UniCredit Luxembourg S.A. Annual Report

Transcription

1 2016 UniCredit Luxembourg S.A. Annual Report

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3 We are a simple pan-european commercial bank with a fully plugged in Corporate & Investment Banking, delivering our unique Western, Central and Eastern European network to our extensive client franchise. We offer local expertise as well as international reach. We accompany and support our 25 million clients globally, providing them with unparalleled access to our leading banks in 14 core markets as well as to another 18 countries worldwide. Our vision is to be One Bank, One UniCredit. Everything we do to implement our vision is based on our Five Fundamentals. Our top priority, every minute of the day, is to serve our customers the very best we can (Customers First). To do this, we rely on the quality and commitment of our people (People Development), and on our ability to cooperate and generate synergies as One Bank, One UniCredit (Cooperation & Synergies). We take the right kind of risk (Risk Management) whilst being very disciplined in executing our strategy (Execution & Discipline).

4 One Bank, One UniCredit. A shared vision based on Five Fundamentals. As a strong pan-european Group with leading banks in 14 core markets, and operations in another 18 countries, we perfectly embody our vision to be One Bank, One UniCredit. A simple pan-european commercial bank enriched by multiple cultures where everybody shares the same vision and are guided by our Five Fundamentals: Customers First, People Development, Execution & Discipline, Cooperation & Synergies and Risk Management Annual Report UniCredit Luxembourg S.A.

5 Contents Message of the CEO of UniCredit 5 Highlights 8 Foreword 13 Report of the Management Board 16 The macroeconomic environment 16 Luxembourg s financial centre 18 Report on operations 20 Report on divisional activities 24 Outlook for Annex transition from FINREP to IFRS 32 Report of the Réviseur d Entreprises Agréé 35 Financial statements 37 Statement of comprehensive income 37 Statement of financial position 38 Statement of changes in equity 39 Statement of cash flows 40 Notes to the financial statements 42 (A) General comments 42 (B) Accounting and measurement methods 42 (1) The consistency principle 42 (2) New standards and interpretations not yet adopted 43 (3) Financial instruments 44 (4) Financial assets held for trading 47 (5) Financial instruments measured at fair value through profit and loss 47 (6) Available-for-sale financial instruments 47 (7) Held-to-maturity financial instruments 47 (8) Loans and receivables 47 (9) Impairment of financial assets 48 (10) Property, plant and equipment 49 (11) Investment property 49 (12) Intangible assets 49 (13) Liabilities 50 (14) Financial liabilities held for trading 50 (15) Hedge adjustment of hedged items in the fair value hedge portfolio 50 (16) Other liabilities 50 (17) Employee benefits 50 (18) Provisions 53 (19) Foreign currency translation 54 (20) Revenues and expenses 54 (C) Financial Risk Management 55 (D) Segment reporting 68 (21) Notes on segment reporting 68 (E) Notes to the statement of comprehensive income 73 (22) Net interest income 73 (23) Net commission income 73 (24) Net income from investments 74 (25) Net trading income 74 (26) Net other expenses/revenues 75 (27) Operating costs 75 (28) Provisions for risks and charges 75 (29) Net write-downs of loans and provisions for guarantees and commitments 76 (30) Income tax for the year 76 (F) Notes to the statement of financial position 78 (31) Cash and cash balances with central banks 78 (32) Financial assets held for trading 78 (33) Financial instruments measured at fair value through profit and loss 78 (34) Available-for-sale financial instruments 78 (35) Loans and receivables with banks 79 (36) Loans and receivables with customers 79 (37) Allowances for losses on loans and receivables with banks and customers 80 (38) Hedging derivatives 81 (39) Fair value changes of the hedged items in portfolio hedge of interest rate risk 81 (40) Property, plant and equipment 81 (41) Investment property 82 (42) Intangible assets 83 (43) Tax assets 83 (44) Other assets 83 (45) Securitisation 83 (46) Liabilities to banks 84 (47) Deposits from customers 84 (48) Financial liabilities held for trading 85 (49) Tax liabilities 85 (50) Other liabilities 85 (51) Provisions 86 (52) Subscribed capital 88 (53) Subordinated capital 88 (G) Notes on financial instruments under IFRS 7 89 (54) Fair values of financial instruments 89 (55) Fair value hierarchy 90 (56) Undiscounted cash flows 90 (H) Other information 91 (57) Structured entities 91 (58) Ratios required under the Luxembourg capital adequacy rules 93 (59) Transfer of financial assets 94 (60) Contingent liabilities, commitments and other commitments 94 (61) Trust business 95 (62) Governing bodies 95 (63) Remuneration of the auditors 96 (64) Our employees 96 (65) Related parties disclosures 96 (66) Significant events after the balance sheet date 97 (67) Executive Management bodies 97 Management 99 Top Management 99 Heads of business units 99 Heads of departments 99 UniCredit Luxembourg S.A Annual Report 3

6 Simple Pan-European Commercial Bank We are a simple pan-european commercial bank with a fully plugged in CIB, enriched by multiple cultures and strong local knowledge, where everybody shares the same vision: One Bank, One UniCredit. That s why when it comes to our client s international needs we have the solution. Whether it is trade or other banking services, we can help: with our deep local knowledge and our unique Western Central and Eastern European network serving our clients in Europe and beyond, we are fully equipped to meet our clients needs, both in our home-markets and further afield.

7 Chief Executive Officer s message I am proud to have the opportunity to lead UniCredit. I and my management team are fully committed to making UniCredit one of the most attractive banks in Europe. Jean Pierre Mustier Chief Executive Officer Dear Shareholders, as this is my very first letter to you, I would like to say how proud and honored I am to have the opportunity to lead UniCredit and that I and my management team, are fully committed to making UniCredit one of the most attractive banks in Europe and to creating recurring value for all our stakeholders was an eventful year for European financial services, including for the Italian banking sector. This, coupled with rapidly evolving client behaviors and expectations and the need to transform and strengthen the Bank, led us to launch an in depth strategic review in early July. Our core priorities are to reinforce and optimize the Group s capital position, improve profitability, ensure continuous transformation of operations, maintain flexibility to seize value creating opportunities, further reduce costs, increase cross selling and above all further improve risk discipline. There is now one executive governing body, one closely knit management team, led by the CEO and composed of the leaders of the key activities and geographies within UniCredit, with one single General Manager in charge of all businesses activities. There is now One Bank, One UniCredit. Before we presented the outcome of the strategic review, Transform 2019, which is the beginning of a long term transformative process for the bank, we took bold actions to strengthen our capital ratios. We did so by agreeing the sales of Pioneer and Pekao and by optimizing our participation in Fineco as well as improving our asset quality by addressing our Italian legacy issues through the de-risking of a 17.7 billion euro non performing portfolio. UniCredit Luxembourg S.A Annual Report 5

8 Transform 2019 s core message is that UniCredit is a simple Pan-European Commercial Bank, with a fully plugged in CIB, delivering a unique Western, Central and Eastern European network to its extensive client franchise; competitive advantages - on which we shall build. The plan is based on pro-active self-help. Key levers of the plan, cost and risk, are fully under management control. This to ensure maximum value creation for all our stakeholders while reducing execution risk. We de-risked the balance sheet by taking an 8.1 billion euro one-off provision in 2016 resulting in boosted coverage. This will significantly improve our asset quality. Very strong risk discipline is another key component of the plan, this to further improve the quality of future origination with the objective to bring our group cost of risk down to about 49 bps by end The transformation of business processes will allow our teams more client facing time, provide a better service and leading to a recurring 1.7 billion euro net annual cost reduction as of Group cost income ratio will decrease by more than 9.5 percentage points to below 52 per cent. However, this transformation will also lead to a number of colleagues leaving the Group, primarily through early retirements and voluntary redundancies. We shall endeavor to treat everyone concerned with the utmost respect and dignity to facilitate their transition. My thanks for the contribution they have made to the Bank. Taking the current low rate environment and prevailing economic context into account, our objective is to reach a RoTE above 9 per cent in Fully loaded CET1 will be above 12.5 per cent in The Transform 2019 targets are tangible pragmatic and based on conservative assumptions. As a team we are fully committed to achieving them with management s interests fully aligned with shareholders. In order to achieve the plan targets and to significantly strengthen the Group s capital position in line with best-in-class global SIFIs, a 13 billion euro rights issue was proposed. Let me also pay tribute to our employees and thank them for their ongoing commitment. This is only the beginning of our transformative journey and it is thanks to our teams, that we will be successful and create value. Sincerely, Jean Pierre Mustier Chief Executive Officer UniCredit S.p.A. Going forward we will have a much leaner but strong steering corporate centre to drive Group performance and ensure accountability through a set of Group-wide KPIs Annual Report UniCredit Luxembourg S.A.

9 Customers First Our top priority, every minute of the day, is to serve our customers the very best we can. We provide solutions for a wide variety of different personal finance and enterprise business needs. Our products and services are based on our customer s real needs and aimed at creating value for both individuals and businesses. UniCredit Luxembourg S.A Annual Report 7

10 Highlights UniCredit is a strong pan-european Group with a simple commercial banking model and a fully plugged in Corporate & Investment Bank, delivering its unique Western, Central and Eastern European network to its extensive 25 million strong client franchise. UniCredit offers local expertise as well as international reach and accompanies and supports its clients globally, providing clients with unparalleled access to leading banks in its 14 core markets as well as an another 18 countries worldwide. UniCredit's European banking network includes Italy, Germany, Austria, Bosnia and Herzegovina, Bulgaria, Croatia, Czech Republic, Hungary, Romania, Russia, Slovakia, Slovenia, Serbia and Turkey. Financial Highlights 1 Operating income 18,801 m Net profit (loss) (11,790) m Shareholders' equity 39,336 m Total assets 859,533 m Common Equity Tier 1 ratio * 11.15% Revenues 1 (%) by Business Lines 36 Commercial Banking Italy CEE Division CIB Commercial Banking Germany Commercial Banking Austria Asset Gathering by Regions 46 Italy Germany CEE Austria Data as at December 31, As at December 31, 2016, in accordance with IFRS5, the assets/liabilities and the profit/loss of Bank Pekao S.A., Pioneer Global Asset Management S.p.A. and their subgroups companies, as a result of their classification as discontinued operations, were recognized: in Balance Sheet under items Non-current assets and disposal groups classified as held for sale and Liabilities included in disposal groups classified as held for sale ; in Income Statement under item Profit (loss) after tax from discontinued operation ; the previous periods were restated accordingly to increase comparability. * Fully loaded CET1 ratio at 11.15% post capital increase, above 12% including Pioneer and Pekao deals. CET1 ratio transitional at 11.49% post capital increase Annual Report UniCredit Luxembourg S.A.

11 International Presence 2 Austria Bosnia and Herzegovina Bulgaria Croatia Czech Republic Germany Hungary Italy Romania Russia Serbia Slovakia Slovenia Turkey Market Shares 3 (%) Austria Bosnia and Herzegovina Bulgaria Croatia Czech Republic Germany Hungary x Italy Romania 0.5x Russia Serbia Slovakia Slovenia Turkey 2. On December 8, 2016, UniCredit ("UCG") entered into a binding agreement with PZU SA and PFR (Polish Development Fund) for the sale of a 32.8% stake in Bank Pekao (Poland) and, on the same date, it announced the disposal of the remaining 7.3% via a market transaction. The CEE division includes only the 11 countries in which the Group operates through Retail branches. Accordingly, Azerbaijan, Estonia, Latvia and Lithuania have been excluded. 3. Market Shares in terms of Total Loans as at December 31, Source: Company data, National Central Banks. UniCredit Luxembourg S.A Annual Report 9

12 One Bank, One UniCredit Transform 2019 A challenging business environment marked by greater regulatory pressure and a lengthy period of low growth and low interest rates has prompted a deep strategic review of every major area of the bank. More specifically, the review has focused on how to reinforce and optimize the Group s capital position, reduce the risk profile of the balance sheet, improve profitability, and ensure that operations are transformed continuously in ways that enable increased client focus, further cost reductions and crossselling across Group entities. These goals are to be pursued while maintaining the flexibility to seize value-creating opportunities and while improving risk discipline still further. Hence, the Transform 2019 strategic plan targets are pragmatic, tangible and achievable and are based on conservative assumptions associated with five strategic pillars defined as follows: Strengthen and optimize capital, to align capital ratios with the best in class G-SIFIs Improve the asset quality, addressing Italian legacies via a proactive balance sheet de-risking Transform the operating model, strengthening our client focus while simplifying and streamlining products and services Maximize commercial bank value, capitalizing on the potential of our retail client relationships and our status as the go-to bank for corporate clients in Western Europe while building on our leadership position in Central and Eastern Europe and increasing cross-selling across business lines and countries Adopt a lean but strong steering Group Corporate Center, establishing consistent Groupwide KPIs to drive performance and improve accountability This transformation will enable the Group to take advantage of future opportunities and generate longterm profits, functioning successfully as a simple pan-european commercial bank with a fully plugged in CIB and a unique network in Western, Central and Eastern Europe. Five Strategic Pillars STRENGTHEN AND OPTIMIZE CAPITAL IMPROVE ASSET QUALITY TRANSFORM OPERATING MODEL MAXIMIZE COMMERCIAL BANK VALUE ADOPT LEAN BUT STEERING CENTER Reinforce capital Capital optimization actions Increasing coverage ratio of bad loans Strong risk discipline Digitalization and process redesign Improved efficiency and customer focus Tailored strategies Synergies and cross-selling KPIs to drive performance and accountability Leaner support functions and transparent cost allocation Annual Report UniCredit Luxembourg S.A.

