Summary Report of the Skilled Person on the Proposed Ring-fence Transfer Scheme of Lloyds Banking Group. Prepared by Michael John Lloyd FCA, FCT

Transcription

1 Summary Report of the Skilled Person on the Proposed Ring-fence Transfer Scheme of Lloyds Banking Group Prepared by Michael John Lloyd FCA, FCT 24 November 2017 Michael John Lloyd FCA, FCT 01/60

2 Table of Contents Section Page 1. Introduction 3 2. Overall conclusions 4 3. Background to ring-fencing 7 4. My role as the Skilled Person 8 5. Purpose and overview of the Scheme 9 6. LBG s approach to ring-fencing Implications for Retail Banking customers Implications for Consumer Finance customers Implications for Commercial Banking customers Implications for Other Relevant Persons Capital, liquidity and funding Governance and risk management Operational continuity arrangements Recovery and resolution planning Information technology and payment implications Taxation implications Pension arrangements Communication approach Process to lodge objections to the Scheme 48 Appendix: Glossary 50 02/60

3 1. Introduction 1.1 I have been appointed as the independent skilled person ( Skilled Person ) to provide the required Scheme Report on the proposed Ring-fencing Transfer Scheme ( RFTS ) to transfer business from Lloyds Bank plc ( LB plc ) and Bank of Scotland plc ( BoS plc ), together known as the Transferors, to Lloyds Bank Corporate Markets plc ( LBCM or the Transferee ), (the Scheme ). I have been appointed by LB plc and my appointment has been approved by the Prudential Regulation Authority ( PRA ), following consultation with the Financial Conduct Authority ( FCA ). In this summary report, I will refer to Lloyds Banking Group plc as LBG plc" and to LBG plc and its subsidiaries, subsidiary undertakings and their associated entities and businesses, together as LBG. 1.2 The purpose of this document is to provide customers of LBG, and persons other than the Transferors who may be adversely affected by the Scheme ( Other Relevant Persons ), with a summarised version of my Scheme Report (the Summary Report ). In particular, it summarises my conclusions on the statutory question ( Statutory Question ) specified in Section 109(A) of the Financial Services and Markets Act 2000 ( FSMA ) as to (a) whether persons other than the transferor concerned are likely to be adversely affected by the scheme, and (b) if so, whether the adverse effect is likely to be greater than is reasonably necessary in order to achieve whichever of the purposes mentioned in Section 106B(3) is relevant. 1.3 This is intended to be a standalone summary of my report, but customers and Other Relevant Persons may wish to read my full Scheme Report, which provides more details of the Scheme and its effect on them, and contains a more comprehensive explanation of my conclusions. Section 1 of my full Scheme Report provides details of the scope, my independence, and why I believe that my work has been prepared in line with the relevant regulatory and professional guidance. The information in that section applies equally to this Summary Report. The full version of my Scheme Report can be obtained online at Limitations of the work performed 1.4 In performing my review and preparing this Summary Report, and my full Scheme Report, I have relied on data and other information provided to me, both written and verbally, by directors and employees of LBG. I have reviewed the data and information for consistency and reasonableness using my knowledge of the United Kingdom ( UK ) banking industry and asked LBG to explain, confirm and/or clarify aspects of the data and information, where I considered necessary. The data and information have not been subject to independent audit verification by Deloitte LLP ( Deloitte ) or me. All of my questions have been answered to my satisfaction. To the extent that any information on which I have relied, in both this Summary Report and in my full Scheme Report, is subsequently identified to be inaccurate, it may be necessary for me to revise my conclusions. 1.5 I note that the economic position of LBG on the date on which the Scheme becomes effective, currently proposed as 28 May 2018 (the Effective Date ), cannot be predicted with certainty at this time and may therefore differ from that shown in this Summary Report and in my full Scheme Report. I will continue to keep the position under review in the period leading up to the Sanction Hearing, and will prepare further information in my Supplementary Report to my full Scheme Report, if required. 1.6 Financial information, data and written information on which I have relied is listed in Appendix 2 of my full Scheme Report. 1.7 In preparing both this Summary Report and my full Scheme Report, I have had access to confidential information. Confidential information includes data, such as financial forecasts, capital projections and internal risk limits, which is not in the public domain. I have considered all confidential information with which I have been provided, but in some instances I have not 03/60

