RBS 2011 Annual Report Download - page 212

210 RBS Group 2011
Risk management: Country risk continued
Monitoring, management and mitigation* continued
Going forward, the Group continues to extend country limit control to
other countries within and outside the eurozone and will continue to
manage medium-term exposure closer to its medium-term benchmark
ratios. In addition, work is continuing on the determination of actual
appetite per country, on the country risk reporting systems and their
integration with credit, treasury and finance systems, on the
representation of country risk aspects in rating models, economic capital
models and integrated stress testing, and on the combination with actual
and expected returns. All of this should help RBS determine and steer its
risk profile and further optimise the Group’s global portfolio management.
Credit default swap (CDS) contracts are used for a number of purposes
such as hedging of the credit trading portfolio, management of
counterparty credit exposure and the mitigation of wrong-way risk. The
Group generally uses CDS contracts to manage exposure on a portfolio
rather than specific exposures. This may give rise to maturity mismatches
between the underlying exposure and the CDS contract as well as
between bought and sold CDS contracts on the same reference entity.
The terms of the Group’s CDS contracts are covered by standard ISDA
documentation, which determines if a contract is triggered due to a credit
event. Such events may include bankruptcy or restructuring of the
reference entity or a failure of the reference entity to repay its debt or
interest. Under the terms of a CDS contract, one of the regional ISDA
Credit Derivatives Determinations Committees is empowered to decide
whether or not a credit event has occurred.
Country risk analysis
All the data tables and related definitions in this section are audited.
The following tables show the Group’s exposure by country of
incorporation of the counterparty at 31 December 2011. Countries shown
are those where the Group’s balance sheet exposure to counterparties
incorporated in the country exceeded £1 billion and the country had an
external rating of A+ or below from S&P, Moody’s or Fitch at 31
December 2011, as well as selected eurozone countries. The numbers
are stated before taking into account the impact of mitigating action, such
as collateral, insurance or guarantees that may have been taken to
reduce or eliminate exposure to country risk events. Exposures relating to
ocean-going vessels are not included due to their multinational nature.
The following definitions apply to the tables and key points on pages 211
to 228:
Lending comprises gross loans and advances to: central and local
governments; central banks, including cash balances; other banks and
financial institutions, incorporating overdraft and other short-term credit
lines; corporations, in large part loans and leases; and individuals,
comprising mortgages, personal loans and credit card balances. Lending
includes impaired loans and loans where an impairment event has taken
place, but the impairment provision is recognised.
Debt securities comprise securities classified as available-for-sale (AFS),
loans and receivables (LAR), held-for-trading (HFT) and designated as at
fair value through profit or loss (DFV). All debt securities other than LAR
securities are carried at fair value with LAR debt securities are carried at
amortised cost less impairment. HFT debt securities are presented as
gross long positions (including DFV securities) and short positions per
country. Impairment losses and exchange differences relating to AFS
debt securities, together with interest, are recognised in the income
statement; other changes in the fair value of AFS securities are reported
within AFS reserves, which are presented gross of tax.
Derivatives comprise the mark-to-market (mtm) value of such contracts
after the effect of enforceable netting agreements, but gross of collateral.
Reverse repurchase agreements (repos) comprise the mtm value of
counterparty exposure arising from repo transactions net of collateral.
Balance sheet exposures comprise lending exposures, debt securities
and derivatives, and repo exposures.
Contingent liabilities and commitments comprise contingent liabilities,
including guarantees and committed undrawn facilities.
Credit default swap (CDS) under CDS contract the credit risk on the
reference entity is transferred from the buyer to the seller. The fair value,
or mtm, represents the balance sheet carrying value. The mtm value of
CDSs is included within derivatives against the counterparty of the trade,
as opposed to the reference entity. The notional is the par amount of the
credit protection bought or sold and is included against the reference
entity of the CDS contract.
The column CDS notional less fair value represents the notional less fair
value amounts arising from sold positions netted against those arising
from bought positions, and represents the net change in exposure for a
given reference entity should the CDS contract be triggered by a credit
event, assuming there is a zero recovery rate. However, in most cases,
the Group expects the recovery rate to be greater than zero and the
exposure change to be less than this amount.
The Group primarily transacts CDS contracts with investment-grade
global financial institutions who are active participants in the CDS market.
These transactions are subject to regular margining. For European
peripheral sovereigns, credit protection has been purchased from a
number of major European banks, predominantly outside the country of
the reference entity. In a few cases where protection was bought from
banks in the country of the reference entity, giving rise to wrong-way risk,
this risk is mitigated through specific collateralisation. Due to their
bespoke nature, exposures relating to CDPCs and related hedges have
not been included, as they cannot be meaningfully attributed to a
particular country or a reference entity. Exposures to CDPCs are
disclosed on page 190.
The Group used CDS contracts throughout 2011 to manage both
eurozone country and counterparty exposures. As shown in the individual
country tables, this resulted in increases in both gross notional bought
and sold eurozone CDS contracts, mainly on Italy, France and the
Netherlands. The magnitude of the fair value of bought and sold CDS
contracts increased over 2011 in line with the widening of eurozone CDS
spreads.
‘Other eurozone’ comprises Austria, Cyprus, Estonia, Finland, Malta,
Slovakia and Slovenia.
*unaudited
Business review Risk and balance sheet management continued