13 Transform Our Operating Model Among the key pillars of UniCredit s strategic plan for , one of the most important objectives is the transformation of the Group s operating model. The purpose of this is to strengthen our customer focus, service and products while simplifying our structure and increasing our efficiency. Digitalization will enable the transformation and make it possible to achieve a lower sustainable cost base. The main initiatives include: Redesigning end-to-end processes and lowering the cost of running the bank by leveraging our global operations and developing economies of scale Strengthening client focus by further improving the customer experience, carrying out product standardization, and engaging in more client-facing activities Investments in IT that will support the business transformation with greater digitalization, the technological improvement of core systems, and ongoing infrastructure updates Transform Our Operating Model REDUCING OPERATING COSTS STRENGTHENING CUSTOMER FOCUS, SERVICE & PRODUCTS INVESTING IN IT TO SUPPORT THE BUSINESS TRANSFORMATION USING DIGITALIZATION AS AN ENABLER 1.7 bn in net annual recurring cost savings as of fewer branches in Western Europe (Italy, Germany and Austria) by end bn in IT investments over the course of the plan UniCredit Luxembourg S.A Annual Report 11

14 People Development Our success depends on the quality and commitment of our people. That s why we have such a strong commitment to developing and empowering our teams. We must make sure we can attract and retain the very best talent and we must create and nurture an environment and culture in which our staff can grow, thrive and reach their full potential Annual Report UniCredit Luxembourg S.A.

15 Foreword Dear Clients and Business Associates, in line with the principles defined in the UniCredit Group wide strategic plan Transform 2019 presented in London on December 13th, 2016, the Group is going to strengthen and optimize capital, improve asset quality, cost discipline and enhance efficiency measures to significantly reduce cost income ratio and transform business. The strategic plan also includes the restructuring of activities in Luxembourg. The sole shareholder of UniCredit Luxembourg S.A. (the Bank) therefore took the decision to significantly restructure the Bank. In order to enhance the offer for financial holdings and family offices, a first step will be the transfer of the Italian Private Banking activities to UniCredit International Bank (Luxembourg) S.A.. The Global Family Office (GFO) project target clients are family offices and holding companies with minimum assets of 500 million and also selected family offices / holding companies with a lower threshold, but with an active presence in financial markets. UniCredit Luxembourg S.A. has notified the CSSF and the ECB of the decision and requested approval of the transaction. Subject to regulatory approval, our Italian Private Banking activities in Luxembourg, including staff, will be shifted to UniCredit International Bank (Luxembourg) S.A. and therefore remain in Luxembourg. The Corporate business is planned to be transferred to UniCredit Bank AG by the end of 2018 at the latest and by end of December 2018 all business activities of the Bank will cease. With regard to the business relationship with the corporate clients in Luxembourg nothing will change as they already have been customers of UniCredit Bank AG. We believe that the Bank s success have been achieved through highly qualified and multilingual staff with their strong analytical skills and high level of documentation and administration experience; a recognised role as a professional agent in the syndicated loans market; several years of hands-on experience in securitisation; and a flexible and professional local treasury. It is our paramount goal, to maintain our client centric approach with effective, real-life solutions for our customers and ensure a smooth transition phase. DR. JOACHIM BECKERT Chief Operating Officer/ Chief Risk Officer/General Manager MICHAELA EHRHARDT Chief Executive Officer GIOVANNI GIALLOMBARDO General Manager UniCredit Luxembourg S.A Annual Report 13

16 The constantly changing environment requires from us flexibility, swift reaction and focus on our client s needs to achieve highest customer satisfaction. Our employees form the indispensable basis for our past and future success. After the introduction in 2014 of the Single Supervisory Mechanism (SSM) applied to banks with assets in excess of 30 billion or 20% of domestic GDP, 2016 was another important milestone for the supervision of the Bank. For the entire year, the European Central Bank (ECB) was in charge of supervising both UniCredit S.p.A. (UC group) at a consolidated level as well as the relevant subsidiaries in the eurozone. A new law dated 18 December 2015 transposed into Luxembourg law EU Directive 2014/59/EU establishing a framework for the recovery and resolution of credit institutions and investment firms ( BRRD ) and EU Directive 2014/49/EU on deposit guarantee schemes ( DGSD ). The significant changes introduced by the law are the following: implementation of the resolution chapters of BRRD governing the resolution of banks and certain investment firms; the Commission de Surveillance du Secteur Financier (CSSF) has been designated as a resolution authority for Luxembourg ( conseil de resolution ); a Luxembourg resolution fund ( Fonds de résolution Luxembourg ) has been created as Luxembourg resolution financing tool; a new public deposit guarantee system under the name Fonds de garantie des dépôts Luxembourg (FGDL) replaced the previous system of the Association pour la Garantie des Dépôts Luxembourg (AGDL), both ex-post funded system; functions carried out in the past by the AGDL in the field of investor protection have been taken over by the Système d indemnisation des investisseurs Luxembourg (SIIL) (Investor Compensation Scheme Luxembourg). In line with the Bank s expectations, the Bank s contribution to the national resolution fund in 2016 increased to 1.7 million. In 2016 the Bank continued its focus on liquidity risk steering and management. The Bank constantly monitored the Liquidity Coverage Ratio (LCR) over the course of the year and consistently adhered to the regulatory limit thanks to increased level of liquid assets. In 2016 the ECB announced the introduction of a new Targeted Longer Term Refinancing Operation (TLTRO II). The Bank considered that TLTRO II was the appropriate instrument for diversifying long-term funding sources and optimising the use of its existing collateral, namely GELDILUX-TS-2015 and parts of the loan portfolio, eligible as Eurosystem collateral. In line with UniCredit S.p.A. and UniCredit Bank A.G., the Bank participated in the June 2016 tranche of TLTRO II. Consequently, the structural liquidity ratios up to the four-year bucket improved sharply and the Bank continued with its commercial operations with the aim of using the TLTRO resources to fund new loans for customers. As of , the Bank s total assets reached 20.3 billion, showing an increase of 0.3 billion, or 1.4%, compared to the previous year-end. This change was mainly due to the increase in loans to customers and in loans to banks. The upward trend in loans to customers was mainly driven by the positive commercial performance in Structured finance and Trade finance.. Overall in 2016, the already very good quality of the Bank s structured finance portfolio improved, and more than 75% of the Bank s commitments were to borrowers with internal ratings of 3- (investment grade equivalent to BBB) or better. Yours faithfully, Michaela Ehrhardt CEO Dr. Joachim Beckert COO / CRO Giovanni Giallombardo General Manager Annual Report UniCredit Luxembourg S.A.

17 Cooperation & Synergies Our ability to cooperate and generate synergies across departments and geographies is what makes us unique and allows us to be One Bank, One UniCredit. We are a true pan-european bank and we work seamlessly across the Group. UniCredit Luxembourg 2014 Annual Report 15

18 Report of the Management Board I The macroeconomic environment Report of the Management Board The macroeconomic environment 1 The global economy As in previous years, the evolution of financial markets in 2016 was driven by the expansionary monetary measures of the main central banks and by various geopolitical factors. More reluctant behaviour on the part of the US Federal Reserve (Fed) in respect of rate increases also had an important influence on financial markets. The beginning of the year was characterised by a high level of risk aversion among market participants. The ongoing drop in oil prices caused fears regarding a slowdown in global economic growth and a possible recession in the United States. Further negative momentum came from China. Disappointing economic figures as well as another sharp devaluation of the Chinese yuan caused uncertainties. A turning point arrived in the middle of February 2016 after a recovery in the oil price as a result of the Russia / Saudi Arabia preliminary agreement to freeze the level of oil production. Further support for the financial markets came from the central banks. The European Central Bank (ECB) fulfilled the expectations of market participants by decreasing its key interest rate to 0.00% and extending its bondbuying programme. The monthly amount of bond purchases was increased by one-third from 60.0 billion to 80.0 billion and the universe of eligible securities was expanded to include investment grade corporate bonds. The Fed, contrary to market expectations, kept its key interest rate unchanged due to risks regarding the world economy and financial market risks. Another important market driver in 2016 was the referendum on British withdrawal from the European Union. After the vote for Brexit, risk aversion increased substantially and core government bonds and gold as safe haven instruments were in high demand, while equities came under pressure. In this context the two most important European currencies, the euro and the UK pound, both depreciated sharply against the US dollar. The yield on ten-year German government bonds slipped into negative territory for the first time in history. At this time, the whole German Bund curve out to the ten-year bucket showed negative yields. The picture changed completely in the second half of the year. Equity markets started a strong recovery after having overcome the initial shock. The upward trend was additionally supported by positive fundamental figures especially in Europe and ongoing expansionary monetary policy at the main central banks. Beside Brexit, the other important political event on the agenda of market participants was the US presidential election in November. Before the election financial markets showed a high level of volatility. After the victory of Donald Trump the core indices turned positive while emerging markets suffered massively. In the short term, market participants expected impetus for the US economy from the protectionist measures proposed by Mr Trump, such as corporate and income tax cuts and extensive infrastructure investments. Possible negative mid/long-term implications of Mr Trump s policies did not play a large role in investor sentiment. In December the Fed decided to raise interest rates by 25 bps. As this was already expected by most analysts, this step was already reflected in market prices and had no effect on investors. The risk appetite of market participants increased at the year-end and the most important US indices reached new all-time highs. Global growth is expected to slow to 3.1% in 2016 due to a worsening outlook for the advanced economies following the June UK referendum vote in favour of leaving the European Union. Financial market sentiment towards emerging market economies improved with expectations of low interest rates in advanced economies and reduced concern about China s prospects following policy support for growth. But trends diverged sharply across countries and regions, with India showing robust growth, China recording a slowdown and sub-saharan Africa experiencing a decline. During 2016, turmoil in the Middle East and terrorist attacks by the Islamic State of Iraq and Syria (ISIS) continued to take their toll even though ISIS lost several key cities in Syria and Iran. Financial market trends In 2016 equity performance was mainly positive. Commodities faced a volatile year. Gold recovered during the first three quarters of the year but after the election of Donald Trump it lost around 16.0% from its year high in July. The oil price rose strongly and closed the year close to its year high. The money market three-month EURIBOR rate was negative for the whole year and closed near its lowest point of the year. Bond yields in European countries dropped in the first part of the year and rose in the fourth quarter of the year. Equity markets The Morgan Stanley Capital International (MSCI) World Index increased by 11.01% (in EUR) in Equities in the US were stronger than those in Europe (S&P 500: %; Euro Stoxx 50: +4.18%), while the emerging markets recovered after a negative 2015 (MSCI Emerging Markets Index: %). The Nikkei was slightly positive at 2.35%. 1 All the macroeconomic data are provided by UniCredit Research MIB (Market & Investment Banking) Annual Report UniCredit Luxembourg S.A.

19 Forex The euro showed significant volatility in The EUR/USD exchange rate ranged between and until the US presidential election. After the election the euro depreciated progressively to against the US dollar. Beside the varying monetary policies of the central banks, the trend after the election also reflected the expectation of higher growth and inflation as a result of the vote for Donald Trump. The euro decreased in value compared to the Japanese yen, too. The yen appreciated by roughly 6% against its European counterpart. The UK pound depreciated significantly compared to the US dollar. The GBP/USD exchange rate decreased from to mainly due to the Brexit vote. Fixed income and interest rates The monetary policies of the ECB and the Fed differed in The ECB continued its expansionary monetary policy. During the year, the ECB again lowered the interbank rate to a new historical low of 0.00% and reduced the deposit facility rate from -0.30% to -0.40%. The Fed raised its target rate by 0.25% in December, which was its first move after the increase in December Looking at the capital market, the yield on ten-year German government bonds declined in the initial months of the year and reached a historical low of -0.19% in July. It rose again in the second half of the year, reaching 0.21% by the end of Yields on sovereign bonds in eurozone periphery countries such as Italy and Spain also fell to long-term lows in the third quarter. At the end of the year the Italian BTP with a maturity of ten years traded at higher yield levels than one year earlier (1.81%) as a result of uncertainty before and after the Italian referendum. In contrast, Spanish Bonos with a maturity of ten years traded at lower yield levels than one year before (1.38%). Outlook for 2017 The following factors are expected to act as key market drivers in 2017: moderate global growth at 3.4% 2 with some question marks especially regarding possibly lower-than-expected growth in China; reflation resulting from the policy programme of newly elected President Trump, with higher growth and inflation; a further rise in US interest rates; low rates and further liquidity stimulus in Japan and Europe through unconventional measures; solid economic growth in the US; improving economic fundamentals in Europe and the eurozone periphery countries owing to the weak euro combined with quantitative easing from the ECB. The key global risks are posed by increasing tensions in the Arab world involving countries such as Syria, Turkey, Iran and Saudi Arabia as well as Russia and the US, and by the ISIS terror campaign. Moreover, the private debt situation in China could cause volatility if the Chinese government is unable to find a solution for it. Lastly, the implementation of President Trump s policy programme could be perceived negatively by the market. A range of additional non-economic factors continues to influence the outlook in various regions: the Brexit vote in the UK, the protracted effects of a drought in eastern and southern Africa; civil war and domestic conflict in parts of Africa and the tragic plight of refugees in neighbouring countries and in Europe; and the spread of the Zika virus in Latin America and the Caribbean, the southern United States, and Southeast Asia. If these factors intensify, they could collectively influence market sentiment, impacting on demand and activity. The behaviour of the foreign exchange markets will depend on a number of factors. The one with the biggest potential impact on the FX markets is the divergent monetary policies of the central banks in the US and Europe. The other main factor is the programme pursued by President Trump and the expected outcome on the US economy. We expect the US dollar to appreciate against the euro in the first quarter of 2017, although the euro may have upside potential over the remainder of the year. 2 Source: International Monetary Fund UniCredit Luxembourg S.A Annual Report 17

20 Report of the Management Board I The Luxembourg s financial centre Report of the Management Board (Continued) Luxembourg s financial centre In 2016, as in previous years, Luxembourg s financial centre coped better than other European countries with weaknesses in the European environment with regard to investment and economic governance. In Luxembourg, GDP growth in 2016 is expected to reach 3.7%. This is higher than the 3.5% achieved in 2015 and stronger than average European GDP growth. The inflation rate should reach 0.3%, the lowest level since The profitability of the Luxembourg banking sector increased. Income in the banking industry as of September 2016 amounted to 8.5 billion, increasing by 0.5 billion versus the same period in 2015 ( 8.0 billion). Luxembourg banking income, operating expenses, net result ( million) 12,000 Banking income Operating expenses Net result 10,000 8,000 6,000 4,000 2,000 n.a. n.a Sept Sept Source: Concerning Basel III capital requirements, in recent years the average total capital ratio of the Luxembourg banking system has remained above 18%, confirming the solidity of the financial industry. This positive outcome is explained by the better capitalisation of banks, by the actions undertaken by banks to comply with the stricter Basel III rules and by the nature of the financial industry in Luxembourg. Businesses such as private banking, depositary banking and asset management have low levels of risk-weighted assets. 3 Source: Statec, December Annual Report UniCredit Luxembourg S.A.

