Annual Financial Report
London Stock Exchange Group plc Annual Report and Accounts, Notice of Annual General Meeting 2017 and related documents.
The Annual Report and Accounts of the London Stock Exchange Group plc (the "Group") for the year ended 31 December 2016 (the "Annual Report"), Notice of Annual General Meeting 2017 (the "AGM Notice") and related form of proxy for the Group's 2017 Annual General Meeting (the "AGM") are being mailed to shareholders today and, in accordance with paragraph 9.6.1 of the FCA Listing Rules, have been submitted to the National Storage Mechanism where they will shortly be available for inspection at www.hemscott.com/nsm.do.
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London Stock Exchange Group plc |
Paul Froud - Investor Relations |
+44 (0) 20 7797 3322 |
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Gavin Sullivan/Lucie Holloway - Media |
+44 (0) 20 7797 1222 |
In compliance with DTR 6.3.5, the following information is extracted from the Annual Report and should be read in conjunction with the Group's preliminary results announcement of 3 March 2017 (the "Preliminary Results"). The information reproduced below and the Preliminary Results together constitute the material required by DTR 6.3.5 to be communicated in full, unedited text through a regulatory information service. This is not a substitute for reading the full Annual Report. Page numbers and cross references in the extracted information below refer to page numbers and cross-references in the Annual Report. The Annual Report, the Preliminary Results and the AGM Notice can be viewed and downloaded at http://www.lseg.com/investor-relations.
The Annual Report contains the following statements regarding important events that have occurred during the year on pages 4 to 5:
"The Group is strong, financially and operationally, as a well diversified and global market infrastructure business with highly valuable franchises.
Overview
2016 was characterised by periods of exceptional unpredictability as geo-political events dominated the headlines. Despite the accompanying global market volatility and uncertainty, London Stock Exchange Group has maintained focus on the execution of its agreed strategy in Capital Formation, Risk and Balance Sheet Management and Intellectual Property with the delivery of a number of new initiatives. We remain true to our Open Access philosophy, having enhanced our customer partnerships across the business. As a Group, we have also continued to focus on cost discipline, while investing for growth, focusing on new opportunities and achieving the benefits of recent acquisitions.
Following the UK's decision to leave the EU, the Group will continue to monitor developments to ensure that our businesses are well prepared. Our priority is to ensure continuity of service and the orderly functioning of our markets and other activities for our customers, members and other stakeholders. The Group operates successfully, and at scale, a full range of market infrastructure services in the UK, Europe and around the world including the provision of trading platforms, indices, data services, clearing and settlement platforms and technology expertise. We are well placed to respond to the needs of our clients and to regulatory changes with a strong footprint and licensed operations in the UK, Europe and the United States.
Financial performance
The Group has delivered another good financial performance with growth across all core business areas. Total continuing income rose to £1,657.1 million, up 17%. Adjusted operating profit increased 17% to £685.8 million and operating profit increased 6% to £426.8 million.
The Board is proposing a final dividend of 31.2 pence per share which results in a 20% year-on-year increase in the total dividend to 43.2 pence per share. The final dividend will be paid on 31 May 2017 to shareholders on the register as at 5 May 2017.
Governance
On my appointment in mid-2015, I led an appraisal of the skills and backgrounds of the Board members with the aim of developing a Board with the right skills balance, diversity and appropriate size. As a result, a number of changes were made to the Board's composition in December 2015 adding additional buy-side, plc, clearing and regulatory expertise to the Board.
This year, Baroness Sharon Bowles, Sherry Coutu, CBE, and Stuart Lewis stepped down from the Board as Non-Executive Directors in April and Andrea Munari also announced his resignation in September after nine years on the Board. I would like to thank them all for their valuable contributions and to Andrea for his deep financial experience through a period of significant development and expansion for the Group. I would also like to welcome Andrea Sironi who joined the Board in October, maintaining our strong link with Borsa Italiana. In addition, I am pleased that the LSE plc board will continue to benefit from Baroness Bowles and Sherry Coutu's skills and experience whilst Stuart Lewis continues to support the Risk Committee.
Good governance involves having expert independent advice when required and last year the Board set out plans to form Regulatory and Technology Advisory Groups to give Directors access to this external counsel. Appointments were made to both groups in the year and we will keep shareholders updated on the progress of these groups.
As explained in greater detail in the Governance Report on page 56, the Board is in transition in terms of its composition and fully supports the aims of improving gender balance of corporate boards and the wider workforce. During 2016, LSEG signed the UK's HM Treasury Women in Finance Charter, signalling the Group's ongoing commitment to equality in the workplace and to actively challenge both ourselves and others in the financial sector to keep addressing these issues. Our Women's Inspired Network (WIN) also expanded its global footprint with events and networks established in all of our major operational hubs.
Corporate Social Responsibility
As the Group's scale and reach grows we continue to seek opportunities to expand through four distinct pillars: our markets; our services; our people; and in our surrounding communities. In 2016, the Group donated almost £1.1 million to charities and worked closely with global and regional partner charities that focus on helping young people to develop the life and business skills they need to fulfil their potential. We also introduced paid volunteering days for all employees to encourage them to become involved in local charity work, which can make a difference not only to our community but also for an individual's personal development. A number of our employees have taken the opportunity to get involved, offering their time and expertise and we will look to continue to roll this out more broadly over the coming year. A summary of our activities can be found on pages 36 - 37 as well as in our standalone Corporate Responsibility Report, which can be accessed from our website www.lseg.com/about-london-stockexchange-group/corporate-responsibilty.
Proposed Merger
In March 2016, London Stock Exchange Group announced the terms of a recommended all share merger with Deutsche Börse. The transaction received approvals from our shareholders and those of Deutsche Börse and we remain focused on obtaining the necessary regulatory and anti-trust approvals. At the time of publication, we expect a decision from the European Commission on or before 3 April 2017.
We have worked through the regulatory requirements in a systematic manner and, as part of that process, in January 2017 announced the disposal of LCH SA, LCH Group's French-regulated operating subsidiary to Euronext N.V.
The sale is subject to the review and approval by the European Commission and fulfilment of other customary conditions including relevant regulatory approvals and is conditional on the successful closing of the merger.
In February 2017, taking all relevant factors into account, and acting in the best interests of shareholders, the LSEG Board concluded that it could not commit to the divestment of MTS, a leading regulated electronic trading platform for European wholesale Government bonds and other fixed income securities. Based on the Commission's current position, LSEG believes that the Commission is unlikely to provide clearance for the Merger.
Nevertheless, the LSEG Board remains convinced of the strategic benefits of the Merger and recognises the strong support from shareholders for the transaction. LSEG will continue to take steps to seek to implement the Merger. In addition to Commission clearance, the Merger is conditional on regulatory clearances from Italian regulators and all relevant regulators including the Bank of England, FCA, BaFin and the Hessian Exchange Supervisory Authority ("HESA"), as well as all other relevant regulators and authorities in all other countries in which LSEG operates. While discussions are being progressed with a number of these regulators, the regulatory process has not yet been concluded and formal engagement has not yet begun with HESA.
The LSEG Board is highly confident in the strength of LSEG's business, strategy and prospects on a stand alone basis, under its strong management team led by Chief Executive Xavier Rolet.
Conclusion
I thank all employees who have contributed to the Group's development and success over the past year. It is a year in which the innovative and partnership culture of the company has been in particular evidence. The Group is strong, financially and operationally, as a well diversified and global market infrastructure business with highly valuable franchises. We have many opportunities to deliver further growth and we look forward to our future prospects with confidence.
Donald Brydon
Chairman
3 March 2017"
The Annual Report contains the following statements regarding principal risks and uncertainties facing the business, with respect to principal strategic, financial and operational risks, on pages 47 to 53, and, with respect to financial risk management, on pages 123 to 127:
OVERVIEW OF PRINCIPAL RISKS:
Strategic Risks Financial Risks Operational Risks
Global economy Credit risk Technology
Regulatory change & Compliance Market risk Security threats
Competition Liquidity risk Change management
Transformation Capital risk Settlement and custodial risks
Reputation/Brand Employees
STRATEGIC RISKS
Risks related to our strategy (including the implementation of strategic initiatives and external threats to the achievement of our strategy).The category also includes risks associated with reputation or brand values.
