Barclays 2015 Annual Report Download - page 123

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c) Large single name losses
The Group has large individual exposures to single name counterparties.
The default of such counterparties could have a significant impact on
the carrying value of these assets. In addition, where such counterparty
risk has been mitigated by taking collateral, credit risk may remain high if
the collateral held cannot be realised, or has to be liquidated at prices
which are insufficient to recover the full amount of the loan or derivative
exposure. Any such defaults could have a material adverse effect on the
Group’s results due to, for example, increased credit losses and higher
impairment charges.
d) Leverage Finance underwriting
The Group takes on significant sub-investment grade underwriting
exposure, including single name risk, particularly focused in the US and
Europe and to a lesser extent in South Africa and other regions. The
Group is exposed to credit events and market volatility during the
underwriting period. Any adverse events during this period may
potentially result in loss for the Group or an increased capital
requirement should there be a need to hold the exposure for an
extended period.
Market risk
The Group’s financial position may be adversely affected by changes
in both the level and volatility of prices leading to lower revenues, or
reduced capital:
i) Concerns of major unexpected changes in monetary policy and
quantitative easing programmes, foreign exchange movements or
slowdown in emerging market economies spilling over to global
markets (emerging risk)
The trading business model is focused on client facilitation in wholesale
markets, involving market making activities, risk management solutions
and execution.
The Group’s trading business is exposed to a rapid unwinding of
quantitative easing programmes and deterioration in the macro
environment driven by concerns in global growth. An extremely high
level of volatility in asset prices could affect market liquidity and cause
excess market volatility, impacting the Group’s ability to execute client
trades and may also result in lower income or portfolio losses.
A sudden and adverse volatility in interest or foreign currency exchange
rates also has the potential to detrimentally impact the Group’s income
from non-trading activity.
This is because the Group has exposure to non-traded interest rate risk,
arising from the provision of retail and wholesale non-traded banking
products and services, including, products which do not have a defined
maturity date and have an interest rate that does not change in line with
base rate movements, e.g. current accounts. The level and volatility of
interest rates can impact the Group’s net interest margin, which is the
interest rate spread earned between lending and borrowing costs. The
potential for future volatility and margin changes remains in key areas
such as in the UK benchmark interest rate to the extent such volatility
and margin changes are not fully addressed by hedging programmes.
The Group is also at risk from movements in foreign currency exchange
rates as these impact the sterling equivalent value of foreign currency
denominated assets in the banking book, exposing it to currency
translation risk.
ii) Adverse movements in the pension fund
Adverse movements between pension assets and liabilities for defined
benefit pension schemes could contribute to a pension deficit. The
liabilities discount rate is a key driver and, in accordance with
International Financial Reporting Standards (IAS 19), is derived from the
yields of high quality corporate bonds (deemed to be those with AA
ratings) and consequently includes exposure to both risk-free yields and
credit spreads. Therefore, the Group’s defined benefits scheme valuation
would be adversely affected by a prolonged fall in the discount rate or a
persistent low rate and/or credit spread environment. Inflation is another
significant risk driver to the pension fund, as the liabilities are adversely
impacted by an increase in long term inflation expectation. However in
the long term, inflation and rates risk tend to be negatively correlated
and therefore partially offset each other.
Funding risk
The ability of the Group to achieve its business plans may be
adversely impacted if it does not effectively manage its capital
(including leverage), liquidity and other regulatory requirements.
The Group may not be able to achieve its business plans due to: i) being
unable to maintain appropriate capital ratios; ii) being unable to meet its
obligations as they fall due; iii) rating agency methodology changes
resulting in ratings downgrades; and iv) adverse changes in foreign
exchange rates on capital ratios.
i) Inability to maintain appropriate prudential ratios
Should the Group be unable to maintain or achieve appropriate capital
ratios this could lead to: an inability to support business activity; a failure
to meet regulatory capital requirements including the requirements of
regulator set stress tests; increased cost of funding due to deterioration
in credit ratings; restrictions on distributions including the ability to meet
dividend targets; and/or the need to take additional measures to
strengthen the Group’s capital or leverage position. While the
requirements in CRD IV are now in force in the UK, further changes to
capital requirements could occur, whether as a result of (i) further
changes to EU legislation by EU legislators (for example, implementation
of Bank of International Settlements (BIS) regulatory update
recommendations), (ii) relevant binding regulatory technical standards
updates by the European Banking Authority (EBA), (iii) changes to UK
legislation by the UK government, (iv) changes to PRA rules by the PRA,
or (v) additional capital requirements through Financial Policy
Committee (FPC) recommendations. Such changes, either individually
and/or in aggregate, may lead to further unexpected additional
requirements in relation to the Group’s regulatory capital.
Additional prudential requirements may also arise from other regulatory
reforms, including UK, EU and the US proposals on bank structural
reform and current proposals for ‘Minimum Requirement for own funds
and Eligible Liabilities (MREL) under the EU Bank Recovery and
Resolution Directive (BRRD). Included within these reforms are the BoE
proposals on MREL requirements for UK banks which were published in
December 2015. The BoE stated its intentions to communicate MREL
requirements to UK banks during 2016. Many of the proposals are still
subject to finalisation and implementation and may have a different
impact when in final form. The impact of these proposals is still being
assessed. Overall, it is likely that these changes in law and regulation will
have an impact on the Group as they are likely, when implemented, to
require changes to the legal entity structure of the Group and how
businesses are capitalised and funded. Any such increased prudential
requirements may also constrain the Group’s planned activities, lead to
forced asset sales and balance sheet reductions and could increase the
Group’s costs, impact on the Group’s earnings and restrict the Group’s
ability to pay dividends. Moreover, during periods of market dislocation,
as currently seen, or when there is significant competition for the type of
funding that the Group needs, increasing the Group’s capital resources
in order to meet targets may prove more difficult and/or costly.
ii) Inability to manage liquidity and funding risk effectively
Failure to manage its liquidity and funding risk effectively may result in
the Group either not having sufficient financial resources to meet its
payment obligations as they fall due or, although solvent, only being able
to meet these obligations at excessive cost. This could cause the Group
to fail to meet regulatory liquidity standards, be unable to support
day-to-day banking activities, or no longer be a going concern.
iii) Credit rating changes and the impact on funding costs
A credit rating assesses the creditworthiness of the Group, its
subsidiaries and branches and is based on reviews of a broad range of
business and financial attributes including risk management processes
and procedures, capital strength, earnings, funding, liquidity, accounting
and governance. Any adverse event to one or more of these attributes
may lead to a downgrade, which in turn could result in contractual
outflows to meet contractual requirements on existing contracts.
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