21 Total capital ratio of Luxembourg banking system ( million) Total own funds Solvency ratio (weighted average) 54,000 49,000 44,000 39,000 34,000 29,000 24,000 19,000 14, Source: 21% 20% 19% 18% 17% 16% 15% 14% 13% 12% 11% 10% 9% 8% In the latest figures published by the Commission de Surveillance du Secteur Financier (CSSF) in September 2016, the balance sheet total of the banking system in Luxembourg amounted to billion 4, substantially in line with the end of In 2016 the Luxembourg banking system had to cope with increased regulation. As a result, several banks adapted their business model, and others consolidated their operations or departed from Luxembourg. Despite these effects, the number of banks totalled as of December 2016, two less than in The fund business remained strong. In the banking labour market, the number of employees as of September 2016 was 26,132 (25,844 on the same date in 2015), inverting the decreasing trend that began in Source: CSSF, September Source: CSSF, December 2016 UniCredit Luxembourg S.A Annual Report 19

22 Report of the Management Board I Report on operations Report of the Management Board (Continued) Report on operations Key performance indicators Profitability ratios CHANGE 2016 VS VS 2015 ROE 2.7% 4.9% -44% -2.2% ROA 0.18% 0.30% 1-41% -0.12% Cost/income 66.6% 26.7% 149% 39.9% Statement of comprehensive income CHANGE 2016 VS VS 2015 Operating income 135, ,974-18% -28,699 Operating costs 90,097 43, % 46,270 Operating profit 45, ,147-62% -74,970 Profit before tax 45,711 96,215-52% -50,504 Statement of financial position CHANGE 2016 VS VS 2015 Total assets 20,271,668 20,000,505 1% 271,163 Loans and receivables with customers 14,706,993 14,440,737 2% 266,256 Deposits from customers 4,310,355 3,934,471 10% 375,884 Shareholders equity 1,350,601 1,377,583-2% -26,982 Capital ratios CHANGE 2016 VS VS 2015 Core Tier 1/total risk-weighted assets 25.8% 25.6% 1% 0.2% Total capital ratio (incl. op. risk) Regulatory capital/risk-weighted assets 31.7% 31.5% 1% 0.2% LCR ratio 113.6% 112.4% 2 1% 1.2% Leverage ratio 5.1% 4.0% 27% 1.1% 1 percentage recasted for the year LCR ratio has been computed ex-post in March 2016, according to EU Delegated Act 10/10/2014 The Bank s operations Since the introduction in 2014 of the Single Supervisory Mechanism (SSM) applied to banks with assets in excess of 30 billion or 20% of domestic GDP, the ECB has been in charge of supervising both UniCredit S.p.A. (the UC Group) at a consolidated level and the relevant subsidiaries in the eurozone. In 2016 the SSM carried out an assessment of the banks which fall under its direct supervision. For UniCredit Luxembourg (the Bank) the main outcomes of the supervisory review conducted by the ECB in 2016 are the following: the Bank s strategies and processes and its own funds and overall defined liquidity ensure sound management and coverage of its risks; overall, the Bank is considered to have a strong capital position with regard to the type, extent, complexity and risk level of its business model, with capital ratios well above the regulatory minimum; however, the current composition of credit risk exposure shows relevant single-name and cross-sectorial concentration risk; the Bank has in place sound, effective and complete strategies and processes for assessing, maintaining and distributing internal capital, which is broadly adequate to cover the nature and level of risks to which the Bank is exposed or might be exposed; the Bank has broadly implemented, robust strategies, policies, processes and systems for the identification, measurement, management and monitoring of liquidity risk, and the liquidity held by the Bank broadly provides sufficient coverage of liquidity risks. Additionally, based on the results of the supervisory review conducted in 2016, in December 2016 the Bank was notified of a TSCR (Total SREP Capital Requirement) of 9.25% (plus a 2.5% capital conservation buffer) set by the SSM on an individual basis. A new law dated 18 December 2015 transposed into Luxembourg law EU Directive 2014/59/EU establishing a framework for the recovery and resolution of credit institutions and investment firms ( BRRD ) and EU Directive 2014/49/EU on deposit guarantee schemes ( DGSD ) Annual Report UniCredit Luxembourg S.A.

23 The significant changes introduced by the law are the following: implementation of the resolution chapters of BRRD governing the resolution of banks and certain investment firms; the Commission de Surveillance du Secteur Financier (CSSF) has been designated as a resolution authority for Luxembourg ( conseil de resolution ); a Luxembourg resolution fund ( Fonds de résolution Luxembourg ) has been created as Luxembourg resolution financing tool; a new public deposit guarantee system under the name Fonds de garantie des dépôts Luxembourg (FGDL) replaced the previous system of the Association pour la Garantie des Dépôts Luxembourg (AGDL), both ex-post funded system; functions carried out in the past by the AGDL in the field of investor protection have been taken over by the Système d indemnisation des investisseurs Luxembourg (SIIL) (Investor Compensation Scheme Luxembourg). In line with the Bank s expectations, the Bank s contribution to the national resolution fund in 2016 increased to 1.7 million. The steering and management of liquidity risk remained a major topic in In line with the local liquidity policy, the Bank continued to maintain a positive cumulative liquidity gap on the liquidity ladder up to the three-month bucket, monitored its liquidity coverage ratio (LCR) and consistently adhered to the regulatory limit for the LCR over the course of the year. As part of the Bank s risk appetite, the Bank defined, in addition to the 70% LCR regulatory requirement, an internal target of 90% and a trigger of 80%. Escalation procedures were implemented for violations of the trigger or the internal target. In 2016 overall, the Bank increased the level of high quality liquid assets (HQLA). The LCR is calculated by using the functionalities offered by the Micro Strategy tool used by the entire UC Group. In 2016, in addition to the Group tool, the Bank implemented an automated solution to compute the LCR on a daily basis. These HQLA were borrowed by means of securities lending transactions with UniCredit Bank AG. Structural liquidity was also continually monitored during the year, ensuring that for every time bucket at least 90% of liabilities funded the corresponding assets. As in previous years, special attention was given to the Bank s largest foreign currency position so that part of the mid/long-term funding took place in US dollars. In 2016 the ECB announced the introduction of a new Targeted Longer Term Refinancing Operation (TLTRO II). The Bank considered that TLTRO II was the appropriate instrument for diversifying longterm funding sources and optimising the use of its existing collateral, namely GELDILUX-TS-2015 and parts of the loan portfolio, eligible as Eurosystem collateral. In line with UniCredit S.p.A. and UniCredit Bank A.G., the Bank participated in the June 2016 tranche of TLTRO II. The participation totalled 2.0 billion. The interest rate risk arising from the transaction was already pre-hedged, likewise in line with similar actions undertaken in other Group entities. Consequently, the structural liquidity ratios up to the four-year bucket improved sharply thanks to the TLTRO II funding. The Bank continued with its commercial operations with the aim of using the TLTRO resources to fund new loans for customers. The Bank produced Transfer Pricing Local Documentation for the 2015 financial year in order to be in line with the new transfer pricing standards defined by actions 8, 9, 10 and 13 of the OECD Action Plan on Base Erosion and Profit Shifting (BEPS). The Transfer Pricing Local Documentation gives detailed information about the local business, including related party payments and receipts for products, services, interests, etc. The Transfer Pricing Local Documentation will be continuously updated. The UniCredit Luxembourg Private Banking strategy did not materially change in During the year, efforts were constantly directed at attracting (ultra) high net worth individuals (U)HNWI requiring the sophisticated approach that only a strategic location like Luxembourg can provide. As in the past, development activities were primarily aimed at supporting UC Group onshore networks and customers. Close cooperation with Group onshore networks was confirmed as the main way to attract customers for the Private Banking business. This link was even stronger in the insurance business, where assets under management (AuM) growth was directly linked to the commercial efforts of other Group entities. Consistent with the UC Group s roll-out plan for the advanced internal rating based (IRBA) methods for credit risk, the roll-out of additional rating systems was started in 2011 in order to optimise the coverage of the Bank s loan portfolios. In 2013 Banca d Italia (BoI), the Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin) and the CSSF approved the use of the following internal rating systems: Income Producing Real Estate, Foreign Corporate Customer, Small Business Customer, Private Wealthy Customer (only EGON business), Global Project Finance, Corporate Treasury/Funding vehicles and Securities Industry. In 2015 the European Central Bank authorised the Bank to use IRBA methods for its trade finance portfolio. No major roll-out of internal rating systems was on the agenda for 2016, except extensions of the existing ones. Thus about 95% of the Bank s loan exposure is covered by internal rating systems. In 2016 the Bank was fully integrated with a Group-wide project launched to fulfil the requirements of the ECB regarding the implementation of a central credit register in the Eurosystem planned for October 2018 and called the Analytical Credit Dataset (ANACREDIT). In the context of operational risk management, the Bank has implemented the Advanced Measurement Approach (AMA). The implemented AMA model is subject to a yearly review and a subsequent internal validation report. UniCredit Luxembourg S.A Annual Report 21

24 Report of the Management Board I Report on operations Report of the Management Board (Continued) After the Bank s successful implementation of two strategic projects in 2015 Olympic Upgrade to version A and Document Management System Doxis in 2016 additional activities were planned for these two projects. With regard to Olympic, the core banking software, at the end of 2016 the Bank successfully implemented the Customer Value Management (CVM) module (replacing UBM) together with the Foreign Account Tax Compliance Act (FATCA) and Common Reporting Standard (CRS) modules. The CVM module allows the Bank to have a better and integrated view of clients static data (including for FATCA and CRS) and better monitoring of the client opening process. The Doxis solution has been successfully used at the Bank for a year. In 2016 phase two started and covered the customising activities of the tool in line with the business requirements. The third and last phase is planned for 2017 with the implementation of the workflow, a functionality which is the starting point for the optimisation and reduction of the paper-driven business processes in the Bank. The processes in the scope of the last phase of the project will be Operating Guidelines (OGs) management, Group guidelines and CSSF circulars implementation. The Bank still owns two buildings in Luxembourg City. The Weicker building is fully let to two tenants. The Bank classifies this building as an investment property and has applied IAS 40 since September The second building, at 8-10, Rue Jean Monnet, is used by the Bank itself. A small part of this building is let to other UC Group and non-uc Group companies. Risk management and internal control systems in relation to the financial reporting process In the Bank, the Risk Management System (RMS) refers above all to the strategic management, identification and assessment of risks as well as the assumption or avoidance of risk. The respective risk types are described in detail in the ICAAP Report for 2016 and are monitored via various risk management and control systems across the different risk types. As an essential part of the Risk Management System, the Bank has defined an Internal Capital Adequacy Assessment Process (ICAAP). The central risk measure is internally determined risk capital (economic capital), calculated in accordance with the methods laid down by the UC Group. Risk capital is set against available financial resources (AFR), enabling a statement to be made on the Bank s risk-bearing capacity with regard to the coverage of the economic capital by AFR. As at the end of 2016, the AFR was 1,672.6 million. Risk-bearing capacity (coverage of calculated economic capital by the AFR) was always well above the defined trigger of 110% and the fixed limit of 100% in the course of Due to the growing importance of liquidity risk management and in anticipation of the requirements introduced under the new Basel III regulations, over the past three years the Bank Assets and Liabilities Committee (ALCO) has been mainly concerned with the implementation of new measures for both short and medium-term liquidity management and the Fund Transfer Pricing policy. The new Fund Transfer Pricing framework was updated in line with the UC Group guidelines and principles. In 2016 special attention was paid to the Net Stable Funding Ratio (NSFR). Together with the implementation of the NSFR as the leading ratio for structural liquidity steering, liquidity buffers will be decentralised into the single legal entities (including the Bank) of the HVB Group. Currently liquidity buffers for committed lines granted by members are maintained only by HVB. In 2016 the Bank also implemented an Additional Liquidity Monitoring Metric (ALMM). In general the guidelines and general principles as well as the procedures of the Bank are fully aligned with CSSF circular 12/552, as amended by CSSF circulars 13/563, 14/597, 16/642 and 16/647. The Internal Control System (ICS) relates to the operational monitoring and management of risk. The purpose of the RMS and the ICS in the financial reporting process is to implement controls that ensure, with an adequate degree of certainty, that annual financial statements together with the management report and management s discussion and analysis are prepared in compliance with regulations, despite the identified risks. Value systems such as the Integrity Charter and the Code of Conduct as well as compliance policies and rules have been in place in all legal entities of the UC Group for many years, and constitute the standards according to which all the employees of the UC Group perform their activities. These values are essential elements for the Bank in the risk management process and are the basis for responsible action on the part of employees, including those involved in the financial reporting process. With regard to the financial reporting process, the RMS and the ICS encompass the policies, processes and measures needed to ensure the effectiveness of financial reporting and compliance with the applicable legal provisions as well as risk hedging and the recording of mapping valuation units. They ensure that internal and external financial reporting is correct and reliable and that assets, liabilities and equity are classified, recognised and measured. The Management Board determines the scope and orientation of the RMS and the ICS specifically in line with the Bank s require Annual Report UniCredit Luxembourg S.A.