4 included in this Summary Report, or my full Scheme Report, such information that has led to my conclusions for reasons of confidentiality. Limitations on the use of this Summary Report 1.8 No liability is accepted to any person other than LBG except in so far as any liability arises to the Court from the giving of evidence in my role as the Skilled Person. 1.9 For the avoidance of doubt, Deloitte and I have excluded liability to avoid us having potential liability to an unlimited number of people. Without this exclusion, neither Deloitte nor I would be able to do this work. If you are concerned with the content of this Summary Report, my full Scheme Report or any part of my analysis, you should take urgent advice and, if you wish to raise an objection with the Court in connection with the effect of the Scheme upon you, raise the matter with the Court under one of the procedures set out on the LBG ring-fencing microsite: or otherwise by contacting your usual contact within LBG A copy of this Summary Report, and my full Scheme Report, will be made available to customers of LBG or to any other potentially affected persons as part of the communications process LBG will carry out to bring the Scheme to the attention of such persons, whether by way of being published on the websites of LBG companies or entities, posted to such persons, made available for inspection at the offices of those companies or entities solicitors or by any other method. This Summary Report will be made available by LBG to its shareholders, customers, policyholders or others with an interest in the Scheme. No other summary of my full Scheme Report may be made without the prior written consent of Deloitte and/or me The Directions Hearing is expected to take place on 4 December 2017, with the final hearing for the Court to decide whether to sanction the Scheme currently scheduled for 27 March The Scheme will be submitted to the Court for sanction under Part VII of the FSMA. If approved, it is expected that the Scheme will become operative and take effect on the Effective Date. I will continue to assess the impact of the Scheme in the run up to the Scheme s submission to the Court and, in order to reflect any updated financial information or circumstances nearer to the date of the Sanction Hearing, I will provide a Supplementary Report to my full Scheme Report, if required, setting out any updated opinions in respect of the Scheme. 2. Overall conclusions 2.1 As outlined in paragraph 4.2 of this Summary Report, in assessing the likely effects of the Scheme, I have considered separately the following groups of persons: Current customers with products transferring from either of the Transferors to the Transferee under, or whose products are being duplicated pursuant to, the Scheme ( Transferring Customers ); Current customers of the Transferors with products that are not transferring under the Scheme ( Non-Transferring Customers ); and Other Relevant Persons who are not customers of the Transferors, but who may be directly or indirectly affected by the Scheme, as listed in paragraph 10.5 of this Summary Report. 2.2 In the remainder of this overall conclusion section of my Summary Report I have provided a high-level summary of the likely effects of the Scheme on these groups of persons. 04/60

5 2.3 I have also considered a number of additional areas that may be relevant to multiple groups of customers and Other Relevant Persons. This analysis looks at the effect of the Scheme on the relevant entities before and after the changes with regards to the following areas: (a) where I am satisfied that no material adverse effect is likely: Capital, liquidity and funding positions of LBG and certain other legal entities; Governance and risk management arrangements for LBG plc, the Transferors and LBCM; Operational continuity; Information technology and payment implications; Tax implications; and Pension arrangements. (b) where I have identified a material adverse effect is likely, but am satisfied that the effect is no greater than reasonably necessary in order to achieve the relevant ring-fencing purpose, as set out in Section 106B(3)(a) of the FSMA: Recovery and resolution planning. 2.4 For further information on each of the areas considered in paragraph 2.3, refer to the respective sections of this Summary Report, or the respective sections of my full Scheme Report. Transferring Customers 2.5 Transferring Customers are made up of a portion of the customers of the Commercial Banking division of LBG. LBG s decision to implement a wide RFBs and narrow NRFB model (as outlined in Section 5 of this Summary Report) will result in the majority of the products and services offered to Commercial Banking customers remaining unchanged and residing within the Transferors. However, approximately 4,000 1 customer legal entities (which represents approximately 1.4% of the total number of customer entities in Commercial Banking) will have products transferred under or duplicated pursuant to the Scheme. 2.6 There may be certain customers of LBG (approximately 255 customers across all divisions in LBG) that may have their products curtailed; however, this will not be as a result of the Scheme, which the Court is being asked to sanction, but will be as a consequence of complying with the broader Ring-fencing Regime. 2.7 I have identified a number of potential adverse effects on Transferring Customers as a result of the Scheme, however, where the Scheme will have an adverse effect on Transferring Customers, I am satisfied that the effect is no greater than reasonably necessary in order to achieve the relevant ring-fencing purpose, as set out in Section 106B(3)(a) of the FSMA. 2.8 For further information of the identified adverse effects on Transferring Customers, refer to Section 9 of this Summary Report, or Section 6 of my full Scheme Report. 1 The customer numbers are based on LBG s best estimate of the customers that would have their products transferred under, or duplicated pursuant to the Scheme but do not account for (a) multiple fund entities within a customer group that may, or have the option to, participate within lending facilities where LBG data recognises only a single entity as the principal borrower; and (b) approximately 255 customers (across all divisions in LBG) whose products may be curtailed by LBG, but for avoidance of doubt will receive appropriate communications as per the First Witness Statement of Mark George Culmer. 05/60