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Risk Description |
Mitigation |
Risk level |
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Global economy As a diversified markets infrastructure business, we operate in a broad range of equity, bond and derivative markets servicing clients who increasingly seek global products and solutions. If the global economy underperforms, lower activity in our markets may lead to lower fee revenue. During 2016 market volatility followed results from referenda in the UK and Italy and elections in the US. During 2017, the potential for political upheaval continues with further elections across Europe and this, combined with continued uncertainty regarding both the future of the UK's relationship with the European Union and its broader direction, could impact the Group's businesses. In particular, the outcome of the UK referendum on membership of the EU injected notable uncertainty into global markets and weakened sterling. Despite signs of economic stability towards the latter end of 2016, the prospect of a lengthy negotiation period upon triggering Article 50 may weigh on market sentiment and reduce activity, including IPOs and further issues. Customers may also start contingency plans if location of specific activities in the UK appears threatened by UK exit negotiations. Strong economic data from the US in 2016 has resulted in the second interest rate hike by the US Federal Reserve in consecutive years and there is potential for further rate increases during 2017. There is, however, uncertainty in the global economic outlook and US forecast growth could fail to materialise. The US approach to financial services regulation may also impact market volatility. Ongoing geopolitical tensions continue to add uncertainty in the markets and may impact investors' confidence and activity levels. |
The broader footprint of the Group has improved the geographical diversification of the Group's income streams. The Group mitigates the foreign exchange translation exposure created by ownership of overseas businesses by matching, to the extent possible, the currency of its debt to the currency of its income streams. This is supplemented as required by a hedging programme using market standard derivative instruments. Material foreign currency transactions relate mainly to M&A and dividend related payments and are hedged as required by Group Treasury Policy.
The Group performs regular analyses to monitor the markets and the potential impacts of market price movements on the business. Activities include Key Risk Indicator tracking, stress testing, and hedging. We continue to actively monitor the ongoing developments following the result of the UK referendum. Special Committees have been set up to respond to the risks to our operations. The Group has formulated contingency plans to remain well positioned to service its clients.
The Financial Risk Committee closely monitors and analyses multiple market stress scenarios and action plans in order to minimise any impacts stemming from a potential deterioration of the macroeconomic environment. The stress scenarios are regularly reviewed and updated in response to changes in macroeconomic conditions. |
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For more information, see Market trends and our response, pages 12-15, and Note 2 to the accounts: Financial Risk Management on pages 123-127. |
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Regulatory change and compliance The Group and its exchanges, other trading venues, clearing houses, index administrators, central securities depositories, trade repository and other regulated entities operate in areas that are highly regulated by governmental, competition and other regulatory bodies. There is a range of measures which impact our business directly or indirectly including MiFID/MiFIR, EMIR, Benchmark Regulation, SFTR and BRRD. In addition, the European Commission reached agreement with the Council and Parliament on the Prospectus Regulation in a form which supports both EU and international issuers across LSEG's equity and fixed-income markets. New provisions will support SMEs, secondary issuance and retail bond investors. Provisions supporting larger European markets survived review after the Brexit referendum. There is a risk that the UK's exit from the EU may lead to considerable regulatory change. The Group monitors developments closely. The MiFID and MiFIR secondary legislation is nearly completed and the rulesets will come into effect on 3 January 2018. Key provisions on Open Access and SME Growth Markets are complete and we do not expect significant changes to near-final secondary legislation affecting market data and information services. Further delay to legislation finalisation could impact Group system change projects and put implementation timelines at risk. CCP regulatory initiatives are ongoing. In November 2016, the European Commission proposed a framework for recovery and resolution of CCPs. This work is being conducted in parallel with the development of international standards from CPMI-IOSCO and FSB. The European Commission has also confirmed the areas of EMIR that will be modified as part of the official review of the regulation. The Basel III rules on capital requirements for banks' exposure to CCPs and BCBS leverage ratio need to be adjusted to mitigate any impact on our CCP clearing volumes, with implications for the Group's revenues. However, the European Commission published proposed changes in November 2016 to the EU Capital Requirements Regulation which largely neutralise the effects for European clients. The changes would allow CCP clearing members to reduce their exposure measures by the amount of initial margin received from clients for CCP cleared derivatives. This will reduce leverage ratios, thus removing a financial barrier for clearing members to offer client clearing. The Benchmarks Regulation primary legislation was completed in 2016 and secondary legislation will be completed this year, with all rules coming into effect in January 2018. The regulation enshrines the IOSCO Principles and we view the new rule set positively as it raises standards across the industry. There is increasing legislative and regulatory focus on cyber security, data protection and emerging technology. LSEG fully supports emerging regulatory regimes for these issues, as they increase the standards for clients, vendors and other third parties with whom we interact. Regulators are monitoring the development of innovative financial services technologies, but no legislative proposals have yet been proposed. Negotiations also continue on a possible Financial Transaction Tax (FTT). During 2016 little progress was made, however a FTT could adversely impact volumes in financial markets. There is a risk that one or more of the Group's entities may fail to comply with the laws and regulatory requirements to which it is, or becomes, subject. In this event, the entity in question may be subject to censures, fines and other regulatory or legal proceedings. |
Changes in the regulatory environment form a key input into our strategic planning, including the impact on our growth strategies, both organic and inorganic. We monitor regulatory developments continually and engage directly with regulatory and governmental authorities at national, EU and international levels. We continue to develop our relationships with the key political stakeholders in the EU, North America and Asia. Potential impacts from regulatory change are assessed and, depending on the impact, opportunities are developed and mitigating strategies and actions are planned. As the various regulatory initiatives progress, there will be greater certainty about their likely final form. The Group continues to focus on remaining well positioned to respond to regulatory developments and further opportunities exist for the Group to deliver solutions to help the market address the changing regulatory environment. The Group continues to maintain systems and controls to mitigate compliance risk. Compliance policies and procedures are regularly reviewed to ensure that Group entities and staff are compliant with applicable laws and regulations and uphold our corporate standards. All staff across the Group are subject to mandatory compliance training. |
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For more information on regulatory changes see Market trends and our response on pages 12-15.
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Competition The Group operates in a highly competitive industry. Continued consolidation has fuelled competition including between groups in different geographical areas. In our Capital Markets operations, there is a risk that competitors will improve their products, pricing and technology in a way that erodes our businesses. There is strong competition for primary listings and capital raises from other global exchanges and regional centres. In Post Trade Services, competition will continue to intensify as we see a shift towards open access and interoperability of CCPs and legislative requirements for mandatory clearing of certain OTC derivative products. While this may create new business opportunities for the Group, competitors may respond more quickly to changing market conditions or develop products that are preferred by customers. The Group's Information Services business faces competition from a variety of sources, notably from other venues that offer market data relating to securities that are traded on the Group's equity markets, as well as from index providers which offer indices and other benchmarking tools which compete with those offered by the Group. Furthermore, if the Group's share of equity trading on its revenue were to come under further pressure, the Group's market data offering might be seen by current and prospective customers as being less valuable, which may adversely affect the Group's business, financial condition and operating results. In Technology Services, there is intense competition across all activities and there are strong incumbents in some of our growth areas. |
Competitive markets are, by their very nature, dynamic, and the effects of competitor activity can never be fully mitigated. Senior management actively engages with clients and the Group undertakes constant market monitoring and pricing revision to mitigate risks. Commercial initiatives are aligned with our clients and this is complemented by an ongoing focus on technology. The Group's track record of innovation and diversification ensures the Group offers best-in-class services with a global capability. The Group is focused on integrating acquisitions and delivering tangible synergies. This is supported by robust governance and programme management structures. We maintain a dedicated international team who promote the benefits of listing on our markets to international issuers, the global advisory community and other stakeholders. |
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Transformation The Group is exposed to transformation risks (risk of loss or failure resulting from change/transformation) given the current levels of change and alignment activity taking place across the Group. As part of the alignment processes, the Group targets specific synergy deliveries. A failure to successfully align the businesses of the Group may lead to an increased cost base without a commensurate increase in revenue; a failure to capture future product and market opportunities; and risks in respect of capital requirements, regulatory relationships and management time. The additional work related to M&A and alignment activities could have an adverse impact on the Group's day-to-day performance and/or key strategic initiatives which could damage the Group's reputation. The size and complexity of the recent acquisitions and the recent merger proposal have increased the Group's change management and transformation risks. However, it has also increased its opportunities to compete on a global scale. |
The LSEG Enterprise Risk Management Framework (ERMF) ensures appropriate Risk Management across the Group, and the governance of the Group following a merger or acquisition is aligned and strengthened as appropriate. The Group performs regular reporting of change performance, including ongoing alignment activity. Each major initiative is overseen by a steering committee which monitors the associated risks closely and is typically chaired by the Chief Financial Officer and includes Executive Committee members. Regular reports are submitted to the Executive Committee, the Board Risk Committee and the Board. |
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Reputation/Brand A number of the Group's businesses have iconic national brands that are well-recognised at international as well as at national levels. The strong reputation of the Group's businesses and their valuable brand names are a key selling point. Any events or actions that damage the reputation or brands of the Group could adversely affect its business, financial condition and operating results. Failure to protect the Group's Intellectual Property rights adequately could result in costs for the Group, negatively impact the Group's reputation and affect the ability of the Group to compete effectively. Further, defending or enforcing the Group's Intellectual Property rights could result in the expenditure of significant financial and managerial resources, which could adversely affect the Group's business, financial condition and operating results. |
LSEG has policies and procedures in place which are designed to ensure the appropriate use of the Group's brands and to maintain the integrity of the Group's reputation. LSEG actively monitors the use of its brands and other Intellectual Property in order to prevent or identify and address any infringements. The Group protects its intellectual property by relying upon a combination of trademark laws, copyright laws, patent laws, trade secret protection, confidentiality agreements and other contractual arrangements with its affiliates, clients, customers, suppliers, strategic partners and others. |
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FINANCIAL RISKS
The risk of financial failure, reputational loss, loss of earnings and/or capital as a result of investment activity, lack of liquidity, funding or capital, and/or the inappropriate recording, reporting and disclosure of financial results, taxation or regulatory information.