25 ments and subject to the approval of the Supervisory Board, taking measures for the ongoing development of the systems and their adaptation to changing conditions. In the process of preparing the annual financial statements, the Management Board is responsible for adopting the Annual Report and approving the reporting package for UC Group consolidated financial statements (Group view). It is the task of the Supervisory Board to monitor and regularly advise the Management Board as it conducts its business. It is directly involved in decisions that are of fundamental importance. For support in the performance of its duties, including those relating to the financial reporting process, the Supervisory Board has set up an Audit and Risk Committee made up of three members of the Supervisory Board. The Audit and Risk Committee provides assistance in fulfilling the oversight responsibilities to shareholders relating to the reliability and integrity of corporate accounting and financial reporting practices, compliance with laws, regulations and company policies and maintenance of a sound system of internal controls. At a minimum, the Audit and Risk Committee meets on a semi-annual basis. If circumstances warrant it, an unscheduled meeting can be called at any time. At the preparatory meeting of the Audit and Risk Committee and at the subsequent Supervisory Board meeting dedicated to the annual financial statements, the independent auditor reports on the material findings of the audit of the annual financial statements, specifically including any significant weaknesses of the ICS in connection with the financial reporting process identified during the audit. In addition, the Management Board explains the annual financial statements and the reporting package for the UC Group consolidated financial statements in detail at the Supervisory Board meeting dedicated to the financial statements. Responsibility for the financial reporting process and, in particular, for the annual financial statements and reporting package for the UC Group consolidated financial statements, lies within the CFO area. The Bank uses Olympic software as a general ledger to prepare its annual financial statements. The Advanced Management Information System (AMIS) project was finalised at the end of 2012 and the system has been in use since January It has enabled the Bank to integrate all principal CFO IT systems and thus to increase data integrity and consistency and considerably reduce operational risk. AMIS is based on the mainly automated uploading of individual transaction data from the upstream systems relevant to financial reporting (sub-ledger). The SAP Business Warehouse, automatically supplied with data by AMIS, is used for reporting and data retrieval. At year-end 2015 its reporting functionalities were extended from CFO to all the other departments of the Bank. Several training courses were organised in 2016 to extend AMIS know-how to all the Bank s employees. The new standards of financial reporting (FINREP) of the European Banking Authority (EBA) were implemented in The COO is responsible for the IT systems required for the financial reporting process. The figures for the UC Group consolidated financial statements and the subsequent consolidated bookings are collected and reported using the TAGETIK CPM consolidation system used in the entire UC Group and network across all UC Group companies. Employees Below are the staff figures as at 31 December 2016: BANK S STAFF Top management 3 3 Department heads Salaried employees Total Dedicated, well-trained and professionally certified employees with special advisory qualities are the necessary prerequisites for meeting the high expectations of the Bank s clients. In this respect, it is important that the Bank s commitment to outstanding performance is reflected in the day-to-day work of its staff. The Bank expects qualities such as client orientation, competence and innovation. Client satisfaction is the Bank s goal, as stated in the fundamentals of the Group: Customers First. As of 31 December 2016, the Bank employed 74 female and 90 male staff members. 39 employees, or 24.0% of the total number, are employed on a part-time basis, allowing them to successfully balance family commitments and a career. The Bank has developed cooperative arrangements with universities and offers several traineeships. Total expenditure in 2016 on professional training for all employees was approximately 97.0 thousand, or about per person on average. In the context of the UC Group s Multi Year Plan , the Bank began with its first Early Retirement Programme at the beginning of the year. This will allow 23 employees to leave the bank up to 36 months before their legal (pre-)retirement with a reduced income. Seven employees have already left the bank within the scope of this scheme, while the others out of the total of 23 will follow in 2017 and The Management Board wishes to express its sincere thanks to all of the Bank s employees for their contribution to the Bank s performance over the past year. UniCredit Luxembourg s success would not have been possible without their personal efforts and commitment. UniCredit Luxembourg S.A Annual Report 23

26 Report of the Management Board I Report on divisional activities Report of the Management Board (Continued) Report on divisional activities Financing & Advisory (F&A) The Bank s business area Financing & Advisory (F&A) is an integral part of the global F&A product line of the Corporate and Investment Banking (CIB) division. The business area continues to provide highquality financing products and services primarily for the UC Group s corporate customers in the CIB and Commercial Banking divisions. F&A s product range extends from plain vanilla credit lines to sophisticated structured finance solutions offered to small and medium-sized enterprises and large and multinational corporate clients, as well as real estate clients, generally originated by HVB. The added value provided by F&A to the HVB Group s Commercial Banking and CIB division is attributable to the Bank s excellent services, know-how and experience in handling primarily syndicated international and structured finance transactions, the efficient, safe and fully automated processing of standardised, mainly short-term loans originated and referred to the Bank by the German business units of HVB (known as EGON loans (EuroGeschäft Online)). A significant portion of the EGON loan portfolio is securitised through one of Europe s largest funded ABS programmes, known as GELDILUX. Furthermore, trade financing, including supply chain finance products such as trade purchase, is a relevant business for the Bank and UniCredit s Global Transaction Banking. Finally, agency services are provided to corporate customers of UniCredit Bank AG, Munich, and UniCredit Bank Austria AG, Vienna. Analysis of balance sheet items by geographical area LOANS AND OTHER BALANCE SHEET ITEMS COMMITMENTS AND CONTINGENT LIABILITIES OECD countries 19,201,734 18,654,942 13,098,668 13,395,071 Germany 12,696,761 12,033,748 7,957,292 7,181,535 Italy 246, ,880 9,283 5,287 Luxembourg 2,575,636 3,207, ,569 1,410,806 Selected eurozone debts 122, ,401 65,000 55,000 of which Spain 105, ,584 65,000 55,000 of which Portugal 16,819 13, of which Ireland - 62, Other EU 1,848,027 1,502,052 2,580,587 2,828,647 Other Europe (without EU) 1,339, ,661 1,661,069 1,755,743 North America 156, ,785 94, ,053 Other OECD countries 215, , Non-OECD countries 646, , Europe 111,592 88, of which Russia 96,758 83, of which Ukraine Central and South America 56,034 57, Asia 334, , Africa 144,518 22, Other balance sheet items 422, , Total balance sheet 20,271,668 20,000,505 13,099,311 13,395, Annual Report UniCredit Luxembourg S.A.

27 The combination of highly qualified and motivated, multilingual staff coupled with state-of-the-art IT support enables the Bank to provide products and services to UC Group clients at high quality standards and competitive prices. In 2016 the utilisation of credit lines committed by the Bank to its corporate clients increased significantly as compared to At the end of 2016 the aggregate amount of committed credit lines remained around the high 18.0 billion mark. The aggregate amount of outstandings under committed lines in structured finance averaged more than 5.1 billion in This was 16.4% above the average amount of outstandings in New commitments were not made at the expense of increased risk. From a credit risk point of view the Bank s credit portfolio is still excellent. This can also be attributed to its predominant client base: German corporates acting in a favourable economic environment with an emphasis on exports. In 2016 the Bank s EGON loan portfolio increased by 0.1 billion compared to 2015, to a yearly average amount of just above 7.2 billion. Again, the Bank grew its portfolio of receivables purchased from corporate clients to new record levels. The average portfolio volume of 2.4 billion achieved in 2016 was well above the previous year s average of 1.8 billion. At the end of 2016 the total trade finance portfolio was close to 3.3 billion, whereas at the previous year-end it was 2.1 billion. This aggregate portfolio includes forfaiting, discounting, L/C post-financing and trade purchase transactions. More and more corporate customers took advantage of the sale of trade receivables via the web-based TradePurchase platform, thereby converting trade receivables into cash without using their credit lines. Since the pricing is positively influenced by the creditworthiness of the debtor of the trade receivables, this conversion of receivables into cash is carried out on attractive terms for our clients as well. The peak of our trade purchase portfolio exceeded million in December Private Banking (PB) In 2016 the Bank s PB confirmed its goal: becoming the UC Group centre of excellence for (U)HNWI through the Bank s ability to craft solutions tailored to the needs of the Group s most sophisticated clients. Financial assets were managed according to the independent Global Investment Strategy (GIS) view. In 2016 GIS Holding was contractually engaged as an advisor for investment management activities. Italian clients in particular reiterated their requests for qualified services, with the added safety of the reliable Luxembourg regulatory environment. The highly skilled and multilingual workforce has been one of the key selling points; additionally, UniCredit Luxembourg has increased its visibility via a completely redesigned website, aligned with Group corporate standards. Business development activities were also strengthened by successfully pursuing an enlargement of the insurance partnership network. Due to unfavourable market effects, PB total financial assets decreased to 20.8 billion, but AuM within the insurance department reached an all-time high of 1.3 billion. Treasury & Business Services (T&BS) The very close cooperation of T&BS with Treasury and Finance units in HVB remained strong in T&BS updated the Bank s liquidity policy and organised and executed the Asset and Liability Committee (ALCO) meetings. Treasury revenues were above expectations mainly thanks to negative interest rates combined with postponement of the implementation of the zero floor on funding with HVB, income on European sovereign bonds and minor valuation effects on the derivatives portfolio. Treasury executed a high number of securities orders for clients, in particular for the GIS desk. In 2016 the average daily order volume increased by 51% compared to the previous year. Deposits from Treasury clients remained stable despite the very low interest rate environment. UniCredit Luxembourg S.A Annual Report 25

28 Report of the Management Board I Report on divisional activities Report of the Management Board (Continued) Statement of financial position Assets AMOUNT PERCENT Cash and cash balances with central banks 206, , , % Financial assets held for trading 7,556 10,160-2, % Financial assets designated at fair value through profit or loss 71,915 73,671-1, % Available-for-sale financial assets 327, ,233-81, % Loans and receivables with banks 4,706,869 4,140, , % Loans and receivables with customers 14,706,993 14,440, , % Derivatives Hedge accounting 59,490 80,915-21, % Fair value changes of the hedged items in portfolio hedge of interest rate risk 76,983 78,043-1, % Tangible assets 30,359 31, % Investment properties 22,446 23, % Intangible assets 1,365 1, % Tax assets % Other assets 53,388 88,001-34, % Total assets 20,271,668 20,000, , % CHANGE Liabilities and shareholders equity AMOUNT PERCENT Liabilities to banks 14,239,678 14,315,541-75, % Deposits from customers 4,310,355 3,934, , % Financial liabilities held for trading 84,339 37,197 47,142 >100% Hedging derivatives 71,262 73,755-2, % Fair value changes of the hedged items in portfolio hedge of interest rate risk 48,134 66,496-18, % Tax liabilities 8,047 59,900-51, % Other liabilities 96, ,116-7, % Provisions 62,934 31,446 31,488 >100% Total liabilities 18,921,067 18,622, , % Subscribed capital 238, , Additional paid-in capital 421, , Other reserves 648, , % AfS reserve 1,507 3,084-1, % Hedge reserve 5,791 2,989 2, % Result of the year 35,713 64,243-28, % Shareholders equity 1,350,601 1,377,583-26, % Total liabilities and equity 20,271,668 20,000, , % CHANGE Annual Report UniCredit Luxembourg S.A.

