Brexit risks, political and economic climate risks, banking

Barclays PLC – Annual report – 31 December 2017

Industry: banking

Governance: Directors’ report (extract)

Board report (extract)

Governance in Action – Structural reform and Brexit

Execution of structural reform

The execution of our structural reform programme was a significant focus for the Group in 2017 as we move towards the legal entity stand up of our ring-fenced bank in 2018. Building on from the work carried out in 2016, the Board continued to closely monitor and evaluate progress on the execution of the programme in 2017. Specific matters addressed by the Board included the following:

  • overseeing the establishment of the Group Service Company, which was launched on 1 September 2017
  • monitoring the stakeholder communications plan (including, in particular, the communications plan for customers and employees)
  • considering regular updates on migrating sort codes with a focus on any potential impact on customers and clients
  • overseeing and approving various transfers of assets and liabilities among Barclays Group entities including establishing a Committee to provide appropriate Board-level oversight of the processes involved
  • with the support of the Board Nominations Committee, debating the composition of, and appointments to each of, the boards of Barclays UK, Barclays International and the Group Service Company and discussing the appropriate governance arrangements for the new Group structure.

Preparations for Brexit

Another area of focus for the Board was preparations for the impact of the UK’s exit from the EU. Barclays has created an internal programme specifically in relation to the planning and preparation for Brexit. The Board debated potential EU hubs for Barclays’ European operations and decided to pursue expansion in Ireland where we have been operating for over 40 years and have an existing banking licence held by Barclays Bank Ireland. Specific matters considered by the Board included debating the feasibility of a significant expansion of Barclays Bank Ireland’s operations, the transfer of capital and resources to Barclays Bank Ireland and assessing the progress being made with applications for the necessary regulatory licensing requirements with the relevant authorities.

The successful completion of the Group’s structural reform programme and further progress on our Brexit plans will continue to be areas of focus for the Board in 2018.

Risk review (extract)

Material existing and emerging risks potentially impacting more than one Principal Risk (extracts)

i) Business conditions, general economy and geopolitical issues

The Group offers a broad range of services, including to retail, institutional and government customers, in a large number of countries. The breadth of these operations means that deterioration in the economic environment, or an increase in political instability in countries where the Group is active, or in any systemically important economy, could adversely affect the Group’s operating performance, financial condition and prospects.

Although economic activity continued to strengthen globally in 2017 a change in global economic conditions and the reversal of the improving trend may result in lower client activity of the Group and/or an increase of the Group’s default rates, delinquencies, write-offs, and impairment charges, which in turn could adversely affect the Group’s performance and prospects.

In several countries, reversals of capital inflows, as well as fiscal austerity, have already caused deterioration in political stability. This could be exacerbated by a renewed rise in asset price volatility or sustained pressure on government finances. In addition, geopolitical tensions in some areas of the world, such as the Korean Peninsula, the Middle East and Eastern Europe, are already acute and at risk of further deterioration, thus potentially increasing market uncertainties and adverse global economic and market conditions.

In the US, there is uncertainty around the policy platform of the administration which took office in 2017. There is the possibility of significant changes in policy in sectors including trade, healthcare and commodities which may have an impact on associated Barclays portfolios. A significant proportion of the Group’s portfolio is located in the US, including a major credit card portfolio and a range of corporate and investment banking exposures. Stress in the US economy, weakening GDP, an unexpected rise in unemployment and/or an increase in interest rates could lead to increased levels of impairment.

Most major central banks have indicated that they expect prevailing loose monetary policies to tighten. Should ‘normalisation’ paths diverge substantially, flows of capital between countries could alter significantly, placing segments with sizeable foreign currency liabilities, in particular emerging markets, under pressure. In addition, possible divergence of monetary policies between major advanced economies risks triggering further financial market volatility (see also ii) Interest rate rises adversely impacting credit conditions, below).

In the UK, the vote in favour of leaving the EU (see iii) Process of UK withdrawal from the European Union, below) has given rise to political uncertainty with attendant consequences for investment and market confidence. The initial impact was a depreciation of Sterling resulting in higher costs for companies exposed to imports and a more favourable environment for exporters. Rising domestic costs resulting from higher import prices may impact household incomes and the affordability of consumer loans and mortgages. In turn this may affect businesses dependent on consumers for revenue. There has also been a reduction in activity in both commercial and residential real estate markets which has the potential to impact value of real estate assets and adversely affect mortgage assets.

Sentiment towards emerging markets as a whole continues to be driven in large part by developments in China, where there is some concern around the ability of authorities to manage growth while transitioning from manufacturing towards services. Although the Chinese government’s efforts to stably increase the weight of domestic demand have had some success, the pace of credit growth remains a concern, given the high level of leverage and despite regulatory action. A stronger than expected slowdown could result if authorities fail to appropriately manage the end of the investment and credit-led boom.

Deterioration in emerging markets could affect the Group if it results in higher impairment charges for the Group via sovereign or counterparty defaults.

More broadly, a deterioration of conditions in the key markets where the Group operates could affect performance in a number of ways including, for example: (i) deteriorating business, consumer or investor confidence leading to reduced levels of client activity, including demand for borrowing from creditworthy customers, or indirectly, a material adverse impact on GDP growth in significant markets and therefore on Group performance; (ii) higher levels of default rates and impairment; (iii) mark to market losses in trading portfolios resulting from changes in factors such as credit ratings, share prices and solvency of counterparties (iv) reduced ability to obtain capital from other financial institutions for the Group operations; and (v) lower levels of fixed asset investment and productivity growth overall.

iii) Process of UK withdrawal from the European Union

The uncertainty and increased market volatility following the UK’s decision to leave the EU in 2019 is likely to continue until the exact nature of the future trading relationship with the EU becomes clear. The potential risks associated with an exit from the EU include:

  • Increased market risk with the impact on the value of trading book positions, mainly in Barclays International, expected to be driven predominantly by currency and interest rate volatility.
  • Potential for credit spread widening for UK institutions which could lead to reduced investor appetite for Barclays’ debt securities, which could negatively impact the cost of and/or access to funding. Potential for continued market and interest rate volatility could affect the interest rate risk underlying, and potentially affect the value of the assets in the banking book, as well as securities held by Barclays for liquidity purposes.
  • Changes in the long-term outlook for UK interest rates which may adversely affect IAS 19 pension liabilities and the market value of equity investments funding those liabilities.
  • Increased risk of a UK recession with lower growth, higher unemployment and falling UK house prices. This would likely negatively impact a number of Barclays’ portfolios, particularly in Barclays UK, notably: higher Loan to Value mortgages, UK unsecured lending including credit cards and Commercial Real Estate exposures.
  • Changes to current EU “Passporting” rights which will likely require adjustments to the current model for the Group’s cross-border banking operation which could increase operational complexity and/or costs.
  • The ability to attract, or prevent the departure of, qualified and skilled employees may be impacted by the UK’s future approach to the EU freedom of movement and immigration from the EU countries and this may impact Barclays’ access to the EU talent pool.
  • The legal framework within which Barclays operates could change and become more uncertain as the UK takes steps to replace or repeal certain laws currently in force, which are based on EU legislation and regulation (including EU regulation of the banking sector). Certainty of existing contracts, enforceability of legal obligations and uncertainty around the outcome of disputes may be affected until the impacts of the loss of the current jurisdictional arrangements between UK and EU courts and the universal enforceability of judgements across the EU (including the status of existing EU case law) are fully known.