rbs201102246k8.htm
 
FORM 6-K
SECURITIES AND EXCHANGE COMMISSION
Washington D.C. 20549
 
 
Report of Foreign Private Issuer
 
Pursuant to Rule 13a-16 or 15d-16
of the Securities Exchange Act of 1934
 
For February 24, 2011
 
Commission File Number: 001-10306
 
The Royal Bank of Scotland Group plc
 
RBS, Gogarburn, PO Box 1000
Edinburgh EH12 1HQ
 
(Address of principal executive offices)
 
 
Indicate by check mark whether the registrant files or will file annual reports under cover of Form 20-F or Form 40-F.
 
Form 20-F X
  
Form 40-F ___
 
Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(1):_________
 
Indicate by check mark if the registrant is submitting the Form 6-K in paper as permitted by Regulation S-T Rule 101(b)(7):_________

Indicate by check mark whether the registrant by furnishing the information contained in this Form is also thereby furnishing the information to the Commission pursuant to Rule 12g3-2(b) under the Securities Exchange Act of 1934.

Yes
   ___
No X
 
 
If "Yes" is marked, indicate below the file number assigned to the registrant in connection with Rule 12g3-2(b): 82- ________
 
 
The following information was issued as a Company announcement in London, England and is furnished pursuant to General Instruction B to the General Instructions to Form 6-K:
 
 
 

Risk and balance sheet management (continued)

Market risk
Market risk arises from changes in interest rates, foreign currency, credit spread, equity prices and risk related factors such as market volatilities. The Group manages market risk centrally within its trading and non-trading portfolios through a comprehensive market risk management framework. This framework includes limits based on, but not limited to, value-at-risk (VaR), stress testing, position and sensitivity analyses.

At the Group level, the risk appetite is expressed in the form of a combination of VaR, sensitivity and stress testing limits. VaR is a technique that produces estimates of the potential change in the market value of a portfolio over a specified time horizon at given confidence levels. For internal risk management purposes, the Group’s VaR assumes a time horizon of one trading day and a confidence level of 99%. The Group's VaR model is based on a historical simulation model, utilising data from the previous two years.

The VaR disclosure is broken down into trading and non-trading portfolios. Trading VaR relates to the main trading activities of the Group and non-trading VaR reflects reclassified assets, money market business and the management of internal funds flow within the Group’s businesses.

As part of the ongoing review and analysis of the suitability of the Group’s VaR model, a methodology enhancement to the ABS VaR was approved and incorporated into the regulatory model in 2010. The credit crisis in 2007-2009 caused large price changes for some structured bonds and the spread based approach to calculating VaR for these instruments started to give inaccurate risk levels, particularly for bonds trading at a significant discount to par. The methodology enhancement harmonised the VaR approach in the US and Europe by replacing the absolute spread-based approach with a more reliable and granular relative price-based mapping scheme. The enhancement better reflects the risk in the context of position changes, downgrades and vintages as well as improving the differentiation between prime, Alt-A and sub-prime exposures.

The VaR model has been approved by the FSA to calculate regulatory capital for the trading book. The approval covers general market risk in interest rate, foreign exchange, equity and limited commodity products and specific risk in interest rate and equity products.

As the VaR model is an important market risk measurement and control tool and is used for determining a significant component of the market risk capital, it is regularly assessed. The main approach employed is the technique known as back-testing which counts the number of days when a loss (as defined by the FSA), exceeds the corresponding daily VaR estimate, measured at a 99% confidence interval. The FSA categorises a VaR model as green, amber or red. A green model is consistent with a good working model and is achieved for models that have four or less back-testing exceptions in a 12 month period. For the Group’s trading book, a green model status was maintained throughout 2010.


 
RBS Group – Annual Results 2010
 
 
 


Risk and balance sheet management (continued)

Market risk (continued)

The Group’s VaR should be interpreted in the light of the limitations of the methodology used, as follows:

·
Historical simulation VaR may not provide the best estimate of future market movements.  It can only provide a prediction of the future based on events that occurred in the 500 trading day time series. Therefore, events more severe than those in the historical data series cannot be predicted.
   
·
The use of a 99% confidence level does not reflect the extent of potential losses beyond that percentile.
   
·
The use of a one day time horizon will not fully capture the profit and loss implications of positions that cannot be liquidated or hedged within one day.
   
·
The Group computes the VaR of trading portfolios at the close of business. Positions may change substantially during the course of the trading day and intra-day profits and losses will be incurred.

These limitations mean that the Group cannot guarantee that profits or losses will not exceed the VaR.

 
RBS Group – Annual Results 2010
 
 
 


Risk and balance sheet management (continued)

Market risk (continued)

The table below details the Group’s trading portfolio, segregated by type of market risk exposure, and between Core and Non-Core, Counterparty Exposure Management (CEM) and Core excluding CEM.