29 The balance sheet total of 20.3 billion at 31 December 2016 showed an increase of 0.3 billion, or 1.4%, compared to the previous year-end. This change is mainly due to the increase in loans and receivables with customers and in loans and receivables with banks. The upward trend in loans to customers was mainly driven by the positive commercial performance in structured finance and trade finance whereas loans to PB clients decreased. As shown below, a significant part of the Bank s assets and liabilities is composed of inter-group loans 6 and deposits. Total liabilities (%) 1,449 7% 1,341 7% 876 4% 2,852 14% 2,851 14% 10,938 54% Intercompany deposit from banks Geldilux deposits Other liabilities Tier 1 capital Deposits with clients Funding with Central Bank Total assets (%) 2,131 11% 493 2% 4,902 24% 2,106 10% 206 1% 4,252 21% 6,217 31% Intercompany (Loans and securities) EGON Structured Finance Short trade finance Other assets Geldilux notes Cash with Central Bank The Bank s total committed volume for structured finance business was 16.3 billion (of which 11.4 billion consisted of unused offbalance-sheet credit lines). This is 2.0% less than in the previous year ( 16.7 billion). Overall in 2016, the already very good quality of the Bank s structured finance portfolio improved, and more than 75% of the Bank s commitments were to borrowers with internal ratings of 3- (investment grade equivalent to BBB) or better. Cash balances with central banks decreased by 0.4 billion. Statement of comprehensive income Client deposits at year-end 2016 amounted to 4.3 billion (shown in the charts above in both GELDILUX deposits and deposits with clients), a 9.6% increase from the 3.9 billion at the end of 2015 mainly due to increased deposits from institutional clients. The statement of comprehensive income for 2016 is as follows: Statement of comprehensive income CHANGE % Net interest income 105, , % Net commission income 20,452 21, % Net income from investments Net trading income 1, % Net other revenues and expenses 7,984 9, % Net non-interest income 29,589 31, % Total revenues 135, , % Staff expenses -71,896-26, % Other operating costs -15,312-15, % Amortisation, depreciation and impairment losses on intangible and tangible assets -2,889-2, % Operating costs -90,097-43, % Operating result 45, , % Provisions for risk and charges ,014 >100% Net write-downs of loans and provisions for guarantees and commitments , % Profit before tax 45,711 96, % Income tax -9,998-31, % Net profit 35,713 64, % 6 A portion of the structured finance, EGON and STF loans portfolio represented in the chart above is included in the category IC UniCredit Luxembourg S.A Annual Report 27

30 Report of the Management Board I Report on divisional activities Report of the Management Board (Continued) Revenues Net interest income amounted to million at the end of 2016, with a decrease of 19.9%, or 26.3 million, compared to the previous year. This drop is mainly due to a positive one-off effect that occurred in 2015 relating to the early repayment of a loan by a client in the F&A division. Net trading income 2,000 1,000 0 Net interest income 40,000-1,000 I Q15 II Q15 III Q15 IV Q15 I Q16 II Q16 III Q16 IV Q16 AVG 15 AVG 16 20,000 I Q15 II Q15 III Q15 IV Q15 I Q16 II Q16 III Q16 IV Q16 Net commission income amounted to a total of 20.5 million in 2016, showing a 1.4 million decrease compared to the 2015 figure. AVG 15 AVG 16 Other net revenues and expenses came to 8.0 million in 2016 with a year-on-year decrease of 1.5 million. The difference is principally due to a one off effect determined by the sale of warrants linked to a restructured credit transaction in This position mainly includes profits from rental of premises and reimbursements for GELDILUX securitisation transactions, which offset corresponding margins from EGON loans. Net commissions income 7,000 Net other revenues and expenses 4,000 5,000 2,000 3,000 I Q15 II Q15 III Q15 IV Q15 I Q16 II Q16 III Q16 IV Q16 AVG 15 AVG 16 1,000 I Q15 II Q15 III Q15 IV Q15 I Q16 II Q16 III Q16 IV Q16 At the end of 2016, net trading income amounted to 1.2 million. This is related mainly to valuation effects on derivatives and represents a noticeable increase compared to the 0.6 million reported in the previous year. AVG 15 AVG 16 Total net revenues amounted to million at the end of This represents a decrease of 28.7 million, or 17.5%, as compared with the previous year s figure. The decrease in revenues versus 2015 is mainly explained by the earlier repayment of a loan by a client in the F&A division that occurred in Total revenues 60,000 40,000 20,000 I Q15 II Q15 III Q15 IV Q15 I Q16 II Q16 III Q16 IV Q16 AVG 15 AVG Annual Report UniCredit Luxembourg S.A.

31 Operating costs Operating costs increased by 176.1% year on year, from 43.8 million in 2015 to 90.1 million at the end of This increase is mainly explained by restructuring costs related to UniCredit Group wide strategic plan Transform Staff expenses increased by 45.9 million as compared to the previous year. The rise was entirely driven by 52.0 million in restructuring costs related to staff reductions related to wide strategic plan Transform Net of the restructuring costs effects, i.e million in 2016 and 4.9 million in 2015, staff expenses decreased by 1.2 million. Depreciation on tangible/intangible assets amounted to 2.9 million as of 31 December 2016, as compared with 2.6 million in Depreciation on tangible and intangible assets 1, Staff expenses 60,000 I Q15 II Q15 III Q15 IV Q15 I Q16 II Q16 III Q16 IV Q16 AVG 15 AVG 16 40,000 In 2016 the operating result was 45.2 million. This represents a 62.4% decrease, or 75.0 million, on the 2015 result of million. 20,000 I Q15 II Q15 III Q15 IV Q15 I Q16 II Q16 III Q16 IV Q16 AVG 15 AVG 16 Operating result 40,000 20,000 Other operating costs amounted to 15.3 million and were 0.1 million higher than in the previous year ( 15.2 million) mainly due to higher restructuring consultancy costs. 0-20,000 Other operating costs 5,000 I Q15 II Q15 III Q15 IV Q15 I Q16 II Q16 III Q16 IV Q16 AVG 15 AVG 16 3,000 1,000 I Q15 II Q15 III Q15 IV Q15 I Q16 II Q16 III Q16 IV Q16 AVG 15 AVG 16 UniCredit Luxembourg S.A Annual Report 29

32 Report of the Management Board I Report on divisional activities Outlook for 2017 Report of the Management Board (Continued) Provisions for risks and charges had a positive impact in 2016 thanks to the reversal of the remaining provision for AGDL. The 2015 result included a provision related to the preliminary investigation by the Cologne public prosecutor. Provisions for risk and charges 5,000 After accounting for provisions, depreciation, amortisation and taxes, the Bank s net profit of 35.7 million was down 44.4% compared to the 64.2 million reported in Net profit 20,000-5, ,000-20,000 I Q15 II Q15 III Q15 IV Q15 I Q16 II Q16 III Q16 IV Q16 AVG 15 AVG 16 I Q15 II Q15 III Q15 IV Q15 I Q16 II Q16 III Q16 IV Q16 AVG 15 AVG 16 Loan impairments had a slight negative impact in They amounted to million versus million in the latter included a one-off effect from a change in the parameters used by the UC Group to compute general loss provisions for Net write down on loans 1,000-1,000-3,000 I Q15 II Q15 III Q15 IV Q15 I Q16 II Q16 III Q16 IV Q16 AVG 15 AVG 16 The Bank s net profit of 35.7 million is to be appropriated as follows, subject to the approval of the Extraordinary General Shareholders Meeting: Proposed distribution of profits % Dividend on capital entitled to dividend payment 35,500 64, % Allocation to free reserves % Total 35,713 64, % CHANGE Annual Report UniCredit Luxembourg S.A.

33 Outlook for 2017 In line with the principles defined in the UniCredit Group wide strategic plan Transform 2019 presented in London on December 13th, 2016, the Group is going to strengthen and optimize capital, improve asset quality, cost discipline and enhance efficiency measures to significantly reduce cost income ratio and transform business. The strategic plan also includes the restructuring of activities in Luxembourg. The sole shareholder of UniCredit Luxembourg S.A. (the Bank) therefore took the decision to significantly restructure the Bank with the aim to cease all business activities by end of December A first step is the transfer of the Italian Private Banking activities to UniCredit International Bank (Luxembourg) S.A. scheduled for April 1st, The Corporate business is planned to be transferred to UniCredit Bank AG by the end of 2018 at the latest. With regard to the business relationship with the corporate clients in Luxembourg nothing will change as they already have been customers of UniCredit Bank AG. The remaining part will be restructured. The Supervisory Board of the Bank took note of the decision. A communication to the staff and the staff representatives has taken place on March 6th, 2017.The Bank has entered into negotiations with the works council. In the context of a UC Group project aimed at enhancing the offer for financial holdings and family offices, the relevant Group bodies approved the transfer of UniCredit Luxembourg Italian private banking business (including insurance activities performed for Italian clients) to UniCredit International Bank (Luxembourg) S.A. The Global Family Office (GFO) project target clients are family offices and holding companies with minimum assets of 500 million and also selected family offices / holding companies with a lower threshold, but with an active presence in financial markets. UniCredit Luxembourg has notified the CSSF and the ECB of the decision and requested approval of the transaction. It is expected that the transfer will take place in the first part of Subject to regulatory approval, our Italian Private Banking activities in Luxembourg, including staff, will be shifted to UniCredit International Bank (Luxembourg) S.A. and therefore remain in Luxembourg. Under its current and future strategy, the Bank will continue to place its clients at the centre of its endeavours. The Bank takes its clients needs as a starting point, with the aim of accompanying them and fostering their wealth over decades. In the commercial lending business, whether on the short-term side or in the capital markets, small increases in interest rates may be anticipated but this should not lead to contracting portfolios. Therefore, our EGON portfolio is planned not to shrink, our syndicated lending portfolio should be more or less stable and our trade finance portfolio will probably continue to grow in The persisting low yield environment will further lower the revenues from own equity investments. In 2010, the Basel Committee on Banking Supervision of the Bank for International Settlements (BIS) published a set of reforms with a view to strengthening the resilience of the banking sector by enacting stricter global rules for equity capital and liquidity. The Basel III reform essentially comprises more stringent qualitative and quantitative capital requirements complete with additional liquidity standards comprising a short-term (LCR) and a long-term ratio (NSFR) as well as a non-risk-sensitive debt ratio (Leverage Ratio). The Bank has been computing and monitoring the new ratios on a regular basis since The next step for the steering of liquidity risk will be the implementation of the NSFR starting from January The Bank will define its internal targets for NSFR and will regularly monitor the evolution of NSFR in The Bank will enhance the current monitoring of structural liquidity ratios with a comprehensive methodology including internal and regulatory indicators. In 2017 the liquidity buffer for committed lines will be held by the Bank and no longer in a centralised approach at sub-group level. Regarding Financial Reporting Standards (IFRS), an IFRS Conversion Project was re-launched at the UC Group level in 2015 with the primary goal of replacing IAS 39 with IFRS 9. The mandatory effective date for IFRS 9 is 1 January UniCredit Luxembourg s IFRS project is integrated into the UC Group s project. Implementation, in close cooperation with the UC Group, is planned for The FATCA is a US law applicable to foreign financial institutions (FFIs) and other financial intermediaries to prevent and avoid tax evasion by US citizens and residents through the use of offshore accounts and/or other structures. The Bank has set up a local project to become FATCA-compliant and implement the necessary new processes. UniCredit Luxembourg has registered on the relevant FATCA portal and received its GIIN number from the IRS. The necessary steps were initiated in 2014: a FATCA-compliant account-opening process and initial client due diligence. All other tasks will be implemented gradually by This project is part of the UC Group s FATCA project. Furthermore, on 14 October 2014 the European Council established a draft directive extending the scope of the Automatic Exchange of Information (AEoI) for tax purposes among EU member states. This Directive includes Automatic Exchange of Information obligations based on the OECD CRS, which represents another important step for tax transparency and a global agreement to disclose certain incomes earned by individuals and enterprises. More than 80 jurisdictions will participate in this OECD initiative. Luxembourg will apply CRS reporting as from 2017 (reporting on calendar year 2016). The Bank has already created a specific project in this regard to fully comply with this new legal requirement in Luxembourg. UniCredit Luxembourg S.A Annual Report 31

34 Report of the Management Board I Annex transition from finrep to IFRS Report of the Management Board (Continued) Annex transition from FINREP to IFRS Statement of comprehensive income Comprehensive income as at EXPLANATION OF TRANSITION TO IFRS FINREP (LUX GAAP) RECLASSI- FICATION ADJUSTMENTS IFRS Interest income 380,902-6, ,234 (Interest expenses) -275,216 6,641 1, ,936 Fee and commission income 32,361 2, ,770 Fee and commission expenses -11, ,909 Gains (losses) on financial assets and liabilities held for trading, net 1, ,280 Gains (losses) on financial assets and liabilities designated at fair value through profit or loss, net Other operating net income 7,984-2, ,626 Administration costs -87, ,900-85,359 Depreciation -2, ,889 Provisions Impairment TOTAL PROFIT BEFORE TAX 45, ,849 49,560 Tax expense (income) -9, ,209-15,207 NET PROFIT 35, ,360 34, Annual Report UniCredit Luxembourg S.A.

35 Statement of financial position Explanation of transition to IFRS financial position as at ASSETS FINREP (LUX GAAP) RECLASSI- FICATION ADJUST- MENTS Cash and cash balances with central banks 206, , Financial assets held for trading 7, ,556 Financial assets designated at fair value through profit or loss 71, ,915 Available-for-sale financial assets 327, ,313 Loans and receivables (including finance leases) 19,413, ,233 35,600 19,655,695 Derivatives Hedge accounting 59, ,490 Fair value changes of the hedged items in portfolio hedge of int. rate risk 76, ,983 Tangible assets 52, ,805 Intangible assets 1, ,365 Tax assets Other assets 53, ,234 65,622 TOTAL ASSETS 20,271, ,834 20,319,502 IFRS LIABILITIES FINREP (LUX GAAP) RECLASSI- FICATION ADJUST- MENTS Deposits from central banks 2,800, ,800,000 Financial liabilities held for trading 84, ,339 Financial liabilities measured at amortised cost 15,750, ,750,033 Derivatives Hedge accounting 71, ,262 Fair value changes of the hedged items in portfolio hedge of interest rate risk 48, ,134 Provisions 62, ,900 61,034 Tax liabilities 8, ,804 23,851 Other liabilities 96, , ,941 Shareholders' equity 1,314, ,667 1,340,555 Net profit or loss 35, ,360 34,353 TOTAL LIABILITIES 20,271, ,834 20,319,502 IFRS UniCredit Luxembourg S.A Annual Report 33

36 Risk Management In order to be successful in what we do we must take risks, but we must rigorously manage our risks. We must be fully aware of the impacts of our decisions, we must take risks but we must take the right risks. And to do that, we must apply strong risk management to everything we do Annual Report UniCredit Luxembourg S.A.

