RBS 2011 Annual Report Download - page 465

RBS Group 2011 463
The recoverability and regulatory capital treatment of certain deferred tax
assets recognised by the Group depends on the Group’s ability to
generate sufficient future taxable profits and there being no adverse
changes to tax legislation, regulatory requirements or accounting
standards
In accordance with IFRS, the Group has recognised deferred tax assets
on losses available to relieve future profits from tax only to the extent that
it is probable that they will be recovered. The deferred tax assets are
quantified on the basis of current tax legislation and accounting standards
and are subject to change in respect of the future rates of tax or the rules
for computing taxable profits and allowable losses. Failure to generate
sufficient future taxable profits or changes in tax legislation or accounting
standards may reduce the recoverable amount of the recognised
deferred tax assets. In April 2011, the UK Government commenced a
staged reduction in the rate of UK corporation tax from 28% to 23% over
afour-year period. Such a change in the applicable tax rate will reduce
the recoverable amount of the recognised deferred tax assets.
There is currently no restriction in respect of deferred tax assets
recognised by the Group for regulatory purposes. Changes in regulatory
capital rules may restrict the amount of deferred tax assets that can be
recognised and such changes could lead to a reduction in the Group’s
Core Tier 1 capital ratio. In particular, on 16 December 2010, the Basel
Committee published the Basel III rules setting out certain changes to
capital requirements which include provisions limiting the ability of certain
deferred tax assets to be recognised when calculating the common equity
component of Tier 1 capital. CRD IV which will implement Basel III in the
EU includes similar limitations. The implementation of the Basel III
restrictions on recognition of deferred tax assets within the common
equity component of Tier 1 are subject to a phased-in deduction starting
on 1 January 2014, to be fully effective by 1 January 2018.
The Group’s participation in the APS is costly and may not produce the
benefits expected and the occurrence of associated risks may have a
material adverse impact on the Group’s business, capital position,
financial condition and results of operations
On 22 December 2009, the Group acceded to the APS with HM Treasury
acting on behalf of the UK Government. Under the APS, the Group
purchased credit protection over a portfolio of specified assets and
exposures of the Royal Bank and certain members of the Group
(“Covered Assets”) from HM Treasury in return for an annual fee. If
losses on assets covered by the APS exceed £60 billion (net of
recoveries), HM Treasury will bear 90% of further losses. The costs of
participating in the APS include, among others, a fee of £700 million per
annum, payable in advance to HM Treasury for each of the first three
years of the APS and £500 million per annum thereafter until the earlier
of (i) the date of termination of the APS and (ii) 31 December 2099. In
order to terminate the Group’s participation in the APS, the Group must
have FSA approval and must pay an exit fee.
Ultimately, there is a risk that the amounts received under the APS may
be less than the costs of participation. In addition, the aggregate effect of
the joining, establishment, operational and exit costs and fees and
expenses of, and associated with, the APS may significantly reduce or
even eliminate the aggregate benefit of the APS to the Group.
The Group’s choice of assets or exposures to be covered by the APS
was based on certain predictions and assumptions at the time of its
accession to the APS. There is therefore, a risk that the Covered Assets
will not be those with the greatest future losses or with the greatest need
for protection and the Group’s financial condition, income from operations
and the value of any securities may still suffer due to further impairments
and credit write-downs. Notwithstanding the Group’s participation in the
APS, the Group remains exposed to a substantial first loss amount of £60
billion (net of recoveries) in respect of the Covered Assets and for 10% of
Covered Assets losses after the first loss amount. There is therefore, no
assurance that the Group’s participation in the APS will achieve the
Group’s goals of improving and maintaining the Group’s capital ratios in
the event of further losses. Moreover, the Group continues to carry the
risk of losses, impairments and write-downs with respect to assets not
covered by the APS.
The APS is a unique form of credit protection over a complex range of
diversified assets and exposures in a number of jurisdictions. Due to the
complexity, scale and unique nature of the APS and the uncertainty
resulting from the recent economic recession, there may be unforeseen
issues and risks that are relevant in the context of the Group’s
participation in the APS and in the impact of the APS on the Group’s
business, operations and financial condition. Such risks may have a
material adverse effect on the Group. The Group may also be subject to
further tax liabilities in the UK and overseas in connection with the APS
and the associated intra-group arrangements which would not otherwise
have arisen.
As a result of the significant volume, variety and complexity of assets and
exposures and the resulting complexity and extensive governance, asset
management, disclosure and information requirements of the APS
documents, there is a risk that the Group may have included assets or
exposures within the Covered Assets which are, or may later become
(including by reason of failure to comply with the requirements of the APS
or resulting from the disposal of an asset or exposure), ineligible for
protection under the APS or for which the protection is limited, which
would reduce the anticipated benefits to the Group of the APS. Further,
there is no ability to nominate additional or alternative assets or
exposures in place of any which may turn out not to be covered under the
APS. In addition, HM Treasury may, following consultation with the
Group, modify or replace certain of the UK APS terms and conditions (the
“Scheme Conditions”) in such a manner as it considers necessary (acting
reasonably) in certain circumstances. Such modifications or
replacements may be retrospective and may have a material adverse
effect on the expected benefits of the APS and, therefore, the Group’s
financial condition and results of operations.
Lastly, the APS is treated as a credit derivative accounted for at fair
value, which exhibits counter-cyclical behaviour. As a result, improving
market conditions result in a charge to the income statement, and vice
versa. Therefore, changes in the fair value of the APS can have a
significant adverse impact on the Group’s results of operations.