET1 capital through either of these
alternatives.
The amount of regulatory capital required to meet the Group's regulatory
capital requirements (and any additional management buffer), is determined by
reference to the amount of risk-weighted assets held by the Group. 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
Group's risk-weighted assets are subject to regulatory changes which may
impact the levels of regulatory capital required to be met by the Group.
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 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 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 Group, 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 '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 Group or its
subsidiaries. This uncertainty is compounded by Brexit which may result in
further changes to the prudential and regulatory framework applicable to the
Group.
If the Group is unable to raise the requisite amount of regulatory capital
(including loss absorbing capital in the form of MREL), or to otherwise meet
regulatory capital and leverage requirements, it may be exposed to increased
regulatory supervision or sanctions, loss of investor confidence, restrictions
on distributions and it may be required to reduce further the amount of its
risk-weighted assets or total assets and engage in the disposal of core and
other non-core businesses, which may not occur on a timely basis or achieve
prices which would otherwise be attractive to the Group.
This may also result in write-down or the conversion into equity of certain
regulatory capital instruments issued by the Group or the issue of additional
equity by the Group, each of which could result in the dilution of the Group's
existing shareholders. A breach of the Group's applicable capital or leverage
requirements may also trigger the application of the Group's recovery plan to
remediate a deficient capital position.
Failure by the Group to comply with its capital requirements or to maintain
sufficient distributable reserves may result in the application of
restrictions on its ability to make discretionary distributions, including the
payment of dividends to its ordinary shareholders and coupons on certain
capital instruments.
In accordance with the provisions of CRD IV, a minimum level of capital
adequacy is required to be met by the Group in order for it to be entitled to
make certain discretionary payments.
Risk factors continued
Pursuant to Article 141 (Restrictions on distribution) of the CRD IV
Directive, as transposed in the UK, institutions that fail to meet the
'combined buffer requirement' will be subject to restricted 'discretionary
payments' (which are defined broadly by CRD IV as payments relating to CET1
instruments (dividends), variable remuneration and coupon payments on
additional Tier 1 instruments). The resulting restrictions are scaled
according to the extent of the breach of the 'combined buffer requirement' and
calculated as a percentage of the profits of the institution since the last
distribution of profits or 'discretionary payment' which gives rise to a
maximum distributable amount (MDA) (if any) that the financial institution can
distribute through discretionary payments.
The EBA has clarified that the CET1 capital to be taken into account for the
MDA calculation should be limited to the amount not used to meet the Pillar 1
and Pillar 2 own funds requirements of the institution. In the event of a
breach of the combined buffer requirement, the Group will be required to
calculate its MDA, and as a consequence it may be necessary for the Group to
reduce or cease discretionary payments to the extent of the breach.
The ability of the Group to meet the combined buffer requirement will be
subject to the Group holding sufficient CET1 capital in excess of its minimum
Pillar 1 and Pillar 2 capital requirements. In addition, the interaction of
such restrictions on distributions with the capital requirements and buffers
applicable to the Group remains uncertain in many respects while the relevant
authorities in the EU and the UK consult on and develop their proposals and
guidance on the application of the rules. In particular, the proposals
published by the European Commission in November 2016 contain certain proposed
amendments to Article 141, including to introduce a 'stacking order' in the
calculation of the maximum distributable amount and establish certain
priorities in the payments which could be made in the event the restrictions
apply (with payments relating to additional Tier 1 instruments being required
to be made before payments on CET1 instruments (dividends) or other
discretionary payments). The treatment of MDA breaches under the European
Commission proposals differ from the proposed consequences set out in the
final PRA rules and may result in uncertainty in the application of these
rules.
In addition to these rules and the requirement for PRA approval, in order to
make distributions (including dividend payments) in the first place, RBSG is
required to have sufficient distributable reserves available. Furthermore,
coupon payments due on the additional Tier 1 instruments issued by RBSG must
be cancelled in the event that RBSG has insufficient 'distributable items' as
defined under CRD IV. Both distributable reserves and distributable items are
largely impacted by the Group's ability to generate and accumulate profits or
conversely by material losses (including losses resulting from conduct
related-costs, restructuring costs or impairments).
RBSG's distributable reserves and distributable items are sensitive to the
accounting impact of factors including the redemption of preference shares,
restructuring costs and impairment charges and the carrying value of its
investments in subsidiaries which are carried at the lower of cost and their
prevailing recoverable amount. Recoverable amounts depend on discounted future
cash flows which can be affected by restructurings, including the
restructuring required to implement the UK ring-fencing regime, or unforeseen
events.