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Risk Description |
Mitigation |
Risk level |
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Credit risk Clearing CCPs in the Group are exposed to credit risk as a result of their clearing activities. Default by a CCP clearing member could adversely affect that CCP's revenues and its customers' goodwill. CCPs authorised in the EU are required to make a proportion of their regulatory capital available to cover default losses after the defaulter's resources have been exhausted and prior to allocation of losses to non-defaulters and so, in extreme circumstances, a default could lead to a call on the Group CCPs' own capital 'skin-in-the-game'. CCPs may also be exposed to credit exposure to providers of infrastructure services such as Central Securities Depositaries (CSDs) and concentration banks. In addition, certain CCPs within the Group have interoperability margin arrangements with other CCPs requiring collateral to be exchanged in proportion to the value of the underlying transactions. The relevant clearing provider entities within the Group are therefore exposed to the risk of a default of other CCPs under such arrangements. Non-Clearing CCPs and other parts of LSEG Group are also exposed to credit risk as a result of placing money with investment counterparties on both a secured and unsecured basis. Losses may occur due either to the default of the investment counterparty or of the issuer of bonds bought outright or received as collateral.
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Clearing As CCP members continue to work towards strengthening of their balance sheets, the risk to LSEG CCPs of a member default, reduces, although continuing geopolitical uncertainty continues and the banking sectors of some countries remain stressed. The financial risks associated with clearing operations are further mitigated by: --Strict CCP membership rules including supervisory capital, financial strength and operational capability --The maintenance of prudent levels of margin and default funds to cover exposures to participants. Members deposit margin, computed at least daily, to cover the expected costs which the clearing service would incur in closing out open positions in a volatile market in the event of the member's default. A default fund sized to cover the default of the two members with the largest exposures in each service using a suite of extreme but plausible stress tests mutualises losses in excess of margin amongst the clearing members --Regular 'Fire Drills' are carried out to test the operational soundness of the CCPs' default management processes Infrastructure providers are regularly assessed in line with policy. Non-Clearing Policies are in place to ensure that investment counterparties are of good credit quality, and at least 95% of CCP commercial bank deposits are secured. CCP and non-CCP counterparty concentration risk is consolidated and monitored daily at the Group level and reported to the Executive Committee and to the Board Risk Committee, including limits and status rating. |
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For more information on this risk see the Post Trade Services section of the Segmental Review on pages 26 - 30, and Note 2 to the accounts, Financial Risk Management on pages 123 - 127. |
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Market risk Clearing The Group CCPs assume the counterparty risk for all transactions that are cleared through their markets. In the event of default of their clearing members, therefore, credit risk will manifest itself as market risk. As this market risk is only present in the event of default this is referred to as 'latent market risk'. The latent market risk includes interest rate risk, foreign exchange risk, equity risk and commodity price risk as well as country risk, issuer risk and concentration risk. This risk is greater if market conditions are unfavourable at the time of the default. Non-Clearing The Group is exposed to foreign exchange risk as a result of its broadening geographical footprint. There are, however, also benefits of global diversification including reduced exposure to local events such as the UK Brexit vote. The Group is exposed to interest rate risk through its borrowing activities and treasury investments. A changing environment of increasing interest rates in 2017 may increase the Group's exposure to these risks. |
Clearing The margins and default funds referred to above are sized to protect against latent market risk. The adequacy of these resources is evaluated daily by subjecting member and customer positions to 'extreme but plausible' stress scenarios encapsulating not only historical crises, but theoretical forward-looking scenarios and decorrelation events. All our CCPs are compliant with the appropriate regulatory requirements regarding margin calculations, capital and default rules. Latent market risk is monitored and managed on a day-to-day basis by the risk teams within the clearing services. Committees overseeing market risks meet on a regular basis. Non-Clearing Foreign Exchange (FX) risk is monitored closely and translation risk is managed by matching the currency of the Group's debt to its earnings to protect key ratios and partially hedge currency net assets. To ensure this is effective, and also to manage any local FX transaction risks, foreign exchange derivatives including cross-currency swaps are used - under a control framework governed by LSEG Board approved policy. The split between floating and fixed debt is managed to support the Group's target of maintaining an interest coverage ratio that underpins a good investment grade credit rating. Authorised derivatives can be used to supplement a mix of floating rate loan borrowings and fixed rate bond debt to achieve the Group's Policy objective. |
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For more information on this risk, see Note 2 to the accounts, Financial Risk Management on pages 123 - 127. |
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Liquidity risk Clearing There are two distinct types of risk to which the Group CCPs are exposed that are commonly referred to as liquidity risk - market liquidity risk and funding liquidity risk. The former is the risk that it may be difficult or expensive to liquidate a large or concentrated position and is addressed under market risk. The latter is the risk that the CCP may not have enough cash to pay variation margin to non-defaulters or to settle physically securities delivered by a non-defaulter that cannot be on-sold to a defaulter and this is the subject of this section. The Group's CCPs collect clearing members' margin and/or default funds contributions in cash and/or in highly liquid securities. To maintain sufficient ongoing liquidity and immediate access to funds, the Group's CCPs deposit the cash received in highly liquid and secure investments, such as sovereign bonds and reverse repos, as mandated under EMIR; securities deposited by clearing members are therefore held in dedicated accounts with CSDs and/or International Central Securities Depositaries (ICSDs). The Group's CCPs also hold a small proportion of their investments in unsecured bank and money market deposits subject to the limitations imposed by EMIR. The successful operation of these investment activities is contingent on general market conditions and there is no guarantee that such investments may be exempt from market losses. Non-Clearing Liquidity risk in a non-clearing context is the risk that the firm may be unable to make payments as they fall due. |
Clearing The Group's CCPs have put in place regulatory compliant liquidity plans for day-to-day liquidity management, including contingencies for stressed conditions. The Group's CCPs have multiple layers of defence against liquidity shortfalls including; intraday margin calls, minimum cash balances, access to contingent liquidity arrangements, and, for certain CCPs, access to central bank liquidity. Under the ERMF, CCP investments must be made in compliance with the Group CCP Financial Risk Policy (as well as the policies of the CCPs themselves). These policies stipulate a number of Risk Management standards including investment limits (secured and unsecured) and liquidity coverage ratios. Committees overseeing CCP investment risk meet regularly. Each CCP monitors its liquidity needs daily under stressed and unstressed assumptions and reports to the Group Financial Risk Committee each month. Non-Clearing Requirements for liquidity including headroom requirements are set out in the Group Treasury Policy. The Group maintains liquidity facilities and monitors its requirements on an ongoing basis. Group Treasury risk is monitored daily and is managed within the constraints of a Board approved policy by the Group Treasury team, and is overseen by the Treasury Committee (a sub-Committee of the Financial Risk Committee chaired by the CFO). An update on Group Treasury risks and actions is provided monthly to the Financial Risk Committee and to each Board Risk Committee. |
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For more information on this risk, see Note 2 to the accounts, Financial Risk Management on pages 123 - 127. |
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Capital risk Principal risks to managing the Group's capital are: --In respect of regulated entities, capital adequacy compliance risk (the risk that regulated entities do not maintain and report sufficient qualifying capital to meet regulatory requirements) and capital reporting compliance risk (the risk that regulated entities fail to comply with capital reporting and regulatory obligations). If a regulated entity in the Group fails to ensure that sufficient capital resources are maintained to meet regulatory requirements, this could lead to loss of regulatory approvals and/or financial sanctions --In respect of regulated and unregulated entities, commercial capital adequacy and quality risk (the risk that Group and solo entities do not maintain both sufficient quantity and quality of capital to meet commercial requirements) and investment return risk (the risk that capital is held in subsidiaries or invested in projects that generate a return that is below the Group's cost of capital) --Availability of debt or equity capital (whether specific to the Group or driven by general financial market conditions) |