6 Non-Transferring Customers Commercial Banking customers 2.9 It is estimated by LBG that the majority of Commercial Banking customers (more than 98% of the total customer entities) will not have any products transferred under the Scheme. This includes customers of non-european Economic Area ( non-eea ) entities which may be transferring products, but not via the Scheme For those non-transferring Commercial Banking customers, I am satisfied that they will not experience any adverse effect as a result of the Scheme. In particular, for these customers, I have not identified: Changes to the terms and conditions of the existing Commercial Banking products (for example, the economic terms will remain unchanged); and Significant changes to the way those customers will interact with LBG or the quality of the service provided. For example, the coverage of these customers by their Relationship Manager ( RM ) and by product specialists will remain unchanged For further information on non-transferring Commercial Banking customers, refer to Section 9 of this Summary Report, or Section 6 of my full Scheme Report. Retail Banking, Consumer Finance sub-division and Insurance Sub-group customers 2.12 I have not identified any likely adverse effects of the Scheme on customers of the Retail Banking division and Consumer Finance sub-division 2. In particular, I have not identified any material changes to the: Terms and conditions of the existing products and services offered to these customers; Level of protection afforded by the Financial Services Compensation Scheme ( FSCS ); and Manner in which customers will interact with LBG or the quality of the service provided For further information on Retail Banking customers, refer to Section 7 of this Summary Report, or Section 7 of my full Scheme Report, and for further information on Consumer Finance customers refer to Section 8 of this Summary Report, or Section 8 of my full Scheme Report The policies held by customers of the Insurance Sub-group are not transferring under the Scheme. Given this, I do not believe that the Scheme would change the level of benefits that customers would expect to receive, the division s regulatory capital requirements, risk appetite framework and the applicability of the FSCS to the business in the division and therefore I am satisfied that there are not likely to be any adverse effects of the Scheme on the customers of the Insurance Sub-group. Other Relevant Persons 2.15 Of the Other Relevant Persons listed in paragraph 10.5 of this Summary Report, I have identified: certain groups of persons connected with customers (as identified in paragraph 10.36); LBG plc, the RFB Sub-group and the NRFB Sub-group; and regulatory authorities, namely the PRA and the FCA, as having a likely adverse effect. However, based on my analysis and the information provided to me, I am satisfied that the adverse effects identified are not greater than reasonably necessary in order to achieve the relevant ring-fencing purpose, as set out in Section 106B(3)(a) of the FSMA. For further information on Other Relevant Persons, refer to Section 10 of this Summary Report, or Section 9 of my full Scheme Report. 2 The Consumer Finance sub-division is, for the purpose of this Summary Report and my full Scheme Report, taken to include a number of smaller sub-divisions of the Retail division. More detail is set out in paragraph 8.1 of this Summary Report. 06/60

7 Overall conclusion 2.16 For the reasons set out in the remainder of this Summary Report (and in more detail in my full Scheme Report), I am satisfied that either: (a) the Scheme is not likely to adversely affect any persons other than the Transferors or; (b), where the Scheme is likely to have an adverse effect, that the effect is no greater than reasonably necessary in order to achieve the relevant ringfencing purpose, as set out in Section 106B(3)(a) of the FSMA The rest of this Summary Report provides a high level overview of and rational for my conclusions. For further detail please refer to my full Scheme Report Within this Summary Report, and in my full Scheme Report, I highlight several matters that I will keep under review until the date of the Sanctions Hearing and I will draw any significant developments or changes that are relevant to my conclusions to the attention of the Court in a Supplementary Report, if required. 3. Background to ring-fencing 3.1 In response to the financial crisis, which started in 2007, the UK Government commissioned Sir John Vickers to consider structural and other reforms to the UK banking sector to improve the resilience and resolvability of banks, as well as to promote financial stability and competition. The Independent Commission on Banking ( ICB ) reported in September 2011 and recommended that banks with retail and small and medium sized enterprise deposits be required to ring-fence their retail and business banking from more complex banking, such as wholesale and investment banking. The UK Government determined that only banks with core deposits over 25bn would be required to implement a ring-fence. 3.2 The Financial Services (Banking Reform) Act 2013 (the Banking Reform Act ) implemented the recommendations of the ICB and the key recommendations of the Parliamentary Commission on Banking Standards ( PCBS ), which reviewed the professional standards and culture in the banking industry. 3.3 The intention of ring-fencing is to protect retail banking from risks unrelated to the provision of retail banking services and to help ensure that banking groups can be resolved in an orderly manner, thereby avoiding taxpayer liability, minimising the risk of loss to retail customers and maintaining the continuous provision of necessary retail banking services. 3.4 The Excluded Activities and Prohibitions Order 2014 ( EAPO ) and Sections 142D and 142E of the FSMA set out restrictions that are classified as excluded activities and prohibitions. These excluded activities and prohibitions together are termed the Perimeter Rules, as they classify what activities can and cannot be conducted by the RFB after 1 January 2019 (the Statutory Deadline ). 3.5 In very broad terms, and subject to certain exceptions, the Perimeter Rules outline that: RFBs must hold the deposits of retail and Small and Medium Sized Enterprises ( SME ) customers within its group; and RFBs must not carry on dealings in investments as principal, deal in commodities as principal, incur exposures to Relevant Financial Institutions ( RFI ) 3, access payment systems indirectly or have non-eea branches, subsidiaries or participating interests. For activities that are not mandated for RFBs, or prohibited/excluded within RFBs, the RFBs have an element of discretion as to whether to carry on such activities. 3 RFIs as defined in Article 2 of the EAPO. 07/60