37 Report of the Réviseur d Entreprises Agréé Report of the Réviseur d Entreprises Agréé Report on the financial statements Following our appointment by the General Meeting of the Shareholders dated 29 February 2016, we have audited the accompanying financial statements of UniCredit Luxembourg S.A., which comprise the statement of financial position as at 31 December 2016 and the statement of comprehensive income, statement of changes in equity and statement of cash flows for the year then ended, and a summary of significant accounting policies and other explanatory information. Responsibility of the Management Board for the financial statements The Management Board is responsible for the preparation and fair presentation of these financial statements in accordance with Luxembourg legal and regulatory requirements relating to the preparation of the financial statements, and for such internal control as the Management Board determines is necessary to enable the preparation of financial statements that are free from material misstatement, whether due to fraud or error. Responsibility of the Réviseur d Entreprises Agréé Our responsibility is to express an opinion on these financial statements based on our audit. We conducted our audit in accordance with International Standards on Auditing as adopted for Luxembourg by the Commission de Surveillance du Secteur Financier. Those standards require that we comply with ethical requirements and plan and perform the audit to obtain reasonable assurance whether the financial statements are free from material misstatement. An audit involves performing procedures to obtain audit evidence about the amounts and disclosures in the financial statements. The procedures selected depend on the Réviseur d Entreprises Agréé s judgement, including the assessment of the risks of material misstatement of the financial statements, whether due to fraud or error. In making those risk assessments, the Réviseur d Entreprises Agréé considers internal control relevant to the entity s preparation and fair presentation of the financial statements in order to design audit procedures that are appropriate in the circumstances, but not for the purpose of expressing an opinion on the effectiveness of the entity s internal control. An audit also includes evaluating the appropriateness of accounting policies used and the reasonableness of accounting estimates made by the Management Board, as well as evaluating the overall presentation of the financial statements. We believe that the audit evidence we have obtained is sufficient and appropriate to provide a basis for our audit opinion. Opinion In our opinion, the financial statements give a true and fair view of the financial position of UniCredit Luxembourg S.A. as of 31 December 2016, and of its financial performance and its cash flows for the year then ended in accordance with Luxembourg legal and regulatory requirements relating to the preparation of the financial statements. Emphasis of Matter We draw attention to notes (A) and (66), which disclose the decision which was taken by the sole shareholder of the Bank to significantly restructure the activities of UniCredit Luxembourg S.A. and to cease all business activities at the latest by the end of The precise scenario leading to this final objective is still under development. This represents a material uncertainty which casts significant doubt on the ability of the Bank to continue as a going concern. Our opinion is not qualified on that matter. Other information The Management Board is responsible for the other information. The other information comprises the information included in the management report but does not include the financial statements and our report of Réviseur d Entreprises Agréé thereon. Our opinion on the financial statements does not cover the other information and we do not express any form of assurance conclusion thereon. UniCredit Luxembourg S.A Annual Report 35

38 In connection with our audit of the annual accounts, our responsibility is to read the other information and, in doing so, consider whether the other information is materially inconsistent with the financial statements or our knowledge obtained in the audit or otherwise appears to be materially misstated. lf, based on the work we have performed, we conclude that there is a material misstatement of this other information, we are required to report this fact. We have nothing to report in this regard. Report on other legal and regulatory requirements The management report, which is the responsibility of the Management Board, is consistent with the financial statements and has been prepared in accordance with the applicable legal requirements. For Deloitte Audit, Cabinet de révision agréé Olivier Lefèvre, Réviseur d entreprises agréé Partner Luxembourg, 24 March Annual Report UniCredit Luxembourg S.A.

39 Financial statements Statement of comprehensive income CHANGE REVENUES/EXPENSES NOTE 000 % Net interest 105, ,987-26, NET INTEREST INCOME , ,987-26, Net commission income 23 20,452 21,811-1, Net income from investments Net trading income 25 1, Net other expenses/revenues 26 7,984 9,476-1, NET NON-INTEREST INCOME 29,589 31,987-2, TOTAL REVENUES 135, ,974-28, Staff expenses -71,896-26,039-45,857 >-100 Other operating costs -15,312-15, Amortisation, depreciation and impairment losses on intangible and tangible assets -2,889-2, OPERATING COSTS 27-90,097-43,827-46,270 >-100 OPERATING PROFIT 45, ,147-74, Provisions for risks and charges ,014 19,694 >100 Net write-downs of loans and provisions for guarantees and commitments ,918 4, PROFIT BEFORE TAX 45,711 96,215-50, Income tax for the year 30-9,998-31,972 21, NET PROFIT 35,713 64,243-28, OTHER COMPREHENSIVE INCOME Fair value reserve (Available-for-sale assets) NET CHANGE IN FAIR VALUE -1, Cash flow hedges EFFECTIVE PORTION OF CHANGES IN FAIR VALUES 6,520-6,113 12,633 >100 NET AMOUNT TRANSFERRED TO PROFIT OR LOSS -3,718 3,580-7,298 >-100 Remeasurement of defined benefit liability Other comprehensive income (net of tax) 1,305-3,038 4,343 >100 Total comprehensive income 37,018 61,205-24, ALLOCATION OF PROFIT Net profit 35,713 64,243 Dividend -35,500-64,000 Allocation to other reserves EARNINGS PER SHARE Net profit ( '000) 35,713 64,243 Number of shares 929, ,043 Earnings per share ( ) Dividend per share ( ) The Notes on pages 42 to 97 are an integral part of these Financial statements. UniCredit Luxembourg S.A Annual Report 37

40 Financial statements (Continued) Statement of financial position CHANGE ASSETS NOTE 000 % Cash and cash balances with central banks , , , Financial assets held for trading 32 7,556 10,160-2, Financial instruments measured at fair value through profit and loss 33 71,915 73,671-1, Available-for-sale financial instruments , ,233-81, Loans and receivables with banks 35 4,706,869 4,140, , Loans and receivables with customers 36 14,706,993 14,440, , Hedging derivatives 38 59,490 80,915-21, Fair value changes of the hedged items in portfolio hedge of interest rate risk 39 76,983 78,043-1, Property, plant and equipment 40 30,359 31, Investment property 41 22,446 23, Intangible assets 42 1,365 1, Tax assets Other assets 44 53,388 88,001-34, Total assets 20,271,668 20,000, , LIABILITIES NOTE 000 % Liabilities to banks 46 14,239,678 14,315,541-75, Deposits from customers 47 4,310,355 3,934, , Financial liabilities held for trading 48 84,339 37,197 47,142 >100 Hedging derivatives 38 71,262 73,755-2, Fair value changes of the hedged items in portfolio hedge of interest rate risk 39 48,134 66,496-18, Tax liabilities 49 8,047 59,900-51, a) current tax liabilities 5,155 45,672-40, b) deferred tax liabilities 2,892 14,228-11, Other liabilities 50 96, ,116-7, Provisions 51 62,934 31,446 31,488 >100 Total liabilities 18,921,067 18,622, , EQUITY Subscribed capital , , Additional paid-in capital , , Other reserves , , AfS reserve 52 1,507 3,084-1, Hedge reserve 52 5,791 2,989 2, Result of the year 35,713 64,243-28, Total equity 1,350,601 1,377,583-26, Total liabilities and equity 20,271,668 20,000, , CHANGE The Notes on pages 42 to 97 are an integral part of these Financial statements Annual Report UniCredit Luxembourg S.A.

41 Statement of changes in equity SUBSCRIBED CAPITAL ADDITIONAL PAID-IN CAPITAL OTHER RESERVES OF WHICH: PENSIONS OBLIGATIONS (IAS 19) CHANGE IN VALUATION OF FINANCIAL INSTRUMENTS AFS RESERVE HEDGE RESERVE NET PROFIT TOTAL EQUITY Shareholders equity at , , , ,025 5,523 84,856 1,400,879 Net income (loss) ,243 64,243 Other comprehensive income, net of tax Change in valuation of financial instruments not affecting income , ,475 Dividend pay-out ,500-84,500 Transfers from net profit Reserve arising from foreign currency transaction and other changes Shareholders equity at , , , ,084 2,989 64,243 1,377,583 SUBSCRIBED CAPITAL ADDITIONAL PAID-IN CAPITAL OTHER RESERVES OF WHICH: PENSIONS OBLIGATIONS (IAS 19) CHANGE IN VALUATION OF FINANCIAL INSTRUMENTS AFS RESERVE HEDGE RESERVE NET PROFIT TOTAL EQUITY Shareholders equity at , , , ,084 2,989 64,243 1,377,583 Net income (loss) ,713 35,713 Other comprehensive income, net of tax Change in valuation of financial instruments not affecting income ,577 2,802-1,225 Dividend pay-out ,000-64,000 Transfers from net profit Reserve arising from foreign currency transaction and other changes Shareholders equity at , , ,547 1,016 1,507 5,791 35,713 1,350,601 The Notes on pages 42 to 97 are an integral part of these Financial statements. UniCredit Luxembourg S.A Annual Report 39

42 Financial statements (Continued) Statement of cash flows The statement of cash flows shows the payment flows for the financial year, broken down into flows from operating activities, investment activities and financing activities. The Bank defines operating activities broadly, so that the basis is the same as for operating profit. Net profit after tax 35,713 64,243 Write-downs, provisions for losses on and write-ups of loans and advances and additions to provisions for losses on guarantees and indemnities 147 4,918 Write-downs and depreciation less write-ups on long-term assets 2,889 2,636 Provisions for risks and charges ,014 Change in other non-cash items 99, ,558 Profit from the sale of investments, property, plant and equipment Other adjustments (mainly income tax paid and interest received less interest paid) -82,296-97,177 Subtotal 55, ,982 Change in assets and liabilities from operating activities after adjustment for non-cash components Increases in assets/decreases in liabilities (-) Decreases in assets/increases in liabilities (+) Financial instruments measured at fair value through profit and loss - 83,671 Available-for-sale financial instruments 80,251 98,714 Loans and receivables with banks -568,614 5,175,506 Loans and receivables with customers -265,416-2,034,517 Other assets -34,613 8,210 Liabilities to banks -67,909-4,358,451 Deposits from customers 375,144 2,424,809 Other liabilities -7, ,087 Taxes on income paid -22,380-31,872 Interest received 385, ,500 Interest paid -280, ,451 Cash flow from operating activities -351,048 1,243,050 Payments received on disposal of investments - 58 Payments made for the acquisition of investments Payments made for the acquisition of property, plant, equipment and intangible assets ,657 Cash flow from investing activities ,599 Dividends paid -64,000-84,500 Other financing activities, net ,838 Cash flow from financing activities -64, ,338 Cash and cash equivalents at end of previous year 1 622,166 10,053 Cash flow from operating activities -351,048 1,243,050 Cash flow from investing activities ,599 Cash flow from financing activities -64, ,338 Cash and cash equivalents at end of year 1 206, ,166 1 Cash and cash equivalents is equal to the cash reserve shown in the Statement of financial position plus cash balances held at central banks. The Notes on pages 42 to 97 are an integral part of these Financial statements Annual Report UniCredit Luxembourg S.A.

