RBS 2011 Annual Report Download - page 126

124 RBS Group 2011
Balance sheet management: Liquidity and funding risk continued
Special purpose entities
The Group arranges securitisations to facilitate client transactions and
undertakes securitisations to sell financial assets or to fund specific
portfolios of assets. The Group also acts as an underwriter and depositor
in securitisation transactions involving both client and proprietary
transactions. In a securitisation, assets, or interests in a pool of assets,
are transferred generally to a special purpose entity (SPE) which then
issues liabilities to third party investors. SPEs are vehicles established for
aspecific, limited purpose, usually do not carry out a business or trade
and typically have no employees. They take a variety of legal forms -
trusts, partnerships and companies - and fulfil many different functions.
As well as being a key element of securitisations, SPEs are also used in
fund management activities to segregate custodial duties from the fund
management advice provided by the Group.
The Group applies the guidance in IAS 27 ‘Consolidated and Separate
Financial Statements’ and SIC 12 ‘Consolidation - Special Purpose
Entities’ in determining whether or not to consolidate an SPE. SPEs are
consolidated where the substance of the relationship between the Group
and the SPE is such that the SPE is controlled by the Group. In
determining whether the SPE is controlled by the Group, the Group
considers whether the activities of the SPE are being conducted on its
behalf so that it obtains benefits from its operation; whether the Group
has the decision-making powers to obtain the majority of the benefits of
the SPE’s activities; whether the Group has rights to obtain the majority
of the benefits of the SPE; and whether the Group retains the majority of
the residual or ownership risks related to the SPE or its assets so as to
obtain benefits from its activities. As a result of applying these principles,
the Group does not consolidate those SPEs where its interests in the
SPE do not provide the Group with a majority of the benefits and/or
residual or ownership risks and therefore the SPE is not controlled by the
Group. SPEs that are in substance controlled by the Group are
consolidated. The Group accounts for its interests, for example, holdings
of securities issued and liquidity commitments, in SPEs it does not
consolidate in accordance with its accounting policy for these items.
The Group sponsors and arranges own-asset securitisations, whereby
the sale of assets or interests in a pool of assets into an SPE is financed
by the issuance of securities to investors. The pool of assets held by the
SPE may be originated by the Group, or (in the case of whole loan
programmes) purchased from third parties, and may be of varying credit
quality. Investors in the debt securities issued by the SPE are rewarded
through credit-linked returns, according to the credit rating of their
securities. The majority of securitisations are supported through liquidity
facilities, other credit enhancements and derivative hedges extended by
financial institutions, some of which offer protection against initial defaults
in the pool of assets. Thereafter, losses are absorbed by investors in the
lowest ranking notes in the priority of payments. Investors in the most
senior ranking debt securities are typically shielded from loss, since any
subsequent losses may trigger repayment of their initial principal.
The Group also employs synthetic structures, where assets are not sold
to the SPE, but credit derivatives are used to transfer the credit risk of the
assets to an SPE. Securities may then be issued by the SPE to investors,
on the back of the credit protection sold to the Group by the SPE.
Residential and commercial mortgages and credit card receivables form
the types of assets generally included in cash securitisations, while
corporate loans and commercial mortgages typically serve as reference
obligations in synthetic securitisations.
The Group sponsors own-asset securitisations primarily as a way of
diversifying funding sources. The Group purchases the securities issued
in own-asset securitisations and may pledge as collateral for repurchase
agreements with major central banks.
Refer to Note 30 on the consolidated accounts on page 396 for the asset
categories, together with the carrying value of the assets and associated
liabilities for those securitisations and other asset transfers, other than
conduits (refer to page 125), where the assets continue to be recorded on
the Group's balance sheet.
Business review Risk and balance sheet management continued