The Group's Capital Management Policy provides a framework to ensure the Group maintains suitable capital levels (both at Group and solo entity levels), and effectively manages the risks thereof. The Group's Treasury Policy recognises the need to observe regulatory requirements in the management of the Group's resources. The Risk Appetite approved by the Board includes components related to the Group's leverage ratios and capital risks; Key Risk Indicators are monitored regularly. The Group maintains an ongoing review of the capital positions of its regulated entities and operates within capital limits which are overseen by the Treasury Committee, the Financial Risk Committee, the Executive Committee and the Board. The Group can manage its capital structure by varying returns to shareholders, issuing new shares or increasing or reducing borrowings. The Board reviews dividend policy and funding capacity on a regular basis and the Group maintains comfortable levels of debt facility headroom. The Group regularly assesses debt and equity markets to maintain access to new capital at reasonable cost. The Group is mindful of potential impacts on its key metrics when considering changes to its capital structure. |
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For more information on this risk, see Note 2 to the accounts, Financial Risk Management on pages 123 - 127. |
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OPERATIONAL RISKS
The risk of loss, or other adverse consequences to the business, resulting from inadequate or failed internal processes, people and systems, or from external events.
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Risk Description |
Mitigation |
Risk level |
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Technology Secure and stable technology performing to high levels of availability and throughput continues to be critical to the support of the Group's businesses. Technology failures may impact our clients, potentially leading to a loss of trading or clearing volumes or impacting our information services activities. The Group continues to consolidate its IT development and operations in its shared services company - LSEG Business Services Ltd - and in the MillenniumIT infrastructure to provide greater control and efficiency. There is a risk that as the Group continues to consolidate its IT development and operations it creates single points of failure for multiple Group businesses, systems and services. The focus of activity in MillenniumIT means there is also a risk of resource over-stretch to meet both the requirements of the Group and those of third parties. Continued innovation and investment in new trading/information systems can lead to further resource stretch in coping with increased volumes and new product development. The Group also has dependencies on a number of third parties for the provision of hardware, software, communication and networks for elements of its trading, clearing, settlement, data and other systems. |
The performance and availability of the Group systems are constantly reviewed and monitored to prevent problems arising where possible and ensure a prompt response to any potential service interruption issues. The Group continues actively to identify, manage and mitigate risks associated with the consolidation of IT development and operations. Regular rigorous Business Impact and Operational Risk Scenario Analysis are performed in conjunction with the Group Risk and Group Business Continuity & Crisis Management functions to identify, assess and remedy potential system and governance vulnerabilities. The Group's technology teams mitigate the risk of resource over-stretch by ensuring prioritisation of key development and operations activities, and resource utilisation and allocation are kept under constant review. The MillenniumIT systems are designed to be fault tolerant and alternative standby computer facilities are maintained to minimise the risk of system disruptions. The Group actively manages relationships with key strategic IT suppliers to avoid any breakdown in service provision which could adversely affect the Group's businesses. Where possible the Group has identified alternative suppliers that could be engaged in the event of a third party failing to deliver on its contractual commitments. The Group actively monitors new technological developments and opportunities such as Blockchain. |
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For more information, see the Technology Services section of the Segmental Review on pages 34 - 35. |
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Security threats The Group is reliant upon secure premises to protect its employees and physical assets as well as appropriate safeguards to ensure uninterrupted operation of its IT systems and infrastructure. The threat of cyber crime requires a high level of scrutiny as it may have an adverse impact on our business. Additionally, new emerging technologies can change the level of cyber security risk. The Group and its appointed third party service providers could suffer a security breach resulting in the loss or compromise of sensitive information (both internal and external) or loss of service. A major information security breach could have a significant negative impact on our reputation and on the confidence of our clients. Terrorist attacks and similar activities directed against our offices, operations, computer systems or networks could disrupt our markets, harm staff, tenants and visitors, and severely disrupt our business operations. Civil or political unrest could impact companies within the Group. Long-term unavailability of key premises or trading and information outages and corruption of data could lead to the loss of client confidence and reputational damages. Security risks have escalated in recent yearsdue to the increasing sophistication of cyber crime. |
Security threats are treated very seriously. The Group has robust physical security arrangements, and extensive IT measures are in place to mitigate technical security risks. The Group is supported by the Centre for the Protection of National Infrastructure (CPNI) in the UK, with both physical and IT security teams monitoring intelligence and liaising closely with police and global Government agencies. A third party security monitoring service is retained to assist with monitoring global physical security events with the potential to impact Group operations. The Group continues to proactively invest in and enhance its information security control environment and cyber defences as it delivers to its Cyber Security Strategy. The Group has well established and regularly tested business continuity and crisis management procedures. The Group risk function assesses its dependencies on critical suppliers and ensures robust contingency measures are in place.
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Change management The considerable change agenda is driven by both internal and external factors. Internal factors include the diversification strategy of the Group and its drive for technology innovation and consolidation. External factors include the changing regulatory landscape and requirements which necessitate changes to our systems and processes. There are a significant number of major, complex projects and strategic actions underway concurrently, that, if not delivered to sufficiently high standards and within agreed timescales, could have an adverse impact on the operation of core services, and revenue growth, as well as damaging the Group's reputation. The volume of simultaneous change could also lead to a loss of client goodwill if the execution is not managed appropriately. Synergies and cost benefits may not be delivered to anticipated levels. The size and complexity of the recent acquisitions and the recent merger proposal have increased the Group's change management and transformation risks. However, it has also increased its opportunities to compete on a global scale. |
The senior management team is focused on the implementation of the Group's strategy and the project pipeline in view of their importance to the Group's future success. Each major project is managed via a dedicated Programme Board overseen by members of the Executive Committee. Software design methodologies, testing regimes and test environments are continuously being strengthened to minimise implementation risk. |
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For more information, see the Chairman's statement on pages 4 - 5, and the Chief Executive's statement on pages 6 - 7. |
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Settlement and custodial risks The Group's CCPs are exposed to operational risks associated with clearing transactions and the management of collateral, particularly where there are manual processes and controls. While the Group's CCPs have in place procedures and controls to prevent failures of these processes, and to mitigate the impact of any such failures, any operational error could have a material adverse effect on the Group's reputation, business, financial condition and operating results. In addition, the Group provides routing, netting and settlement services through its CSDs to ensure that cash and securities are exchanged in a timely and secure manner for a multitude of products. There are operational risks associated with such services, particularly where processes are not fully automated. A failure to receive funds from participants may result in a debiting of the Group's cash accounts which could have a material adverse effect on the Group's business, financial condition and operating results. |
Operational risk is minimised via highly automated processes reducing administrative activities while formalising procedures for all services. The CSD mitigates IT risks by providing for redundancy of systems, daily backup of data, fully updated remote recovery sites and SLAs with outsourcers. Liquidity for CSD operations is provided by European National Central Banks. |
Static |
|
Employees The calibre and performance of senior management and other key employees, taken together, is critical to the success of the Group. The Group's ability to attract and retain key personnel is dependent on a number of factors. This includes (but not exclusively) prevailing market conditions, compensation packages offered by competing companies and any regulatory impact thereon. These factors also encompass the Group's ability to continue to have appropriate variable remuneration and retention arrangements in place, which help drive strong business performance and impact the size of the local labour force with relevant experience and the number of businesses competing for such talent. There can be no assurance that the Group will be successful in attracting and retaining the personnel it requires, which may adversely affect the Group's ability to conduct its business through an inability to execute business operations and strategies effectively.