8 Please refer to Section 3 in my full Scheme Report for a more detailed overview of what ringfencing means for RFBs. 4. My role as the Skilled Person 4.1 Section 109A of the FSMA requires that an application to the Court to effect a scheme is accompanied by a Scheme Report from an appropriately Skilled Person. Both the nomination of that Skilled Person and the form of the Scheme Report must be approved by the PRA, having consulted with the FCA, in accordance with the requirement of Section 3.2 of the PRA Policy Statement. This Summary Report is the summary of my Scheme Report, which is the Scheme Report for LBG s RFTS, and my nomination as Skilled Person has been approved by the PRA, in consultation with the FCA. 4.2 The purpose of my Scheme Report is to assist the Court in reaching a decision as to whether to sanction the Scheme and, in particular, to address the Statutory Question. The Statutory Question requires me to consider the potential effects of the Scheme on all persons other than the transferor(s). In assessing the likely effects of the Scheme, I have considered separately the following groups of persons: Transferring Customers: Current customers with products transferring from either of the Transferors to the Transferee under, or whose products are being duplicated pursuant to, the Scheme. Transferring Customers are made up of a portion of the customers of the Commercial Banking division of LBG; Non-Transferring Customers: Current customers of the Transferors with products that are not transferring under the Scheme. Non-Transferring Customers are made up of all customers of the Retail Banking division and the Consumer Finance sub-division of LBG and a portion of the customers of the Commercial Banking division of LBG; and Other Relevant Persons: Other persons who are not customers of the Transferors, but who may be directly or indirectly affected by the Scheme. 4.3 The Statutory Question is framed by reference to the effect of the Scheme itself on potentially affected persons. However, LBG has been carrying out a large programme of activities, including wider group restructuring, to support compliance with the Banking Reform Act, associated statutory instruments and regulatory rules and guidance, together the Ring-fencing Regime. The effect of the Scheme will depend, to an extent, on these wider group restructuring activities. Given the potential interdependencies of the effects of the Scheme with the wider group restructuring activities of LBG, I did not consider it appropriate to limit my analysis solely to the effect of the Scheme in isolation. For example, where part of the wider group restructuring is not directly affected by the Scheme, but has a potential effect on the ongoing viability of a legal entity to which business is being transferred under the Scheme, I considered this aspect within the scope of my Scheme Report. 4.4 In this Summary Report, and my Scheme Report, I have adopted a broad approach to my analysis and my consideration of whether an effect is material from the perspective of the affected person rather than from the perspective of LBG. I have also considered the effect net of any mitigants that LBG has applied or the affected persons could reasonably be expected to apply themselves. 4.5 Section 4 of my full Scheme Report provides further details of my approach to the Statutory Question. 4.6 My assessment of the Scheme has focused on its effects, implications and impacts on the following: Retail Banking customers; Consumer Finance customers; 08/60

9 Commercial Banking customers; Other Relevant Persons (including customers of the Insurance Sub-group); Capital, liquidity and funding; Governance and risk management; Operational continuity arrangements; Recovery and resolution planning; Information technology and payments; Taxation; and Pensions arrangements. 5. Purpose and overview of the Scheme 5.1 The main purpose of the Scheme is to enable LBG, which will include Ring-fenced Bodies ( RFBs"), to restructure its businesses to comply with the Ring-fencing Regime by the Statutory Deadline, as well as to achieve the regulatory objectives to improve the resilience and resolvability of LBG and promote financial stability. 5.2 LBG intends to conduct a single scheme rather than multiple schemes to enable transfer of assets, liabilities and customers from the Transferors to the Transferee, LBCM. If it is approved by the Court, in broad terms the Scheme will transfer from the Transferors to the Transferee: Derivatives business which cannot be conducted within the Transferors (subject in some cases to permitted exceptions such as for own risk management) and some non-complex customer derivatives business (which may be conducted within the Transferors but which has been selected for transfer in any case, for example, to ensure consistency of treatment for groups of customers, with treatment depending on customer categorisation). Special rules (including in some cases the offer by LBG of optionality to clients) apply to derivatives entered into prior to 1 January 2019, that mature prior to 1 January 2021, and which are therefore eligible to benefit from the transitional (or Grandfathering 4 ) provisions for such trades permitting the RFB to retain or sell investments after the Statutory Deadline; Certain loan and liquidity facilities (and certain sub-participations entered into in connection with such facilities) that involve an exposure to an RFI or that the relevant Transferor would be prohibited from holding under the EAPO 5 ; Liquidity facilities provided by the Transferors to RFIs to support the credit ratings of transferrable securities; Trade finance instruments where the customer that grants the counter-indemnity, or is subject to the reimbursement obligations in favour of the Transferor, is an RFI, and the corresponding counter-indemnity or reimbursement obligations themselves; Receivable Purchase Arrangements which create a prohibited exposure to an RFI; and Certain other assets and liabilities, such as guarantees, security, data, claims, receivables and other rights attributable to the Transferring Business. 5.3 If sanctioned by the Court, it is expected that the Scheme will become effective on the Effective Date and the Transferring Business will transfer from the Transferors to LBCM on that date. The Scheme also provides for certain assets and liabilities that form part of the transferred business (the Residual Assets and the Residual Liabilities ) to be transferred after the 4 Article 21 of the EAPO. 5 The EAPO and Sections 142D and 142E of the FSMA set out restrictions that are classified as excluded activities and prohibitions. These excluded activities and prohibitions together are termed the Perimeter Rules, as they classify what activities can and cannot be conducted by the RFB after the Statutory Deadline. 09/60