 
Quarter ended
  
Year ended
 
31 December 2010
  
30 September 2010
  
31 December 2010
  
31 December 2009
 
Average 
Period 
 end 
Maximum 
Minimum 
  
Average 
Period 
 end 
Maximum 
Minimum 
  
Average 
Period 
 end 
Maximum 
Minimum 
  
Average 
Period 
 end 
Maximum 
Minimum 
Trading
£m 
£m 
£m 
£m 
  
£m 
£m 
£m 
£m 
  
£m 
£m 
£m 
£m 
  
£m 
£m 
£m 
£m 
                                       
Interest rate
64.0 
57.0 
83.0 
47.6 
  
50.5 
74.3 
74.3 
38.6 
  
51.6 
57.0 
83.0 
32.5 
  
57.0 
50.5 
112.8 
28.1 
Credit spread
134.4 
133.4 
196.1 
110.2 
  
214.0 
190.8 
243.2 
174.5 
  
166.3 
133.4 
243.2 
110.2 
  
148.3 
174.8 
231.2 
66.9 
Currency
15.2 
14.8 
25.6 
8.4 
  
15.4 
16.7 
26.2 
9.3 
  
17.9 
14.8 
28.0 
8.4 
  
17.9 
20.7 
35.8 
9.2 
Equity
10.1 
10.9 
15.2 
4.7 
  
7.2 
5.4 
17.9 
2.7 
  
9.5 
10.9 
17.9 
2.7 
  
13.0 
13.1 
23.2 
2.7 
Commodity
7.9 
0.5 
18.1 
0.5 
  
8.9 
13.8 
15.7 
3.2 
  
9.5 
0.5 
18.1 
0.5 
  
14.3 
8.9 
32.1 
6.5 
Diversification
  
(75.6)
        
(119.2)
        
(75.6)
        
(86.1)
    
                                       
Total
154.3 
141.0 
191.5 
110.8 
  
213.1 
181.8 
252.1 
156.1 
  
168.5 
141.0 
252.1 
103.0 
  
155.2 
181.9 
229.0 
76.8 
                                       
Core
99.2 
101.2 
121.0 
58.3 
  
123.8 
115.0 
153.4 
99.6 
  
103.6 
101.2 
153.4 
58.3 
  
101.5 
127.3 
137.8 
54.8 
CEM
49.1 
54.6 
64.2 
38.7 
  
74.7 
73.0 
82.4 
70.4 
  
53.3 
54.6 
82.4 
30.3 
  
29.7 
38.6 
41.3 
11.5 
Core excluding CEM
81.3 
78.7 
102.8 
54.2 
  
84.2 
78.4 
96.5 
72.0 
  
82.8 
78.7 
108.7 
53.6 
  
86.7 
97.4 
128.5 
54.9 
                                       
Non-Core
105.5 
101.4 
119.7 
92.3 
  
135.7 
101.8 
169.4 
97.5 
  
105.7 
101.4 
169.4 
63.2 
  
86.3 
84.8 
162.1 
29.3 


 
RBS Group – Annual Results 2010
 
 
 


Risk and balance sheet management (continued)

Market risk (continued)

Key points
·
The Group’s period end VaR reduced as the exceptional volatility of the market data from the period of the financial crisis dropped out of the 500 days of time series data used in the VaR calculation. The credit spread VaR was particularly impacted as a result of this effect.
   
·
The Group’s maximum and average credit and Non-Core VaR were higher in 2010, than in 2009 due to Non-Core exiting several highly structured positions which due to their complexity and layering, required unwinding with different counterparts over different periods. The timing of the unwind has led to increased VaR, until the exit was completed in October and the VaR then reduced back to the levels held earlier in the year.
   
·
CEM VaR was greater in 2010 than 2009 due to the novation of counterparty risk hedging trades from RBS N.V. to RBS plc. For RBS N.V. there is no local regulatory requirement for counterparty hedges to be included in VaR, as they are treated on a standardised basis but on novation to CEM in RBS plc, under UK regulatory requirements, the trades were captured by the VaR model resulting in an increase in VaR.
   
·
CEM trading VaR also increased as a consequence of the implementation of a discounting approach based on the real funding cost for the collateralised derivatives.
   
·
Commodity VaR decreased during the year since a significant part of the Group’s interest in RBS Sempra Commodities JV. was sold during the year.


 
RBS Group – Annual Results 2010
 
 
 


Risk and balance sheet management (continued)

Market risk:
GBM traded revenue
 

Key points
·
The average daily revenue earned from GBM’s trading, balance sheet management and other trading activities in 2010 was £25.4 million, compared with £37.8 million in 2009. The standard deviation of these daily revenues was £22.0 million compared with £32.3 million in 2009. The standard deviation measures the variation of daily revenues above the mean value of those revenues.
   