|
The Group operates a performance management and appraisal system which assesses performance against financial objectives, strategic deliverables and the way colleagues collaborate and deliver in line with the Group's values and behaviours. Turnover in each division and country in addition to any critical staff turnover is closely monitored with mitigation taken where needed. A performance-related bonus and pay review process for all employees is conducted annually and Long Term Incentive Plans, aligned with performance metrics to deliver the Group's strategic goals and to enhance shareholder value are offered to critical high performers. Regular benchmarking of reward and incentive systems is performed to ensure they are competitive. We continue to enhance our talent management approach and maintain a rigorous in-house recruitment and selection process. A training budget coordinated centrally allows a coordinated approach to development across the Group. Development opportunities are provided for all employees with additional investment offered to identified key talent and executives as well as coaches for key senior successors. The Group undertakes comprehensive annual reviews of critical roles, succession, talent pipelines and risk analysis to minimise the impact of the loss of key staff critical to the operation of the business. There is a focus on internal moves, key external hires and an approach to succession which is reviewed by the Nominations Committee which is responsible for considering succession plans for key senior positions. |
Static |
|
For more information, see Our wider responsibility on pages 36 - 37 and Remuneration Report on pages 70 - 95. |
||
Financial Risk Management
The Group seeks to protect its financial performance and the value of its business from exposure to capital, credit, concentration, country, liquidity and market (including foreign exchange, fair value, cash flow and interest rate) risks.
The Group's financial risk management approach is not speculative. It is performed both at a Group level, where the treasury function identifies, evaluates and hedges financial risks from a Group perspective and also locally, where operating units manage their regulatory and operational risks. This includes clearing operations at the Group's CCPs (at LCH Group and CC&G) that adhere to local regulation and operate under locally approved risk and investment policies.
The Group Chief Risk Officer's team provides assurance that the Group's risk management, governance and internal control processes are operating effectively. The Financial Risk Committee, a sub-committee of the Group Executive Committee and chaired by the Chief Financial Officer, meets monthly to oversee the consolidated financial risks of the Group. In addition, the Treasury Committee, a sub-committee of the Financial Risk Committee (which is also chaired by the Chief Financial Officer), meets regularly to monitor the management of and controls around foreign exchange, interest rates, credit and concentration risks and the investment of excess liquidity in addition to its oversight of the Group's funding arrangements. Both committees provide the Group's senior management with assurance that the treasury and risk operations are performed in accordance with Group Board approved policies and procedures. Regular updates, on a range of key criteria as well as new developments, are provided through the Enterprise Risk Management Framework to the Group Risk Committee. See 'Risk Management Oversight', pages 44 - 46, for further detail on the Group's risk framework.
On 23 June 2016 the UK voted to exit the EU. The UK companies within the Group, as members of the EU or European Economic Area (EEA), rely on a number of rights that are available to them to conduct business with other EU or EEA members. This includes, without limitation, the right for UK CCPs to offer clearing services to EU regulated firms under EMIR, and the right for UK trading venues to offer services to members in the EU or EEA. The Group companies have analysed the potential impacts and considered contingency plans that they may choose to execute should these rights not be replaced by rights that persist outside EU membership.
Capital risk
|
Risk description |
Risk management approach |
||||||||||||||||||||||||
|
The Group is profitable and strongly cash generative and its capital base comprises equity and debt capital. However, the Group recognises the risk that its entities may not maintain sufficient capital to meet their obligations or they may make investments that fail to generate a positive or value enhancing return. The Group comprises regulated and unregulated entities. It considers that: --increases in the capital requirements of its regulated companies, or --negative yields on its investments of cash, or --a scarcity of debt or equity (driven by its own performance or financial market conditions) either separately or in combination are the principal risks to managing its capital. |
The Group focuses upon its overall cost of capital as it seeks, within the scope of its risk appetite, to provide superior returns to its shareholders, fulfil its obligations to the relevant regulatory authorities and other stakeholders and ensure that it is not overly dependent upon short and medium term debt that might not be available at renewal. Maintaining the flexibility to invest for growth is a key capital management consideration. The Group can manage its capital structure and react to changes in economic conditions by varying returns to shareholders, issuing new shares or increasing or reducing borrowings. The Board reviews dividend policy and funding capacity on a regular basis and the Group maintains comfortable levels of debt facility headroom. A summary of the Group's capital structure is presented below:
Whilst the Company is unregulated, the regulated entities within the Group continuously monitor compliance with the capital requirements set by their respective competent authorities and the terms of reference of the Financial Risk Committee includes oversight of the Group's Capital Management Policy. The Capital Management Policy seeks to ensure that compliance with local regulations is maintained and that there is a robust evaluation, undertaken by the Group's Investment Committee, of the impact of new investments, across the Group, on its capital position. Regulated entities within the Group have to date predominantly issued equity and held cash to satisfy their local regulatory capital requirements. We believe that capital held by Group companies is sufficient to comfortably support current regulatory frameworks. The level of amounts set aside by the Group for these purposes remains subject to on-going review with regulators, particularly in Europe. A summary of the Group's regulatory and operational capital is shown below:
The total capital amounts have remained relatively stable through the year and include: --cash and cash equivalents; --certain liquid investments classified as financial assets held at fair value; --the LCH Group's regulated cash and cash equivalents; and --the £200.0 million generally set aside by other Group operations. To maintain the financial strength to access new capital at reasonable cost and sustain an investment grade credit rating, the Group monitors its net leverage ratio which is operating net debt (i.e. net debt after excluding cash and cash equivalents set aside for regulatory and operational purposes) to adjusted EBITDA (Group consolidated earnings before net finance charges, taxation, impairment, depreciation and amortisation, foreign exchange gains or losses and non-recurring items, proforma'd for acquisitions or disposals undertaken in the period) against a target range of 1-2 times. The Group is also mindful of potential impacts on the key metrics employed by the credit rating agencies in considering increases to its borrowings. As at 31 December 2016, net leverage had reduced back to 1.1 times (2015: 1.7 times), and is within the Group's target range. The Group is comfortably in compliance with its bank facility ratio covenants (net leverage and interest cover) and these measures do not inhibit the Group's operations or its financing plans. |
Credit and concentration risk
|
Risk description |
Risk management approach |
|||||||||||||||||||||||||||||||||||||||||||||||||||||||||
|
The Group's credit risk relates to its customers and counterparties being unable to meet their obligations to the Group either in part or in full, including: --customer receivables --repayment of invested cash and cash equivalents --settlement of derivative financial instruments.