10 Effective Date, if there is any reason for which the transfer of those Residual Assets or Residual Liabilities needs to be delayed, but provided such assets and liabilities will be automatically transferred on 31 December 2018 to LBCM, if required for the Transferors to be compliant with the EAPO prior to the Statutory Deadline. 5.4 The precise asset and liability values to be transferred via the Scheme will be subject to change up until the point the Scheme is effected. Table 1 shows indicative values of assets and liabilities to be transferred via the Scheme based on LBG s forecasted transfer values at the point of transfer on the Effective Date. Table 1: RFTS transfers 6 Assets bn Loans and Advances to Customers 6.0 Loans and Advances to Banks 0.0 Collateral Posted 5.2 Other Customer Assets (Derivatives) 13.5 Total Assets 24.7 Liabilities bn Collateral Received 3.7 Other Customer Liabilities (Derivatives) 12.9 Total Liabilities In addition to the Scheme, LBG will implement a group-wide reorganisation in order to put in place a legal entity structure that is compliant with other requirements of the Ring-fencing Regime prior to the Statutory Deadline (the Reorganisation ). This Reorganisation will be carried out both before and after the Effective Date of the Scheme. An overview of the target structure of LBG is illustrated in Diagram 1. 6 The table herein has been extracted from the First Witness Statement of Mark George Culmer and shows only those assets and liabilities that are expected to transfer via the Scheme and not the full balance sheet of LBCM at the point of transfer on the Effective Date. 10/60

11 Diagram 1: Overview of the target structure LLOYDS BANKING GROUP PLC RFB SUB-GROUP NRFB SUB-GROUP INSURANCE SUB-GROUP EQUITY INVESTMENTS SUB- GROUP Key legal entities Key legal entities Key legal entities Key legal entities Lloyds Bank plc and Bank of Scotland plc EEA branches/subsidiaries which carry out permitted activities Key assets/products All mandated activities (core services/activities) Vast majority of deposit taking (not just individuals and Small and Medium Sized Enterprises ( SMEs )) Permitted products assets/products which: (i) are not captured by prohibitions or excluded activities; and (ii) fall into the exemptions to prohibitions or excluded activities Lloyds Bank Corporate Markets plc Non EEA entities: The United States Singapore Crown Dependencies Key assets/products All excluded/prohibited banking activities Products that Transferors choose not to provide (even though Transferors are not prevented from offering these under the Ringfencing Regime) Term deposits for Global Corporates ( GC ) and Financial Institutions ( FI ) which are also offered by Transferors (the client has the choice of which entity to use) Scottish Widows Group Limited and its relevant subsidiaries Key assets/products Insurance business Lloyds Development Capital (Holdings) Limited and its subsidiaries The Housing Growth Partnership group Uberior Investments Limited and its subsidiaries Other strategic minority interests, including Banco de Sabadell and Standard Life Aberdeen Key assets/products All excluded/prohibited equity investment activities 5.6 All costs and expenses incurred by LBG in preparing and implementing the Scheme (including the cost of the Skilled Person) will be borne by LBG. 5.7 Subject to the limitations in LBG s Scheme Document, LBG will also make payments of Reimbursed Amounts to its customers who suffer costs as a result of the Scheme for a period of up to seven months following the Relevant Date in certain circumstances, further information on which is set out in my full Scheme Report and in LBG s Scheme Document. 6. LBG s approach to ring-fencing 6.1 LBG evaluated three possible high-level ring-fencing design structures that it believed would achieve compliance with the Ring-fencing Regime: Wide RFBs and narrow Non Ring-fenced Body ( NRFB ) model: under this model, as many products and services would be kept inside the RFBs as is permissible under the Ringfencing Regime; RFBs only Group: this would seek to create the widest RFBs possible, with any prohibited business that could not be accommodated within them either to be exited, unwound or allowed to run-off. As part of this option, LBG considered whether it could enter into a partnership with other banks and institutions to provide prohibited products, thereby allowing customers to continue to have access to these products; and Narrow RFBs and wide NRFB model: this option would create narrower RFBs, with all transactions with large Global Corporates ( GC ) (with a turnover exceeding 500m), services to Financial Institutions ( FI ) and other wholesale lending business in the NRFB. 6.2 Through my review of the information provided to me by LBG it was evident that the following high-level design principles underpinned the choice of ring-fencing structure: 11/60