43 UniCredit Luxembourg 2014 Annual Report 41

44 Notes to the financial statements (A) General comments As a consequence of the reorganization of UniCredit S.p.A. group s (UC Group) banking activities in Luxembourg, formerly HVB Banque Luxembourg S.A. was renamed UniCredit Luxembourg S.A. (UniCredit Luxembourg) on 1 August At this date UniCredit International Bank (Luxembourg) S.A. transferred its Private Banking business activities to UniCredit Luxembourg (the Bank) and through this concentrates all Private Banking activities in Luxembourg in one legal entity. The Bank is primarily involved in corporate and investment banking, treasury and private banking, focusing on the management of wealth for high net worth and ultra-high net worth segments, as well as providing specialized services to the UC group in areas like asset management of life insurance policies. The Bank has its registered office at 8-10, rue Jean Monnet, L-2180 Luxembourg. UniCredit Luxembourg is a wholly owned subsidiary of UniCredit Bank AG (former: Bayerische Hypo- und Vereinsbank AG). As a subsidiary of UniCredit Bank AG (HVB), the Bank is part of the UniCredit Banking Group (Gruppo Bancario UniCredit, Cod. ABI ). The Bank is included in the HVB Group consolidated financial statements of HVB, which can be obtained from UniCredit Bank AG in Munich. HVB s Group consolidated financial statements are included in the consolidated financial statements of UniCredit Banking Group, which are available from the UC Group parent company s registered office in Rome, via Alessandro Specchi 16. The Bank has prepared its financial statements as at 31 December 2016 in accordance with the requirements of Part 2 Chapter 7bis (Fair Value Measurement) of the law of 17 June 1992 (LuxGAAP with IFRS options). In particular therefore, the format of the financial statements and the measurement of financial instruments follow the provision of International Financial Reporting Standards as they have to be applied within the European Union, except for the accounting principles relating to the lump sum provision. As detailed in Note (66) Significant events after the balance sheet date, the decision has been taken to significantly restructure the Bank with the aim to cease all business activities by the end of December The precise scenario related to this restructuring is currently under development. As a result, this situation casts significant doubt on the going concern of the Bank and its activities depending on the outcome of the decisions, which will be taken in the context of the above mentioned restructuring scenario. As a result, all necessary provisions and assets impairments have been taken into consideration in preparing the financial statements for the year-ending December 31, The financial statements consist of the statement of comprehensive income, the statement of financial position, the statement of changes in equity, the statement of cash flows and the notes to the financial statements. The financial statements are presented in Euro, which is the Company s functional currency. All financial information presented in Euro has been rounded to the nearest thousand. Rounding differences up to one unit may occur in the tables. Due to a change in accounting policy in relation to offsetting, the previous year figures of loans and receivables with customers and deposits from customers were adjusted by an amount of 272,569 thousand. (B) Accounting and measurement methods (1) The consistency principle In accordance with the framework of IFRS and the IAS standards 1 and 8, the Bank is consistent in the use of recognition, measurement and presentation methods. Where errors of recognition or measurement in prior periods need to be corrected, the effects (if material) are recognised retrospectively in the first set of financial statements authorised for issue after their discovery in accordance with the requirements of IAS 8.41 IAS The financial statements are prepared under the assumption of going concern. Please refer to note (A) for further information on the uncertainty around the Bank s ability to continue as going concern. Accounting and valuation in accordance with IFRS contains values that have been determined properly by Management using estimates and assumptions. The estimates and assumptions applied are based on past experience and other factors such as budgets, expectations and forecasts regarding future events which seem appropriate under the present circumstances and are reviewed on an ongoing basis. This mainly affects the determination of the fair value of certain assets and liabilities, net write-downs of loans and provisions for guarantees and commitments, deferred taxes and the valuation of provisions. The actual results may differ from the estimates. All necessary provisions and assets impairments have been taken into consideration in preparing the financial statements for the year-ending December 31, Annual Report UniCredit Luxembourg S.A.

45 Accounting principles applied by the Bank are based on the following International Financial Reporting Standards: IFRS 2: Share-based payments; IFRS 7: Financial Instruments: Disclosures; IFRS 8: Operating Segments; IFRS 10: Consolidated Financial Statements; IFRS 11: Joint arrangements; IFRS 12: Disclosure of interests in Other Entities; IFRS 13: Fair Value Measurement; IAS 1: Presentation of Financial Statements; IAS 7: Statement of cash flows; IAS 8: Accounting Policies, Changes in Accounting Estimates and Errors; IAS 10: Events after the Reporting Period; IAS 12: Income Taxes; IAS 16: Property, Plant and Equipment; IAS 17: Leases; IAS 18: Revenue; IAS 19: Employee Benefits; IAS 20: Accounting for Government Grants and Disclosure of Government Assistance; IAS 21: The Effects of Changes in Foreign Exchange Rates; IAS 24: Related Party Disclosures; IAS 27: Consolidated and Separate Financial Statements; IAS 32: Financial Instruments: Presentation; IAS 33: Earnings per Share; IAS 36: Impairment of Assets; IAS 37: Provisions, Contingent Liabilities and Contingent Assets except as mentioned in (A); IAS 38: Intangible Assets; IAS 39: Financial Instruments: Recognition and Measurement; IAS 40: Investment Property. (2) New standards and interpretations not yet adopted A number of new standards, amendments to standards and interpretations are not yet effective for the year ended 31 December 2016 and have not been applied in preparing these financial statements. IFRS 9, published in July 2014, replaces the existing guidance in IAS 39 Financial instruments. IFRS 9 includes revised guidance on the classification and measurement of financial instruments, including a new expected credit loss model for calculating impairment on financial assets, and the new general hedge accounting requirements. It also carries forward the guidance on recognition and derecognition of financial instruments from IAS 39. IFRS 9 is effective for annual reporting periods beginning on or after 1 January 2018, with early adoption permitted. The standard contains two primary measurement categories for financial assets: amortised cost and fair value. A financial asset would be measured at amortised cost if it is held within a business model whose objective is to hold assets in order to collect contractual cash flows, and the asset s contractual terms give rise on specified dates to cash flows that are solely payments of principal and interest on the principal outstanding. All other financial assets would be measured at fair value. The standard eliminates the existing las 39 categories of held to maturity, available for sale and loans and receivables. For an investment in an equity instrument which is not held for trading, the standard permits an irrevocable election, on initial recognition, on an individual share-by-share basis, to present all fair value changes from the investment in other comprehensive income. No amount recognised in other comprehensive income would ever be reclassified to profit or loss at a later date. However, dividends on such investments are recognised in profit or loss, rather than other comprehensive income unless they clearly represent a partial recovery of the cost of the investment. Investments in equity instruments in respect of which an entity does not elect to present fair value changes in other comprehensive income would be measured at fair value with changes in fair value recognised in profit or loss. UniCredit Luxembourg S.A Annual Report 43

46 Notes to the financial statements (Continued) The standard requires that derivatives embedded in contracts with a host that is a financial asset within the scope of the standard are not separated; instead the hybrid financial instrument is assessed in its entirety as to whether it should be measured at amortised cost or fair value. The Bank has started an IFRS conversion project to implement the changes from this new standard. Given the nature of the bank s operations, this standard is expected to have a pervasive impact on the bank s financial statements. Subsequent to the adoption by the European Union on 22 November 2016, IFRS 9 will be applied by the Bank jointly with the UC Group on 1 January IFRS 15 adopted by the European Union on 22 September 2016 establishes a comprehensive framework for determining whether, how much and when revenue is recognised. It replaces inter alia the existing revenue recognition guidance in IAS 18 Revenue. IFRS 15 is effective for annual reporting periods beginning on or after 1 January The Bank will assess in 2017 the potential impact on its financial statements resulting from the application of IFRS 15. Amendments to IFRS 2 Classification and Measurement of Share-based Payment Transactions. The amendments clarify the following: 1. In estimating the fair value of a cash-settled share-based payment, the accounting for the effects of vesting and non-vesting conditions should follow the same approach as for equity-settled share-based payments. 2. Where tax law or regulation requires an entity to withhold a specified number of equity instruments equal to the monetary value of the employee s tax obligation to meet the employee s tax liability which is then remitted to the tax authority (typically in cash), i.e. the share-based payment arrangement has a net settlement feature, such an arrangement should be classified as equity-settled in its entirety, provided that the share-based payment would have been classified as equity-settled had it not included the net settlement feature. 3. A modification of a share-based payment that changes the transaction from cash-settled to equity-settled should be accounted for as follows: (i) the original liability is derecognised; (ii) the equity-settled share-based payment is recognised at the modification date fair value of the equity instrument granted to the extent that services have been rendered up to the modification date; and (iii) any difference between the carrying amount of the liability at the modification date and the amount recognised in equity should be recognised in profit or loss immediately. The amendments are effective for annual reporting periods beginning on or after 1 January 2018 with earlier application permitted. Specific transition provisions apply. (3) Financial instruments A financial instrument is any contract that gives rise to both a financial asset of one enterprise and a financial liability or equity instrument of another enterprise. Under IAS 39, all financial instruments must be recognised in the statement of financial position, classified according to the prescribed categories and measured in line with this classification. Financial assets and financial liabilities are recognised when the Bank becomes a party to the contractual provisions of the instruments. Financial assets and financial liabilities are initially measured at fair value. Transaction costs that are directly attributable to the acquisition or issue of financial assets and financial liabilities (other than financial assets and financial liabilities at fair value through profit or loss) are added to or deducted from the fair value of the assets or liabilities on initial recognition. The Bank derecognises a financial asset when the contractual rights to the cash flow from the asset expire, or when it transfers the financial asset and substantially all the risks and rewards of ownership of the asset to another party. The Bank derecognises financial liabilities when the Bank s obligations are discharged, cancelled or they expire. In its Securitization transactions, the Bank retains the risks and rewards of the transferred assets and is also the originator. The Bank does not derecognise the assets from its statements of financial position Annual Report UniCredit Luxembourg S.A. 44

47 Repurchase agreements are agreements that require the transferor to repurchase assets (usually securities) back from a transferee at a specified price which is usually equal to the original transaction price plus stated interest. Repo transactions don t meet the derecognition criteria from the statement of financial position of the transferor. Cash collateralized secured lending transactions do not result in derecognition as well. The Bank classifies assets and liabilities in one of the following categories: Cash and cash balances with central banks; Assets and liabilities held for trading (HfT); Financial instruments measured at fair value through profit and loss (FVtPL); Available-for-sale financial instruments (AfS); Held-to-maturity financial instruments (HtM); Loans and receivables with banks; Loans and receivables with customers; Hedging derivatives; Other liabilities (deposits from customers, deposits from banks, debt securities in issue); Financial guarantees and irrevocable loan commitments. Amongst other things, financial instruments must be reported separately by IAS 39 valuation category in the statement of financial position; contribution to income by category must also be shown. This information is included in the notes to the financial statements. The information concerning risk arising from financial instruments required under IFRS 7 is largely presented in notes (C) and (G). As the report about financial risk management is based on internal risk management procedures, it may include quantitative statements on types of risk which use exposure values that are different to the carrying amounts in the statement of financial position. Financial assets and liabilities measured at fair value through profit and loss The category of financial assets and liabilities measured at fair value through profit and loss is divided into two sub-categories: Financial assets and liabilities held for trading (HfT): assets and liabilities classified as held for trading at the time of initial recognition are financial instruments acquired for the purpose of making a short-term profit from market price changes or to capture a bid-offer spread. HfT instruments also include derivatives, except for hedging derivatives which qualify for hedge accounting; All financial instruments initially designated as measured at fair value through profit and loss (the fair value option). The Bank applies the fair value option only for accounting mismatches, where the option to designate makes it possible to avoid or significantly reduce valuation mismatches in economic hedges where hedge accounting is not applied. Both HfT portfolios and fair value option financial instruments are measured at fair value, and price fluctuations are taken through the statement of comprehensive income. Loans and receivables Loans and receivables are non-derivative financial assets originated and acquired which have fixed or determinable payments and are not quoted on an active market, unless they are measured at fair value through profit and loss or classified as available for sale (AfS). Leveraged buyout loans which the Bank holds for the long term or intends to syndicate are classified as loans and receivables, as there is no short-term intention to trade. Loans and receivables are measured at amortised cost and disclosed in the statement of financial position as loans and receivables with banks and loans and receivables with customers. Held-to-maturity financial instruments Held-to-maturity financial instruments (HtM) are non-derivative financial assets with fixed or determinable payments and a fixed maturity where there is the intention and ability to hold them to final maturity, unless they are classified in the categories FVtPL or AfS. They are measured at amortised cost and any premiums or discounts are accrued and released through the statement of comprehensive income in net interest income over their term. Available-for-sale financial instruments All other non-derivative financial assets come into the category of securities and receivables available for sale (AfS). Within this category there is a distinction between those measured at fair value and those measured at amortised cost: Where it is possible to reliably determine the fair value of debt and equity instruments, they are measured at fair value. The difference between fair value and (amortised) cost is recognised directly in a separate line item in other comprehensive income (the AfS reserve) until the asset is sold or an UniCredit Luxembourg S.A Annual Report 45

48 Notes to the financial statements (Continued) impairment has to be taken through the statement of comprehensive income. Premiums and discounts on debt instruments are released through the statement of comprehensive income in net interest income over their term. Equity instruments with no quoted price on an active market and whose fair value cannot be reliable determined are measured at historical cost. This relates, amongst other things, to stakes held in unlisted companies, which are measured at historical cost. As it is not possible to determine a reliable fair value for these equity instruments, it is also not possible to calculate a difference between fair value and historical cost, so they do not appear in the AfS reserve. The sale or purchase of financial assets measured at fair value through profit and loss is recognised on the trade date, whereas the sale or purchase of AfS and HtM instruments is recognised on the value date. Determing fair value Fair value is the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between knowledgeable market participants at the measurement date. In accordance with IFRS 13, fair value is determined according to the following fair value hierarchy: Level 1 Level 2 Level 3 Fair values measured using quoted prices (unadjusted) in active markets for identical assets or liabilities. Fair values measured using inputs other than quoted prices included within level 1 that are observable for the asset or liability, either directly (i.e. as prices) or indirectly (i.e. derived from prices). Fair values measured using inputs for the asset or liability that are not based on observable market data (i.e. unobservable inputs). Thus, the respective fair values also incorporate valuation parameters based on model assumptions. Financial guarantees A financial guarantee is defined as a contract that requires the issuer to make specific payments to reimburse the holder for a loss which incurs due to the fact that a specific debtor fails to make payment when due under the original or amended terms of a debt instrument. Overall, the fair value of a financial guarantee is zero at the time a contract is issued, since for market conform contracts the consideration received is generally equal to the value of the obligation assumed. The guarantee premium is recognised in the statement of comprehensive income over the life of the guarantee. For subsequent measurement it is necessary to check whether any risk provision is needed. Embedded derivatives Embedded financial derivatives within a structured product that must be separately accounted for outside the categories HfT and FVtPL are split off from the host contract and recognised as a stand-alone financial derivative. The host contract is then put into the appropriate category. Changes in the value of derivatives that have been separated and measured at fair value are recognised in income. Hedge accounting With effect of 1 January 2009, UniCredit Luxembourg like its parent company HVB has changed its hedge accounting procedures with respect to the accounting treatment of hedging operations in asset/liability management. Instead of the macro cash flow hedge method previously applied, the portfolio fair value hedge method for interest rate risk will be applied, which is also accepted under IAS 39. The new approach of hedging fair value in relation to a portfolio of interest-bearing financial assets and liabilities enables the Bank s standard risk management procedure of hedging fixed-interest risk on the basis of net risk positions to be recognised in the accounts. Under this accounting treatment of cross-item hedging operations, changes in value in the hedged portion of the underlying transactions from which the hedged risk arises are not entered as changes to the carrying value of individual positions as is the case with micro hedges but as separate asset or liability items. The portion of the underlying transactions hedged is determined within the scope of interest rate risk management. Where the preconditions for hedge accounting are met, changes in value of the hedged portion of the underlying transactions and of the hedging instruments (interest rate derivatives) are taken directly to the statement of comprehensive income. If the hedge is completely efficient, these changes will cancel one another out and produce net income from hedging of zero. Hedge inefficiencies that arise given the necessary limits on hedge efficiency are reported under net income from hedging (positive or negative). The cash flow hedge reserve in existence at the time of the policy change and the equal but contrary existing balance resulting from cash flow hedge derivatives are amortised through net interest income over the residual term of the hedging derivatives and therefore have no impact on profit or loss in the future. Changes in value in these same underlying transactions and hedging derivatives that take place after 1 January 2009, along with all such new transactions, are accounted for using the portfolio fair value hedge method Annual Report UniCredit Luxembourg S.A.