In their roles as central counterparty (CCP) clearers to financial market participants, the Group's CCPs guarantee final settlement of transactions acting as buyer towards each seller and as seller towards each buyer. They manage substantial credit risks as part of their operations including unmatched risk positions that might arise from the default of a party to a cleared transaction. For more information see 'Principal Risk and Uncertainties', pages 47 - 53. Notwithstanding regulations that require CCPs to invest predominantly in secured instruments or structures (such as government bonds and reverse repos), CC&G and the LCH Group CCPs continue to be able to maintain up to 5% of their total deposits at commercial banks on an unsecured basis. Through this potential for its CCPs to invest on an unsecured basis (as well as by certain other regulated and unregulated operations observing agreed investment policy limits), the Group will continue to face the risk of direct loss from a deterioration or failure of one or more of its unsecured investment counterparties. Concentration risk may arise through Group entities having large individual or connected exposures to groups of counterparties whose likelihood of default is driven by common underlying factors. This is a particular focus of the investment approach at the Group's CCPs. |
Group Credit risk is controlled through policies developed at a Group level. Group companies make a judgement on the credit quality of their customers based upon the customer's financial position, the recurring nature of billing and collection arrangements and, historically, a low incidence of default. Furthermore, the Group is exposed to a large number of customers and so concentration risk on its receivables is deemed by management as low. Non-CCP entities Credit risk of cash and cash equivalents is managed by limiting exposure to counterparties with credit rating levels below policy minimum thresholds, potentially overlaid by a default probability assessment. Except where specific approval is arranged to increase this limit for certain counterparties, a maximum of £50.0 million may be invested for up to 12 months with counterparties rated long term AAA (or equivalent), through to a maximum £25 million overnight with counterparties rated short term A-2 (or equivalent). Derivative transactions and other treasury receivable structures are undertaken or agreed with well capitalised counterparties and are authorised by policy, to limit the credit risk underlying these transactions. CCPs To address the market participant and latent market risk, the Group's CCPs have established financial safeguards against single or multiple defaults. Clearing membership selection is based upon supervisory capital, technical and organisational criteria. Each member must pay margins, computed and collected at least daily, to cover the exposures and theoretical costs which the CCP might incur in order to close out open positions in the event of the member's default. Margins are calculated using established and internationally acknowledged risk models and are debited from participants' accounts through central bank accounts and via commercial bank payment systems. Minimum levels of cash collateral are required and non-cash collateral is re-valued daily.
Clearing members also contribute to default funds managed by the CCPs to guarantee the integrity of the markets in the event of multiple defaults in extreme market circumstances. Amounts are determined on the basis of the results of periodic stress testing examined by the risk committees of the respective CCPs. Furthermore, each of the Group's CCPs reinforces its capital position to meet the most stringent relevant regulatory requirements applicable to it, including holding a minimum amount of dedicated own resources to further underpin the protective credit risk framework in the event of a significant market stress event or participant failure. An analysis of the aggregate clearing member contributions to default funds across the CCPs is shown below:
Investment counterparty risk for CCP margin and default funds is managed by investing the cash element in instruments or structures deemed "secure" by the relevant regulatory bodies including through direct investments in highly rated, "regulatory qualifying" sovereign bonds and supra-national debt, investments in tri-party and bi-lateral reverse repos (receiving high quality government securities as collateral) and, in certain jurisdictions, deposits with the central bank. The small proportion of cash that is invested unsecured is placed for short durations with highly rated counterparties where strict limits are applied with respect to credit quality, concentration and tenor.
Associated liquidity risks are considered in the investment mix and discussed further below.
To address concentration risk, the Group maintains a diversified portfolio of high quality, liquid investments and uses a broad range of custodians, payment and settlement banks and agents. The largest concentration of treasury exposures as at 31 December 2016 was 21.7% of the total investment portfolio to the French Government (2015: 24.8% to the French Government).
|
Country risk
|
Risk description |
Risk management approach |
||||||||||||||||||||||||||||||
|
Distress can result from the risk that certain governments may be unable or find it difficult to service their debts. This could have adverse effects, particularly on the Group's CCPs, potentially impacting cleared products, margin collateral, investments, the clearing membership and the financial industry as a whole. |
Specific risk frameworks manage country risk for both fixed income clearing and margin collateral and all clearing members are monitored regularly against a suite of sovereign stress scenarios. Investment limits and counterparty and clearing membership monitoring are sensitive to changes in ratings and other financial market indicators, to ensure the Group's CCPs are able to measure, monitor and mitigate exposures to sovereign risk and respond quickly to anticipated changes. Risk Committees maintain an on-going watch over these risks and the associated policy frameworks to protect the Group against potentially severe volatility in the sovereign debt markets.
The Group's sovereign exposures of £1billion or more at the end of either of the financial reporting periods shown below are:
|
Liquidity, settlement and custodial risk
|
Risk description |
Risk management approach |
|||||
|
The Group's operations are exposed to liquidity risk to the extent that they are unable to meet their daily payment obligations. In addition, the Group's CCPs and certain other subsidiary companies are required to maintain a level of liquidity (consistent with regulatory requirements) to ensure the smooth operation of their respective markets and to maintain operations in the event of a single or multiple market stress event or member failure. This includes the potential requirement to liquidate the position of a clearing member under a default scenario including covering the associated losses and the settlement obligations of the defaulting member. The Group is exposed to the risk that a payment or settlement bank could fail or that its systems encounter operational issues, creating liquidity pressures and the risk of possible defaults on payment or receivable obligations. The Group uses third party custodians to hold securities and is therefore exposed to the custodian's insolvency, its negligence, a misuse of assets or poor administration.
|
The combined Group businesses are profitable, generate strong free cash flow and operations are not significantly impacted by seasonal variations. The Group maintains sufficient liquid resources to meet its financial obligations as they fall due and to invest in capital expenditure, make dividend payments, support acquisitions or repay borrowings. With the exception of regulatory constraints impacting certain entities, funds can generally be lent across the Group or remitted through dividend payments. This is an important component of the Group Treasury cash management policy and approach. Management monitors forecasts of the Group's cash flow and overlays sensitivities to these forecasts to reflect assumptions about more difficult market conditions or stress events. Treasury policy requires that the Group maintains adequate credit facilities provided by a diversified lending group to cover its expected funding requirements and ensure a minimum level of headroom for at least the next 24 months. The financial strength of lenders to the Group is monitored regularly. During the year ended 31 December 2016, the July 2016 £250 million bond was repaid utilising the Group's committed credit facilities. At 31 December 2016, £732.6 million (2015: £518.3 million) of the Group's facilities were unutilised. The Group's CCPs maintain sufficient cash and cash equivalents and, in certain jurisdictions, have access to central bank refinancing or commercial bank liquidity support credit lines to meet the cash requirements of the clearing and settlement cycle. Revised regulations require CCPs to ensure that appropriate levels of back up liquidity are in place to underpin the dynamics of a largely secured cash investment requirement, ensuring that the maximum potential outflow under extreme market conditions is covered (see Credit and concentration risk section above). The Group's CCPs monitor their liquidity needs daily under stressed and unstressed assumptions. Where possible, the Group employs guaranteed delivery versus payment settlement techniques and manages CCP margin and default fund flows through central bank or long-established, bespoke commercial bank settlement mechanisms. Monies due from clearing members remain the clearing members' liability if the payment agent is unable to effect the appropriate transfer. In addition, certain Group companies, including the CCPs, maintain operational facilities with commercial banks to manage intraday and overnight liquidity. Custodians are subject to minimum eligibility requirements, ongoing credit assessment, robust contractual arrangements and are required to have appropriate back-up contingency arrangements in place. The table below analyses the Group's financial liabilities into relevant maturity groupings based on the remaining period from the balance sheet date to the contractual maturity date. The amounts disclosed in the table reflect the contractual undiscounted cash flows. The borrowings line includes interest on debt that is not yet accrued for. |
|||||
|
As at 31 December 2016 |
Less than 1 year |
Between 1 & 2 years |
Between 2 & 5 years |
Over 5 years |
Total |
|
|
|
£m |
£m |
£m |
£m |
£m |
|
|
Borrowings |
653.7 |
37.1 |
638.4 |
14.3 |
1,343.5 |
|
|
Trade & other payables |
601.1 |
- |
- |
|
601.1 |
|
|
CCP liabilities |
558,478.3 |
- |
- |
|
558,478.3 |
|
|
Derivative liabilities |
- |
- |
19.3 |
|
19.3 |
|
|
Other current non-current liabilities |
- |
46.2 |
12.2 |
7.1 |
65.5 |
|
|
|
559,733.1 |
83.3 |
669.9 |
21.4 |
560,507.7 |
|
|
|
|
|
|
|
|
|
|
As at 31 December 2015 |
Less than 1 year |
Between 1 & 2 years |
Between 2 & 5 years |
Over 5 years |
Total |
|
|
|
£m |
£m |
£m |
£m |
£m |
|
|
Borrowings |
973.8 |
178.3 |
338.4 |
314.3 |
1,804.8 |
|
|
Trade & other payables |
452.4 |
- |
- |
- |
452.4 |
|
|
CCP liabilities |
456,663.3 |
- |
- |
- |
456,663.3 |
|
|
Other non-current payables |
- |
- |
40.7 |
2.8 |
43.5 |
|
|
Other current non-current liabilities |
- |
14.7 |
47.8 |
2.8 |
65.3 |
|
|
|
458,089.5 |
193.0 |
426.9 |
319.9 |
459,029.3 |
|
Market Risk - Foreign Exchange
|
Risk description |
Risk management approach |
|||||||||||||||
|
The Group operates primarily in the UK, Europe and North America, but also has growing and strategically important businesses in Asia, and other alliances and investments across the globe. Its principal currencies of operation are Sterling, Euro and US Dollars. With the exception of MillenniumIT (a Sri Lankan Rupee reporting entity), which invoices a material proportion of its revenues in US Dollars, and LCH.Clearnet Limited (a Euro reporting entity), which incurs a majority of its costs in Sterling, Group companies generally invoice revenues, incur expenses and purchase assets in their respective local currencies. As a result, foreign exchange risk arises mainly from the translation of the Group's foreign currency earnings, assets and liabilities into its reporting currency, Sterling, and from occasional, high value intragroup transactions. Intragroup dividends may create short term transactional FX exposures but play their part in controlling the level of translational FX exposures the Group faces. The Group may be exposed from time to time to FX risk associated with strategic investments in or divestments from operations denominated in currencies other than Sterling. |
The Group seeks to match the currency of its debt liabilities to the currency of its earnings and cash flows which to an extent balances the currency of its assets with its liabilities. In order to mitigate the impact of unfavourable currency exchange movements on earnings and net assets, non-Sterling cash earnings are centralised and applied to matching currency debt and interest payments, and where relevant, interest payments on Sterling debt re-denominated through the use of cross-currency swaps. A proportion of the Group's debt is held in or swapped into Euro and a proportion is held in US Dollars.