12 Compliance with the requirements of the legislation: as I would expect, the choice of ring-fencing structure has been shaped by the requirements of the Ring-fencing Regime and, particularly, the activities prohibited under the EAPO; The expected effect on customers: the information provided includes clear consideration of the expected effect on customers of the various options available; and The commercial and strategic implications of the structure: the information provided includes consideration of how the ring-fencing options align with LBG s business model, as a UK-focused, retail and commercial bank. The information also considers the commercial viability of the resultant structure and, as part of this, the likely credit ratings of the various entities after the restructure. 6.3 The Board of LBG plc concluded that the wide RFBs and narrow NRFB model was the optimal option, as it is expected to minimise the strategic, operational, business and legal disruption to LBG s customers while complying with the regulatory requirements. In reaching this decision, LBG considered the consistency of the various options with their high level design principles, as well as detailed analysis on the likely commercial and operational effects of each of the options considered. 6.4 The wide RFBs and narrow NRFB model was viewed by LBG as minimising disruption to customers, as it allows the Scheme to be structured in such a way to minimise the number of customers who are transferred, whilst the narrow RFBs and wide NRFB model would result in a large proportion of customers transferring, and the RFBs only Group model would have resulted in customers with prohibited products and services no longer having access to these from within LBG. LBG s analysis notes that providing customers with a consistent customer proposition was a factor in the choice of decision. As part of this, customers of both the NRFB and the RFBs will have a single RM, who will be able to source products from across both the RFBs and the NRFB. Such a service model would have been more challenging or impractical under the RFBs only Group approach. 6.5 The majority of the product types that will be transferred are required to be transferred by the Ring-fencing Regime. This is in line with LBG s high-level choice of wide RFBs and narrow NRFB model. The main discretion exercised by LBG relates to the exceptions to this rule, which reflect strategic decisions made by LBG to transfer Permitted Derivatives traded by GC 7 and FI customers and certain foreign exchange rate products. While the individual products themselves are not prohibited, the Permitted Derivative instruments are being transferred under the Scheme to achieve compliance with the Relevant Risk Requirement Limit ( RRR Limit ) set out in the EAPO. Note that the foreign exchange rate products transferring to LBCM are a mixture of permitted and prohibited derivative instruments that LBG would typically expect to be held by customers to help manage their risk exposures. Retaining all of these in the Transferors could lead to some customers having their products split across two banks. 6.6 The EAPO sets out quantitative limits for the Relevant Risk Requirement ( RRR ) which is a measure of the market risk capital requirement for the relevant positions. This acts as a constraint on the level of derivative activity within the RFBs. 6.7 In theory, in the absence of the RRR Limit, all Permitted Derivatives transacted with non-rfi customer entities in the five Commercial Banking segments (SME, Mid-Markets ( MM ), GC, FI and Client Asset Management ( CAM )) could remain in the Transferors. However, if the Transferors were to do so, the analysis performed by LBG suggests that the RRR Limit would be breached by several times the regulatory limit. This would prevent the Transferors from complying with applicable regulations and, therefore, necessitates the transfer of some Permitted Derivatives to LBCM, with LBG proposing to transfer all derivatives (subject to application of the Grandfathering rules) held by customers in the FI segments and all derivatives held by customers in the GC (excluding CRE Private Group) segment with a maturity date after 7 Excludes Commercial Real Estate Private Group ( CRE Private Group ) customers belonging to the GC segment as they will be treated like MM customers from a transferring derivatives perspective (for example, Permitted Derivatives will not transfer subject to certain optionality). 12/60

13 31 December 2020, and subject, in each case, to the application of optionality granted to these customers in respect of any short-dated derivatives. 6.8 As a result, LBG has decided to transfer to LBCM all the derivatives held by customers in the FI segments and those held by customers in the GC segment (excluding CRE Private Group) with a maturity date after 31 December LBG has further decided to keep in the Transferors all Permitted Derivatives transacted with non-rfi entities of the SME, MM, CRE Private Group and CAM segments and short-dated derivatives held by customers in the GC segment, subject to offering an option on Grandfathering or otherwise transferring certain transactions. This allows the Transferors to meet the RRR Limit requirements and provides room for future derivatives activity of non-rfi entities for SME, MM, CRE Private Group and CAM customers. 6.9 LBG considered the consistency of the various ring-fencing approaches with its strategy. As a UK-focused, mainly retail bank, LBG s opinion was that a narrow RFBs and wide NRFB model would be inconsistent with that strategy. Further, the choice of a wide RFBs and narrow NRFB model is expected to result in less disruption to customers than would be the case for the RFBs only model or the narrow RFBs and wide NRFB model, which is in line with the stated strategy of being the Best Bank for Customers The credit rating of LBCM is an important factor for customers and Other Relevant Persons that will have exposure to LBCM and has an effect on the commercial viability of LBCM. LBG believes the choice of a wide RFBs and narrow NRFB model is more likely to lead to the target credit ratings being achieved than a wider NRFB. While there remains uncertainty on the final credit ratings of LBCM, two of the main credit rating agencies provided preliminary or expected ratings on 17 July 2017, with Standard & Poor s ( S&P ) and Fitch rating LBCM as A- and A respectively. Moody s provisional rating for LBCM of A2 was published on 7 November LBG also considered the expected operational implications of the choice of ring-fencing approach. Following the Effective Date, LBG will be providing products and services from a new bank, namely LBCM. In order to limit the duplication of infrastructure and functions that would occur if LBCM was to provide these products and services by relying only on services, infrastructure and functions that it owns directly, LBG is intending to adopt a Shared Service Model ( SSM ). Under the SSM, the critical infrastructure and functions for service provisions are held within the Transferors, which will then provide these services to LBCM (as well as the Insurance Sub-group and Equity Investments Sub-group). This reflects LBG s desire to avoid unnecessary duplication of systems and services, which would otherwise increase the one-off and ongoing cost of the changes. It also reduces the risk of the RFBs and NRFB competing for business I note that a wide RFBs and narrow NRFB model leads to a dependence on the Transferors by LBCM, which could lead to challenges in the viability of LBCM as a stand-alone bank should the Transferors fail. I also note that the overall approach to ring-fencing, and particularly the relative size of the Transferors, the heavy alignment to LBG and that the Transferors will provide the critical services, could potentially lead to governance challenges, as it could be difficult to split the interests of the Transferors and LBCM. I consider this in further detail in Section 11 of my full Scheme Report, but note that LBCM will have its own governance framework, which will be led by the LBCM Board Overall, I am satisfied that the choice of ring-fencing structure, by minimising adverse effects on customers to a relatively small cohort of customers, is consistent with LBG s high-level design principles. This choice has been supported by the consideration of a wide range of possible alternative structures and the analysis and governance on the likely outcomes under the various structures. Based on the information I have seen, I am satisfied that the LBG plc Board was appropriately involved in the key decisions that have shaped the approach to ringfencing. As I would have expected, the topic was frequently discussed, particularly in more recent years when the key decisions were being made. In general terms, I am satisfied that the design chosen is reasonable in nature, such that any identified adverse effect arising as a direct result solely of the high-level design of the change programme that LBG has in place to execute the changes to meet the Ring-fencing Regime, and the Scheme, will not be greater than 13/60