The distributable reserves of RBSG also depend on the receipt of income from
subsidiaries, principally as dividends. The ability of subsidiaries to pay
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 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 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 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 Group, the cost
of servicing these liabilities and the implications for 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 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 Group will cease to count towards the
Group's loss-absorbing capacity for the purposes of meeting MREL/TLAC
requirements. The Group's resolution authority can impose an MREL requirement
over and above the regulatory minima and potentially higher than the Group's
peers, if it has concerns regarding the resolvability of the Group. As a
result, RBSG may be required to issue additional loss-absorbing instruments in
the form of CET1 capital or subordinated or senior unsecured debt instruments
or may result in an increased risk of a breach of the 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 within the UK, the EU and globally, and
the final requirements to which the Group will be subject, and the Group may
therefore need to revise its capital plan accordingly.
Risk factors continued
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 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. 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
- More to follow, for following part double click ID:nRSW7514Fc dividends is subject to their performance and applicable local laws and other
restrictions, including their respective regulatory requirements and
distributable reserves. Any of these factors, including restructuring costs,
impairment charges and a reduction in the carrying value of RBSG subsidiaries
or a shortage of dividends from them could limit RBSG's ability to maintain
sufficient distributable reserves to be able to pay coupons on certain capital
instruments and dividends to its ordinary shareholders.
The Group may be required to recognise further impairments in the future if
the outlook for its subsidiaries were to worsen. Whilst this level of
distributable profits does not impact upon RBSG's ability to pay coupons on
existing securities, the Group implemented a capital reorganisation in 2017 in
order to increase RBSG's distributable reserves by approximately £30 billion,
providing greater flexibility for potential future distributions and
preference share redemptions (if any).
Failure by the Group to meet the combined buffer requirement or retain
sufficient distributable reserves or distributable items as a result of
reduced profitability or losses, or changes in regulation or taxes adversely
impacting distributable reserves or distributable items, may therefore result
in limitations on the Group's ability to make discretionary distributions
which may negatively impact the Group's shareholders, holders of additional
Tier 1 instruments, staff receiving variable compensation (such as bonuses)
and other stakeholders and impact its market valuation and investors' and
analysts' perception of its financial soundness.
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 Group's operations.
On 18 September 2017, the 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.
Risk factors continued
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 Group
paid in the form of 'dowries' to business current accounts at the receiving
bank. The 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 also entails additional
costs for the Group, 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
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 Group to
modify certain aspects of the 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 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 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 RBS'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 Group's
operations, additional supervision by the Group's regulators, and loss of
investor or customer confidence, any of which could have a material adverse
impact on the Group. Delays in execution may also impact the Group's ability
to carry out its transformation programme, including the implementation of
cost saving initiatives and mandatory regulatory requirements. Such risks will
increase in line with any delays.
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 Group to meet higher capital
levels than the Group anticipated within its strategic plans and affect 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 the minimum
requirements for 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 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.
Risk factors continued
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 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 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 Group) and
be structurally subordinated to operating and excluded liabilities (which
include insured deposits, short-term debt, derivatives, structured notes and
tax liabilities). Under the single point of entry (SPE) resolution model
that applies to the Group, losses that crystallise in the operating companies
are passed up the chain to RBSG through the write down of the holding
company's investments in the equity and debt of its operating companies. The
probability of the external MREL investors being bailed-in will depend on the
Group's overall going-concern capital resources, the extent of any losses in
the operating companies, and the extent to which those losses are passed up to
the investing entity (recognising that some operating company liabilities,
including obligations to pension schemes, are protected from bail-in).
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 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 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 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 Group, the cost
of servicing these liabilities and the implications for 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 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 Group will cease to count towards the
Group's loss-absorbing capacity for the purposes of meeting MREL/TLAC
requirements. The Group's resolution authority can impose an MREL requirement
over and above the regulatory minima and potentially higher than the Group's
peers, if it has concerns regarding the resolvability of the Group. As a
result, RBSG may be required to issue additional loss-absorbing instruments in
the form of CET1 capital or subordinated or senior unsecured debt instruments
or may result in an increased risk of a breach of the 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 within the UK, the EU and globally, and
the final requirements to which the Group will be subject, and the Group may
therefore need to revise its capital plan accordingly.
Risk factors continued
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 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. 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 will
be required to make additional contributions as a result of the restructuring
of its pension schemes in relation to the
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