The cross currency interest rate swaps are directly linked to Sterling fixed debt. The Euro and USD denominated debt, including the cross-currency swaps, provides a hedge against the Group's net investment in Euro and USD denominated entities. The Group's designated hedges in its net investments were fully effective. Whilst transactional foreign exchange exposure is limited, the Group hedges material transactions in accordance with Group Treasury policy (which requires that cash flows of more than £1 million or equivalent per annum should be hedged) with appropriate derivative instruments or by settling currency payables or receivables within a short timeframe. Where appropriate, hedge accounting for derivatives is considered in order to mitigate material levels of income statement volatility. In addition to projecting and analysing its earnings and debt profile by currency, the Group reviews sensitivities to movements in exchange rates which are appropriate to market conditions. The Group has considered movements in the Euro and the US Dollar over the year ended 31 December 2016 and year ended 31 December 2015, and has concluded that a 10% movement in rates is a reasonable level to measure the risk to the Group. The impact on post tax profit and equity for the years ended 31 December is set out in the table below:
|
|||||||||||||||
|
31 December 2016 31 December 2015
Post tax profit Equity Post tax profit Equity £m £m £m £m Euro Sterling weaken (3.8) 37.6 3.5 17.7 Sterling strengthen 3.5 (34.2) (3.1) (16.0)
US Dollar Sterling weaken 2.3 5.2 3.8 (51.2) Sterling strengthen (2.1) (4.7) (3.4) 46.4
This reflects foreign exchange gains or losses on translation of Euro and US Dollar denominated trade receivables, trade payables, financial assets at fair value through profit or loss including Euro and US Dollar denominated cash and borrowings. The impact on the Group's operating profit for the year before amortisation of purchased intangible assets and non-recurring items, of a 10 Euro cent and 10 US Dollar cent movement in the Sterling-Euro and Sterling-US Dollar rates respectively, can be seen below:
31 December 2016 31 December 2015 £m £m
Euro Sterling weaken 26.9 24.5 Sterling strengthen (22.8) (21.2)
US Dollar Sterling weaken 16.9 5.5 Sterling strengthen (14.6) (6.3) |
||||||||||||||||
Market risk - Cash Flow and Fair Value Interest Rate Risk
|
Risk Description |
Risk management approach |
|
The Group's interest rate risk arises through the impact of changes in market rates on cash flows associated with cash and cash equivalents, investments in financial assets and borrowings held at floating rates. The Group's CCPs face interest rate exposure through the impact of changes in the reference rates used to calculate member liabilities versus the yields achieved through their investment activities. |
Group interest rate management policy focusses on protecting the Group's credit rating and maintaining compliance with bank covenant requirements. To support this objective, a minimum coverage of interest expense by EBITDA of 7 times, and a maximum floating rate component of 50% of total debt are targeted. This approach reflects: (i) a focus on the Group's cost of gross debt rather than its net debt given the material cash and cash equivalents set aside for regulatory purposes; (ii) the short duration allowed for investments of cash and cash equivalents held for regulatory purposes which, by their nature, generate low investment yields; (iii) a view that already low market yields are unlikely to move materially lower; and (iv) the broad natural hedge of floating rate borrowings provided by the significant balances of cash and cash equivalents held effectively at floating rates of interest.
As at 31 December 2016, consolidated net interest expense cover by EBITDA was measured over the 12 month period at 13.0 times (2015: 11.7 times) and the floating rate component of total debt was 40% (2015: 42%). In the Group's CCPs, interest bearing assets are generally invested for a longer term than interest bearing liabilities, whose interest rate is reset daily. This makes investment revenue vulnerable to volatility in overnight rates and shifts in spreads between overnight and term rates. Interest rate exposures (and the risk to CCP capital) are managed within defined risk appetite parameters against which sensitivities are monitored daily. In its review of the sensitivities to potential movements in interest rates, the Group has considered interest rate volatility over the last year and prospects for rates over the next 12 months and has concluded that a 1 percentage point upward movement (with a limited prospect of material downward movement) reflects a reasonable level of risk to current rates. At 31 December 2016, at the Group level, if interest rates on Sterling-denominated, Eurodenominated and US Dollar-denominated cash and borrowings had been 1 percentage point higher with all other variables held constant, post-tax profit for the year would actually have been £4.6 million higher (2015: £2.8 million higher) mainly as a result of higher interest income on floating rate cash and cash equivalents partially offset by higher interest expense on floating rate borrowings. At 31 December 2016, at the CCP level (in aggregate), if interest rates on the common interest bearing member liability benchmarks of Eonia, Fed Funds and Sonia, for Euro, US Dollar and Sterling liabilities respectively, had been 1 percentage point higher, with all other variables held constant, the daily impact on post-tax profit for the Group would have been £1.7 million lower (2015: £1.0 million lower). This deficit would be recovered as investment yields increase as the portfolio matures and is re-invested. |
The Annual Report contains the following statements regarding responsibility for financial statements on pages 100-101:
"The Directors are responsible for preparing the Annual Report, the Directors' Remuneration Report and the financial statements in accordance with applicable law and regulations.
Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have prepared the Group and Company financial statements in accordance with International Financial Reporting Standards (IFRS) as adopted by the European Union.
Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of the affairs of the Group and the Company and of the profit or loss for that year.
In preparing those financial statements, the Directors are required to:
--select suitable accounting policies in accordance with IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors and then apply them consistently;
--present information, including accounting policies, in a manner that provides relevant, reliable, comparable and understandable information;
--make judgements and accounting estimates that are reasonable;
--provide additional disclosures when compliance with the specific requirements in IFRSs as adopted by the European Union is insufficient to enable users to understand the impact of particular transactions, other events and conditions on the Group's and the Company's financial position and financial performance;
--state whether the Group financial statements have been prepared in accordance with IFRSs as adopted by the European Union, subject to any material departures disclosed and explained in the financial statements; and
--prepare the financial statements on the going concern basis, unless it is inappropriate to presume that the Group will continue in business.
The Directors confirm that they have complied with the above requirements in preparing the financial statements.
The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Group's and the Company's transactions and disclose with reasonable accuracy at any time the financial position of the Company and the Group and to enable them to ensure that the financial statements and the Directors' Remuneration Report comply with the Companies Act 2006, other applicable laws and regulations, including the requirements of the Listing Rules and the Disclosure and Transparency Rules, and, as regards the Group financial statements, Article 4 of the IAS Regulation. The Directors are also responsible for safeguarding the assets of the Company and the Group and for taking reasonable steps for the prevention and detection of fraud and other irregularities.