14 reasonably necessary in order to achieve the relevant ring-fencing purpose, as set out in Section 106B(3)(a) of the FSMA. 7. Implications for Retail Banking customers 7.1 I have considered the likely effect of the Scheme on the Retail Banking customers of LBG. The Retail Banking division of LBG offers retail products and services to approximately 38 million customers. Retail Banking customers are primarily individuals, sole traders and small businesses, typically with a turnover of less than 1m. Small business customers are served through Retail Business Banking ( RBB ), which is a sub-division of LBG s Retail Banking division. The Consumer Finance sub-division is another sub-division of the Retail Banking division, which is considered separately in Section 8 of my full Scheme Report. 7.2 LBG s ring-fencing structure will result in no products or services provided to Retail Banking customers being transferred under the Scheme. Based on my analysis of the information provided to me by LBG, I have not identified any likely adverse effects of the Scheme on Retail Banking customers. In particular, I have not identified any material changes to the: Terms and conditions of the existing Retail Banking products and services offered; Level of protection afforded by the Financial Services Compensation Scheme ( FSCS ); and Manner in which customers will interact with LBG or the quality of the service provided. 7.3 I have therefore concluded that Retail Banking customers are not likely to be adversely affected by the Scheme. 7.4 As part of my analysis, I have noted the following matters that are not an effect of the Scheme itself but that are a likely effect of compliance with the Ring-fencing Regime on certain groups of Retail Banking customers: RBB customers classified as RFIs: an estimated 67 RBB customers meet the definition of an RFI and LBG has decided to reclassify such RBB RFIs into the SME division of the Commercial Banking division (expected to be undertaken prior to the Directions Hearing). Certain RBB customers who are RFIs which have exposure bearing products such as credit cards, charge cards and overdrafts, and existing lending products will have such products curtailed; Customers of legal entities and branches in non-eea locations: customers of legal entities and branches in non-eea locations, along with customers of Lloyds Bank Gibraltar Limited ( LGIB ), will be transferred outside of the RFB Sub-group, however these customers will not be transferred via the Scheme but will instead be transferred through a wider group restructuring; and Birmingham Midshires customers affected by a change to their payment mechanisms: the payment mechanism used for Birmingham Midshires customers will change as, under the Ring-fencing Regime, it is no longer allowed to operate in its current form. A small number of customers may experience a degree of inconvenience whilst these changes are implemented. 7.5 Whilst the above changes may result in an adverse effect on certain groups of Retail Banking customers, any such effect will not be as a result of the Scheme, but a consequence of complying with the broader Ring-fencing Regime. 8. Implications for Consumer Finance customers 8.1 I have considered the likely effect of the Scheme on the Consumer Finance customers of LBG. The Consumer Finance sub-division of LBG, which forms part of the Retail Banking division but 14/60

15 is managed separately, provides unsecured personal loans and credit/charge cards to approximately 10 million consumer and commercial customers, the significant majority of whom are UK based. The Consumer Finance sub-division acquired the MBNA credit cards business with approximately 2.3 million active customers on 1 June The Retail Banking division also has smaller sub-divisions, two of which provide motor finance products and International Mortgage Services (a closed book of mortgage loans which is in run off). For the purpose of this Summary Report, and my full Scheme Report, I have included these small sub-divisions of the Retail Banking division within the Consumer Finance sub-division. 8.2 LBG s ring-fencing structure will not result in any products or services provided to Consumer Finance customers being transferred under the Scheme. Based on my analysis of the information provided to me by LBG, I have not identified any likely adverse effects of the Scheme on Consumer Finance customers. In particular, I have not identified any material changes to the: Terms and conditions of the existing products and services offered by the Consumer Finance sub-division; and Manner in which customers will interact with LBG or the quality of the service provided. 8.3 I have therefore concluded that Consumer Finance customers are not likely to be adversely affected by the Scheme. 8.4 As part of my analysis, I have noted the following matters that are not an effect of the Scheme itself but that are a likely effect of compliance with the Ring-fencing Regime on certain groups of Consumer Finance customers: Consumer Finance customers classified as RFIs: as at 20 October 2017, an estimated 231 Consumer Finance customers meet the definition of an RFI. Of those 231 Consumer Finance customers, 169 hold a corporate or business charge card and 19 hold a commercial credit card, which gives rise to a prohibited lending exposure and therefore LBG has taken the decision not to offer these products in LBCM and instead to work with these customers to explore resolution options, such as novating to non-rfi entities of the customer group. If no resolution can be found, LBG will terminate the agreement with the identified RFI. LBG envisages that these types of customers will be able to find alternative credit or charge cards readily available through other providers who are not restricted in selling to RFIs. Of the remaining 43 Consumer Finance customers, 42 such customers hold products with Lex Autolease, which will remain in the RFB Sub-group (relying on an exemption to the prohibition on RFI exposures under the EAPO), and a solution has been agreed with the remaining one Consumer Finance customer with a Black Horse Onshore product such that it can also remain with the Transferors; and Customers of legal entities and branches in non-eea locations: customers of legal entities and branches in non-eea locations will be transferred outside of the RFB Subgroup, however these customers will not be transferred via the Scheme but will instead be transferred through a wider group restructuring. 8.5 Whilst the above changes may result in an adverse effect on certain groups of Consumer Finance customers, any such effect will not be as a result of the Scheme, but a consequence of complying with the broader Ring-fencing Regime. 15/60