·
An analysis of the frequency distribution of daily revenue shows that there were 22 days with negative revenue during 2010 compared with 16 days in 2009. The most frequent result is daily revenue of between £25 million and £30 million with 37 occurrences in 2010 compared with 26 occurrences in 2009.
   
·
The effect of any month end adjustments, not attributable to a specific daily market move, is spread evenly over the days in the month in question.
   
·
The graph of daily revenues for 2010 shows a narrower distribution of revenues compared to 2009.


 
RBS Group – Annual Results 2010
 
 
 


Risk and balance sheet management (continued)

Market risk (continued)

The table below details the Group’s non-trading VaR portfolio, excluding Structured Credit Portfolios (SCP) and loans and receivables (LAR), segregated by type of market risk exposure and between Core and Non-Core.
 
Quarter ended
  
Year ended
 
31 December 2010
  
30 September 2010
  
31 December 2010
  
31 December 2009
 
Average 
Period 
 end 
Maximum 
Minimum 
  
Average 
Period 
 end 
Maximum 
Minimum 
  
Average 
Period 
 end 
Maximum 
Minimum 
  
Average 
Period 
 end 
Maximum 
Minimum 
Non-trading VaR
£m 
£m 
£m 
£m 
  
£m 
£m 
£m 
£m 
  
£m 
£m 
£m 
£m 
  
£m 
£m 
£m 
£m 
                                       
Interest rate
8.0 
10.4 
10.8 
5.3 
  
9.1 
4.4 
20.5 
4.4 
  
8.7 
10.4 
20.5 
4.4 
  
13.0 
13.9 
26.3 
7.7 
Credit spread
17.0 
16.1 
21.8 
15.4 
  
22.6 
19.4 
26.4 
19.4 
  
32.0 
16.1 
101.2 
15.4 
  
81.7 
100.3 
131.5 
39.7 
Currency
2.3 
3.0 
3.7 
1.3 
  
2.8 
2.0 
6.1 
1.5 
  
2.1 
3.0 
7.6 
0.3 
  
1.4 
0.6 
7.0 
0.2 
Equity
2.9 
3.1 
4.6 
0.3 
  
0.4 
0.4 
1.7 
0.3 
  
1.2 
3.1 
4.6 
0.2 
  
3.3 
2.2 
5.8 
1.6 
Diversification
  
(15.9)
        
(6.8)
        
(15.9)
        
(20.4)
    
                                       
Total
16.2 
16.7 
21.3 
13.7 
  
23.8 
19.4 
29.1 
19.4 
  
30.9 
16.7 
98.0 
13.7 
  
80.4 
96.6 
126.9 
46.8 
                                       
Core
15.6 
15.6 
21.3 
12.8 
  
23.6 
19.3 
29.3 
19.3 
  
30.5 
15.6 
98.1 
12.8 
  
78.4 
95.9 
126.9 
46.8 
Non-Core
2.8 
2.8 
4.1 
0.2 
  
0.7 
0.3 
2.0 
0.2 
  
1.3 
2.8 
4.1 
0.2 
  
3.5 
1.9 
16.9 
- 

Key points
·
The non-traded credit spread, Core and total VaR have decreased significantly due to the implementation of the relative price-based mapping scheme in the VaR methodology discussed above and the sale of available-for-sale securities in the US mortgage business.
·
The business model for the US mortgage business has focussed its activity on client facilitation flow trading during 2010. This has encompassed the disposal of a large portfolio of illiquid available-for-sale securities that were sold throughout the year, resulting in the non-traded VaR reducing. In parallel, the risk management of the business has been significantly enhanced to ensure that the business remains focussed on client facilitation flow trading of liquid assets. Tools have been implemented to monitor the liquidity of trading volumes, asset aged inventory controls have been tightened and granular asset concentration risk limits imposed, to complement the existing value-at-risk and stress testing market risk frameworks.

VaR is not always the most appropriate measure of risk for assets in the non-trading book, particularly for those in Non-Core which will diminish over time as the asset inventory is sold down. In order to better represent the risk of the non-traded portfolios, the table above analyses the VaR for the non-trading portfolios but excludes SCP in Non-Core. These assets are shown separately on a drawn notional and fair value basis by maturity profile and asset class and are managed on both an asset and RWA basis. Also excluded from the non-traded VaR are the LAR products that are managed within the credit risk management framework. Consequently, these portfolios have been excluded from non-trading VaR and prior period data has been revised accordingly.