The Directors are responsible for the maintenance and integrity of the corporate and financial information on the Company's website.
Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.
The Group's business activities, together with the factors likely to affect its future development, performance and position are set out in the Overview and Strategic Report sections of the Annual Report on pages 2 - 53. In particular, the current economic conditions continue to pose a number of risks and uncertainties for the Group and these are set out in Principal Risks and Uncertainties on page 47.
The Financial Risk Management objectives and policies of the Group and the exposure of the Group to capital risk, credit risk, market risk and liquidity risk are discussed on pages 50 - 51. The Group continues to meet Group and individual entity capital requirements and day-to-day liquidity needs through the Group's cash resources and available credit facilities. Committed term funding at 31 December 2016 was £1,903.3 million which is committed until June 2017 or beyond (Period ended 2015: £2,132.2 million), described further in the Financial Review on pages 38 - 43.
The Directors have reviewed the Group's forecasts and projections, taking into account reasonably possible changes in trading performance, which show that the Group has sufficient financial resources. On the basis of this review, and after making due enquiries, the Directors have a reasonable expectation that the Company and the Group have adequate resources to continue in operational existence for the foreseeable future. Accordingly, they continue to adopt the going concern basis in preparing the financial statements.
Each of the Directors, whose names and functions are set out on pages 54 - 55 of this Annual Report confirms that, to the best of their knowledge and belief:
--the Group financial statements, which have been prepared in accordance with IFRSs as adopted by the EU, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and the Group taken as a whole;
--the report of the Directors contained in the Annual Report includes a fair review of the development and performance of the business and the position of the Company and the Group taken as a whole, together with a description of the principal risks and uncertainties that they face;
--they consider that the Annual Report and Accounts 2016, taken as a whole, is fair, balanced and understandable and provide the information necessary for shareholders to assess the Company's performance, business model and
strategy.
By Order of the Board
Lisa Condron
Group Company Secretary
3 March 2017"
"34. Transactions with Related Parties
Key management compensation
Compensation for Directors of the Company and key personnel who have authority for planning, directing and controlling the Group:
|
Period ended 31 December 2016 |
Year ended 31 December 2015 |
||
|
£m |
£m |
||
|
Salaries and other short term benefits |
14.9 |
13.0 |
|
|
Pensions |
1.2 |
0.9 |
|
|
Share based payments |
17.8 |
13.1 |
|
|
33.9 |
27.0 |
||
Inter-company transactions with subsidiary undertakings
The Company has loans with some subsidiary undertakings. Details as at 31 December 2016 are shown in the table below:
|
|
Amount in millions due (owed to)/from as at |
|
|
|
Interest in millions (charge)/credit |
||
|
Loan counterparty |
31 December 2016 |
31 December 2015 |
Term |
Interest rate as at 31 Dec 2016 |
Year ended 31 December 2016 |
Year ended 31 December 2015 |
|
|
London Stock Exchange plc |
£(111.3)m |
£(170.9)m |
25 years from May 2006 with five equal annual repayments commencing in May 2027 |
LIBOR plus 2% per annum |
£(4.1)m |
£(4.4)m |
|
|
London Stock Exchange Employee Benefit Trust |
£12.5m |
£21.0m |
Repayable on demand |
Non-interest bearing |
- |
-l |
|
|
London Stock Exchange Group Holdings (Italy) Limited |
€(12.8)m |
€97.7m |
Fifth anniversary of the initial utilisation date which was April 2013 |
EURIBOR plus 1.5% per annum |
€0.2m |
€2.4m |
|
|
London Stock Exchange Group Holdings (Italy) Limited |
£0.8m |
- |
Fifth anniversary of the initial utilisation date which was April 2013 |
LIBOR plus 1.5% per annum |
- |
- |
|
|
London Stock Exchange Group Holdings Limited |
£399.7m |
£340.0m |
Tenth anniversary of the initial utilisation date which was October 2009 |
LIBOR plus 4.0% per annum |
£18.5m |
£18.3m |
|
|
London Stock Exchange Group Holdings Limited |
$(105.0)m |
$(62.3)m |
Tenth anniversary of the initial utilisation date which was October 2009 |
LIBOR plus 4.0% per annum |
$(4.3)m |
$(1.4)m |
|
|
London Stock Exchange Group Holdings Limited |
€(43.9)m |
€(35.5)m |
Tenth anniversary of the initial utilisation date which was October 2009 |
EURIBOR plus 4.0% per annum |
€(1.4)m |
€(1.1)m |
|
|
LSE Reg Holdings Limited |
€18.4m |
€13.5m |
Fifth anniversary of the initial utilisation date which was July 2013 |
EURIBOR plus 1.2% per annum |
€0.2m |
- |
|
|
LSE Reg Holdings Limited |
£(2.4)m |
£1.0m |
Fifth anniversary of the initial utilisation date which was July 2013 |
LIBOR plus 1.2% per annum |
- |
- |
|
|
London Stock Exchange (C) Limited |
€(1.0)m |
€48.4m |
Fifth anniversary of the initial utilisation date which was April 2012 |
EURIBOR plus 1.5% per annum |
- |
€0.7m |
|
|
London Stock Exchange (C) Limited |
- |
£12.2m |
Fifth anniversary of the initial utilisation date which was April 2012 |
LIBOR plus 1.5% per annum |
- |
£0.2m |
|
|
London Stock Exchange Group Holdings (Luxembourg) |
$(2.9)m |
$17.4m |
Fifth anniversary of the initial utilisation date which was December 2014 |
LIBOR plus 1.5% per annum |
$0.3m |
$0.1m |
|
|
LSEG Employment Services Limited |
£53.4m |
£11.0m |
Fifth anniversary of the initial utilisation date which was January 2015. |
LIBOR plus 1.2% per annum |
£0.5m |
£0.1m |
|
|
London Stock Exchange Group (Services) Limited |
£(6.7)m |
- |
Fifth anniversary of the initial utilisation date which was January 2016. |
LIBOR plus 0.9% per annum |
£(0.1)m |
- |
|
During the year, the Company charged in respect of employee share schemes £11.3 million (2015: £5.0 million) to LSEG Employment Services Limited, £6.3 million (2015: £4.3 million) to LCH.Clearnet Group Limited, £4.2 million (2015: £3.1 million) to London Stock Exchange Group Holdings Italia S.p.A group of companies, £1.3million (2015: £1.9 million) to FTSE Group, £1.0 million (2015: £0.7 million) to London Stock Exchange Group Holdings Inc, £0.9 million (2015: £1.1 million) to Millennium Group, £0.8 million (2015: £0.7 million) to LSEG US Holdco Inc., £0.3 million (2015: £0.2 million) to Turquoise Global Holdings Limited, £0.3 million (2015: nil) to LSEG Business Services Colombo (Private) Limited, £0.2 million (2015: £0.3 million) to SSC Global Business Services Limited, £0.2 million (2015: £0.2 million) to UnaVista Limited and £0.2 million (2015: £3.7 million) to London Stock Exchange plc.
In the current year, the Company received dividends of £407.8 million from LSEG US HoldCo Inc (2015: nil), £168.8 million from London Stock Exchange plc (2015: £125.2 million), £64.6 million from LSEGH (Luxembourg) Ltd (2015: nil) and £64.0 million from LSE Group Holdings (Italy) Ltd (2015: nil). The Company recognised £60.8 million income and £42.2 million expenses with Group undertakings in relation to corporate recharges. At 31 December 2016, the Company had £107.3 million (2015: £47.5 million) other receivables due from Group companies and other payables of £55.7 million (2015: £7.2 million) owed to Group undertakings.
In the year ended 31 December 2016, the Group recognised £2.2 million revenue (2015: nil) and £1.1 million other income from associates (2015: nil). The Group had £18.0 million (2015: £0.2 million) receivable from associates which includes a £3.0 million loan (2015: nil) presented within other non-current assets, and £15.0 million (2015: £0.2 million) of current receivable presented within trade and other receivables.
All transactions with associates were carried out on an arm's length basis."
This information is provided by RNS
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