16 9. Implications for Commercial Banking customers 9.1 I have considered the likely effect of the Scheme on the Commercial Banking customers of LBG. Commercial Banking customers are defined by LBG as any business with a turnover greater than 1m, which holds products or services offered by LBG. LBG divides the Commercial Banking customer base into five main segments, which are defined by their subsegments, as shown in Table 2 on the next page. 16/60

17 Table 2: Commercial Banking customer segments as at 20 October 2017 Segment Sub-segment Customer definition Small and Medium Sized Enterprises ( SME ) Mid-Markets ( MM ) Global Corporates ( GC ) Financial Institutions ( FI ) Business Business Education, Charities and Government Social Housing Business Business Commercial Real Estate ( CRE ) CRE Private Group Banks Insurance Pensions, Wealth and Stockbrokers Financial Sponsors Institutional Investors Intermediaries Specialist Finance Group Subsidiaries Government Bodies Turnover of 1m - 25m or Lending of 75k m Turnover of 25m - 750m (or up to 500m in London) Higher and further education institutions, charities and local government organisations Housing Associations who build and manage more than 1,000 residential housing units Turnover in excess of 750m (or 500m in London) Real Estate companies with asset values in excess of 25m or LBG lending in excess of 12.5m Subset of CRE consisting of entrepreneurs and smaller property companies Banks (including correspondent, agency, UK challenger banks and other international banks) and Building Societies UK-based life, non-life and composite insurance companies, international insurers with a UK presence and brokers UK-based pension administrators, wealth managers and stockbrokers Private market investment managers (and funds) Asset Managers and Sovereign, Supranational and Agency bodies Brokerage firms, clearing and settlement firms, exchanges and market data firms Specialist lenders and debt purchasers LBG entities UK central Government and Government Bodies Number of entities affected by the Scheme* ,493 Client Asset Management ( CAM ) 30 TOTAL 3,449 Source: Information provided by LBG. * Includes customer entities with products subject to mandatory transfers, optional transfers and duplicating empty agreements. 17/60

18 9.2 Commercial Banking customers use a wide variety of financial products and this typically varies by the segments identified. For example, an SME s needs are generally simpler than that of a large FI and this is reflected in the complexity of products that they require. This section of the Summary Report contains a broad overview of the key potential adverse effects to Commercial Banking customers and my view of those effects. However, due to the complexity of Commercial Banking and the technical nature of the products offered by LBG s Commercial Banking division, I would encourage anyone who is interested in my assessment as to whether Commercial Banking customers will be affected by the Scheme, to read my full Scheme Report in its entirety. Non-Transferring Customers - Commercial Banking 9.3 LBG s decision to implement a wide RFBs and narrow NRFB model, designating LB plc and BoS plc within its RFB Sub-group, will result in the majority of the products and services offered to Commercial Banking customers remaining unchanged and continuing to reside within the Transferors. It is estimated by LBG that the majority of Commercial Banking customers (more than 98% of the total customer entities) will not have any products transferred under the Scheme. This includes customers of non-eea entities which may be transferring products but not via the Scheme. 9.4 For those non-transferring Commercial Banking customers, I am satisfied that they will not experience any adverse effect as a result of the Scheme. In particular, for these customers, I have not identified: Changes to the terms and conditions of the existing Commercial Banking products (for example, the economic terms will remain unchanged); and Significant changes to the way those customers will interact with LBG or the quality of the service provided. For example, the coverage of these customers by their RM and by product specialists will remain unchanged. 9.5 As part of the wider group restructuring, LBG will transfer other Commercial Banking business from the various non-eea entities and branches (including in the United States of America ( USA ), Singapore and the Crown Dependencies). Whilst these customers may experience a change, any such change will not be a result of the Scheme, which the Court is being asked to sanction, but will be as a consequence of complying with the broader Ring-fencing Regime. Transferring Customers - Commercial Banking 9.6 Based on the information as at 20 October 2017, there would be 3,449 customer legal entities, mainly GC and FI customers that would have products transferred to LBCM, and/or have contracts duplicated, as a result of the Scheme. LBG estimates that, based on the likely growth in customers between 20 October 2017 and the Effective Date, the total number of affected customers on the Effective Date will be approximately 4,000. This represents approximately 1.4% of the total number of customer entities in Commercial Banking. It should be noted that this estimate does not account for: (i) multiple fund entities within a customer group that may, or have the option to, participate within lending facilities where LBG data recognises only a single entity as the principal borrower; and (ii) approximately 255 customers (across all divisions in LBG) whose products may be curtailed by LBG (which, in any event, is not a result of the Scheme). 9.7 Customers will have products transferred to LBCM under the Scheme due to four key restrictions in the Ring-fencing Regime: An RFB must not maintain or establish a branch in any country or territory which is not an European Economic Area ( EEA ) member state, therefore products currently booked to the non-eea branches of the Transferors must be moved; An RFB cannot have any exposure to customer entities defined as an RFI, unless subject to exemptions such as holding the position for its own risk management or liquidity purposes; 18/60