 
RBS Group – Annual Results 2010
 
 
 


Risk and balance sheet management (continued)

Market risk: Structured credit portfolio (continued)

 
Drawn notional
  
Fair value
 
CDOs 
CLOs 
MBS (1)
Other 
 ABS 
Total 
  
CDOs 
CLOs 
MBS (1)
Other 
 ABS 
Total 
 
£m 
£m 
£m 
£m 
£m 
  
£m 
£m 
£m 
£m 
£m 
                       
31 December 2010
                      
1-2 years
- 
- 
- 
47 
47 
  
- 
- 
- 
42 
42 
2-3 years
85 
19 
44 
98 
246 
  
81 
18 
37 
91 
227 
3-4 years
- 
41 
20 
205 
266 
  
-  
37 
19 
191 
247 
4-5 years
16 
- 
- 
- 
16 
  
15 
- 
- 
- 
15 
5-10 years
98 
466 
311 
437 
1,312 
  
87 
422 
220 
384 
1,113 
>10 years
412 
663 
584 
550 
2,209 
  
161 
515 
397 
367 
1,440 
                       
 
611 
1,189 
959 
1,337 
4,096 
  
344 
992 
673 
1,075 
3,084 
                       
30 September 2010
                      
1-2 years
- 
- 
- 
58 
58 
  
- 
- 
- 
50 
50 
2-3 years
84 
19 
46 
66 
215 
  
79 
18 
34 
63 
194 
3-4 years
- 
35 
29 
211 
275 
  
- 
31 
27 
183 
241 
4-5 years
19 
7 
6 
57 
89 
  
17 
7 
4 
52 
80 
5-10 years
99 
366 
404 
485 
1,354 
  
86 
324 
265 
414 
1,089 
>10 years
519 
793 
591 
548 
2,451 
  
177 
627 
379 
368 
1,551 
                       
 
721 
1,220 
1,076 
1,425 
4,442 
  
359 
1,007 
709 
1,130 
3,205 
                       
30 June 2010
                      
1-2 years
- 
- 
- 
67 
67 
  
- 
- 
- 
61 
61 
2-3 years
75 
20 
43 
85 
223 
  
70 
18 
31 
80 
199 
3-4 years
30 
37 
19 
298 
383 
  
23 
32 
18 
239 
312 
4-5 years
20 
11 
38 
59 
128 
  
17 
10 
33 
53 
113 
5-10 years
90 
439 
394 
548 
1,470 
  
80 
390 
255 
455 
1,180 
>10 years
624 
1,004 
689 
607 
2,925 
  
233 
810 
420 
387 
1,850 
                       
 
839 
1,511 
1,183 
1,664 
5,196 
  
423 
1,260 
757 
1,275 
3,715 
                       
31 December 2009
                      
1-2 years
- 
- 
- 
81 
81 
  
- 
- 
- 
68 
68 
2-3 years
40 
- 
- 
19 
59 
  
24 
- 
- 
18 
42 
3-4 years
19 
18 
42 
99 
178 
  
16 
17 
31 
76 
140 
4-5 years
17 
47 
36 
332 
432 
  
3 
41 
29 
275 
348 
5-10 years
107 
685 
424 
521 
1,737 
  
90 
594 
251 
394 
1,329 
>10 years
594 
1,114 
820 
573 
3,101 
  
193 
896 
468 
325 
1,882 
                       
 
777 
1,864 
1,322 
1,625 
5,588 
  
326 
1,548 
779 
1,156 
3,809 

Note:
(1)
Mortgage-backed securities (MBS) include sub-prime residential mortgage-backed securities (RMBS) with a notional amount of £471 million (30 September 2010 - £477 million; 30 June 2010 - £562 million; 31 December 2009 - £682 million) and a fair value of £329 million (30 September 2010 - £316 million; 30 June 2010 - £350 million; 31 December 2009 - £415 million), all with residual maturities of greater than 10 years.

The SCP is within Non-Core. The risk on this portfolio is not measured or disclosed using VaR, as the Group believes this is not an appropriate tool for the banking book portfolio comprising of illiquid debt securities. The main driver of the reduction in drawn notional is the asset sales from a portfolio within an unwound securitisation arbitrage conduit. The impact of disposals on portfolio fair value has been partially offset by an increase in residual average price to 75% (2009 - 68%).

 
RBS Group – Annual Results 2010
 
 
 


 
 
Signatures

 
Pursuant to the requirements of the Securities Exchange Act of 1934, the registrant has duly caused this report to be signed on its behalf by the undersigned, thereunto duly authorized.
 
 

 
 
Date: 24 February 2011
 
 
THE ROYAL BANK OF SCOTLAND GROUP plc (Registrant)
 
 
 
By:
/s/ Jan Cargill
 
 
Name:
Title:
Jan Cargill
Deputy Secretary
 

 

 

*