49 Investment tax credits The Bank has received Investments tax credits (ITC) which have reduced the Bank s taxable income and which are directly linked to specific loans and receivables. Following IAS 20 by analogy, Investment tax credits are recognised as interest income over the periods necessary to match them with the related premiums which they are intended to compensate. The ITC are initially recognised in the statement of financial position as accruals under other liabilities and subsequently presented in the statement of comprehensive income as interest income. (4) Financial assets held for trading This item includes securities held for trading purposes and positive market values of traded derivatives. All other derivatives not classified as hedging derivatives (which are shown separately in the statement of financial position) are similarly considered as held for trading. Provided they are held for trading purposes, Schuldscheindarlehen, registered bonds and public sector bonds are carried as other financial assets held for trading. Financial assets held for trading purposes are carried at fair value. Gains and losses arising from the valuation and realisation of financial assets held for trading are taken to the statement of comprehensive income as net trading income. (5) Financial instruments measured at fair value through profit and loss The Bank applies the fair-value option for financial assets with economic hedges for which hedge accounting is not applied. The designation removes or significantly reduces differences resulting from an accounting mismatch. The portfolio mostly comprises interest-bearing securities not held for trading that are hedged against interest rate risks by means of interest rate swaps. Changes in fair value of the hedged items and the associated derivatives are shown separately in net trading income; current interest income/expenses are recognised in net interest income. (6) Available-for-sale financial instruments The Bank recognises interest-bearing securities, equities and shareholdings as available-for-sale financial instruments under available-for-sale financial instruments in the statement of financial position. Available- for-sale instruments are generally measured at fair value. For instruments which have no fixed or determinable payments in accordance with IAS 39.AG8 the carrying amounts are recalculated by computing the present value of estimated cash flows at the financial instruments original effective interest rate. The adjustment is recognised in the statement of comprehensive income as interest income. Listed companies are always carried at fair value. Where the fair value cannot be determined reliably for non-listed companies, they are valued at cost. (7) Held-to-maturity financial instruments The Bank has classified interest-bearing assets as held to maturity and recognised them under held-to-maturity financial instruments. Held-to-maturity financial instruments are measured at amortised cost; the resulting interest income is included in net interest income. (8) Loans and receivables Loans and receivables are recognised in the statement of financial position under loans and receivables with banks, and loans and receivables with customers. They are carried at amortised cost. The amount shown in the statement of financial position has been adjusted for allowances for losses on loans and receivables. UniCredit Luxembourg S.A Annual Report 47

50 Notes to the financial statements (Continued) (9) Impairment of financial assets Impairment losses are recognised for financial assets that are measured at amortised cost or classified as available for sale. An impairment loss is determined in two steps. First, an assessment is made to analyse if there is any objective evidence that the financial asset is impaired (at each reporting date). The second step involves assessing whether the financial instrument actually is impaired. Objective evidence of impairment refers to events that normally lead to an actual impairment. In the case of debt instruments, these are events that could result in the borrower not being able to settle his obligations in full or at the agreed date. In the case of equity instruments, significant or prolonged lower market values compared with the carrying amount represent objective evidence of impairment. Objective evidence is provided only by events that have already occurred, not anticipated events in the future. Examples of such events are: significant financial difficulty of the issuer or borrower; payment defaults; renegotiation of the terms of an asset due to financial difficulty of the borrower; significant restructuring due to financial difficulty or expected bankruptcy; disappearance of an active market for an asset due to financial difficulties. A change in credit rating is not itself evidence of impairment, but it may be evidence of impairment with other available information, such as one of the indicators noted above. In addition, an entity should take into account information about the borrower s/issuer s liquidity and solvency, trends for similar financial assets, and local economic trends and conditions when evaluating evidence of impairment. In the case of loans and receivables and held-to-maturity financial instruments, an impairment is the difference between the carrying amount and the present value of the anticipated future cash flows. The future cash flows are determined taking into account past events (objective evidence). The anticipated future cash flows may comprise the repayment and/or interest payments still expected and the income from the realisation of collateral. The impairment is the difference between the present value of the anticipated future cash flows and the carrying amount. A specific loan-loss provision is recognised for the impairment determined. During subsequent measurement, both changes in the anticipated future cash flows and the time effect arising from a reduction of the discounting period are taken into account. The difference between the newly determined present value of the anticipated future cash flows at each balance sheet date and the carrying amount at the previous reporting date is recognised as a reversal of, or an addition to, allowances for losses on loans and receivables. In the case of loan receivables, the impairment determined in this way is posted to an impairment account which reduces the carrying amount of the receivable on the assets side. In the case of securities, an impairment directly reduces the carrying amount of the security. In the case of financial guarantees, a possible impairment is determined in the same way; the impairment loss is recognised as a provision. Specific loan-loss allowances or provisions to the amount of the anticipated loss have been made individually to cover all identifiable default risks arising from lending operations (loans, receivables and financial guarantees), with the amount of the expense being estimated. Specific loan-loss allowances are reversed as soon as the reason for forming the allowance no longer exists, or used if the receivable is classified as uncollectable and written off. Acute country-specific transfer risks are included in this process. In the case of receivables (and guarantees) for which no specific allowances have been formed, portfolio allowances are set up to cover losses (= impairments) that have been incurred but not yet recognised by the Bank at the reporting date. The Bank applies the loss confirmation period method for this. The loss confirmation period represents the period between a default event occurring or a borrower defaulting, and the point at which the Bank identifies the default. The loss confirmation period is determined separately for various credit portfolios on the basis of statistical surveys. The loss that has occurred but has not yet been recognised is estimated by means of the expected loss. In the case of assets classified as available for sale, a distinction is made between debt and equity instruments. A debt instrument is impaired when an event occurs that results in the borrower not being able to settle his obligations in full or at the agreed date. Essentially, an impairment exists in the same cases as for loan receivables from the same borrower (issuer). The amount of the impairment is defined as the difference between the amortised cost and the current fair value, whereby the difference first recognised in the AfS reserve in the statement of financial position is taken to the statement of comprehensive income when an impairment occurs Annual Report UniCredit Luxembourg S.A.

51 Should the reason for the impairment no longer apply the difference between the higher market value and the carrying amount at the previous balance sheet date is written back in the statement of comprehensive income up to the amount of initial cost. If the current market value at the reporting date exceeds the initial cost, the difference is recognised in the AfS reserve under shareholders equity. In the case of equity instruments carried at fair value, an impairment exists if the current fair value is significantly below the carrying amount or if the fair value has remained below the carrying amount for a prolonged period of time. Where this is the case, the difference between the current fair value and initial cost is recognised as profit or loss in the statement of comprehensive income. Such an impairment recognised in profit or loss has to be considered for the new cost basis required for the calculation of the AfS reserve. If the fair value rises in the future, the difference between a higher fair value and the initial cost adjusted as described is recognised in the AfS reserve under shareholders equity. Equity instruments valued at cost are considered impaired if the present value is significantly or permanently less than the acquisition cost (or, if an impairment has already been recognised in the past, it is less than the acquisition cost less the recognised impairment loss). If there is objective evidence of an impairment, the present value of the equity instruments must be determined. The estimated future cash flows discounted by the current market return on a comparable asset are used as the basis for determining this value. The amount of the impairment is calculated as the difference between the present carrying amount and the value of the equity instrument determined as described above. The impairment is taken to the statement of comprehensive income. An impairment of an equity instrument is not permitted to be reversed if the reasons for the impairment no longer apply. The Bank maintains a lump-sum provision for latent risks ( provision forfaitaire ) in accordance with the Luxembourg tax regulations calculated on the regulatory risk weighted assets. According to the provisions of the tax administration of 16 December 1997 a maximum rate of 1.25% can be applied for this tax-deductible provision, which is deducted from loans to banks and loans to customers. As at 31 December 2016 the lump-sum provision amounted to 35.6 million (in 2015: 35.6 million). (10) Property, plant and equipment Property, plant and equipment is valued at acquisition or production cost less depreciation insofar as the assets are depreciable using the straightline method based on the assets useful lives. ASSET DEPRECIATION RATE Buildings 2.00% Office fittings, business equipment 10.00% / 12.50% Vehicles, office equipment 20.00% / 33.33% IT hardware 25.00% Impairments are taken on property, plant and equipment whose value is impaired. Should the reasons for the impairment no longer apply, a subsequent write-up is taken to the statement of comprehensive income; the amount of this subsequent write-up must not increase the value of the property, plant and equipment to a level in excess of the amortised acquisition or production cost. Subsequent expenditure relating to an item of property, plant and equipment is capitalised, provided additional future economic benefits will flow to the Bank. Expenditure on repairs or maintenance of property, plant and equipment is recognised as expense in the year in which it is incurred. (11) Investment property Compliant with IAS in conjunction with IAS 40.56, since 1 July 2010 a building held by the Bank as investment with a view to generating rental income and/or capital gains is carried at amortised cost and written down on a straight-line basis over a useful economic life of 50 years. Current expenses and rental income from investment property is disclosed in net other expenses/income. Scheduled depreciation on such investments carried at amortised cost is included in operating expenses, whereas impairments are recognised in net income from investments. (12) Intangible assets The items included in intangible assets are software. An intangible asset shall only be recognised if it is probable that the expected future economic benefits attributable to the asset will flow to the entity and the cost of the asset can be measured reliably. Intangible assets are valued at amortised cost and are written down over an expected useful life of three to five years. UniCredit Luxembourg S.A Annual Report 49

52 Notes to the financial statements (Continued) (13) Liabilities Deposits from banks and customers and debt securities in issue are carried at amortised cost. (14) Financial liabilities held for trading This caption includes the negative fair values of traded derivatives and all other derivatives that are not classified as hedging derivatives (which are recognised separately). Financial liabilities held for trading are carried at fair value. Gains and losses arising from the valuation and realisation of financial liabilities held for trading are taken to the statement of comprehensive income under net trading income. (15) Hedge adjustment of hedged items in the fair value hedge portfolio The Bank recognises the change in fair value of the hedged item as a gain or loss and separately in the statement of financial position under fair value changes of the hedged items in portfolio hedge of interest rate risk. (16) Other liabilities Compliant with IAS 37, accruals and other items are shown under other liabilities. These reflect future expenditure of uncertain timing or amount, but the uncertainty is much less than for provisions. Accruals are carried at the amount likely to be used. Accruals are liabilities for goods and services received that have been neither paid for nor invoiced by the supplier, nor formally agreed. This also includes current liabilities to employees, such as flexi-time credits and outstanding vacation. Accruals are carried at the amount likely to be used. (17) Employee benefits Benefit pension plan The Bank operates three defined benefit pension plans in favour of some employees transferred from UniCredit International Bank (Luxembourg) S.A. on 1 August The pension plans are all funded through payments to an insurance company, determined by periodic actuarial calculations. A defined benefit plan is a pension plan that defines an amount of pension benefit that an employee will receive on retirement, usually dependent on one or more factors, such as age, years of service and compensation. The liability recognized in the statement of financial position in respect of defined benefit pension plans is the present value of the defined benefit obligation at the end of the reporting period date less the fair value of plan assets, together with adjustments for unrecognized actuarial gains or losses and past- service costs. The defined benefit obligation is calculated annually by independent actuaries using the projected unit credit method. The present value of the defined benefit obligation is determined by discounting the estimated future cash outflows using interest rates of high-quality corporate bonds that are denominated in the currency in which the benefits will be paid, and that have terms to maturity approximating the terms of the related pension liability. From 2013 on the remeasurements of the net defined benefit obligation are recognized immediately in Other Comprehensive Income. Contribution pension plan In addition to the defined benefit pension plans, the Bank maintains also a defined contribution pension plan, under which the bank pays fixed contributions into the fund PensionInvest and will have no legal or constructive obligation to pay further amounts. The contributions payable are recognized in the statement of comprehensive income when they are due in respect of services rendered before the end of the reporting period Annual Report UniCredit Luxembourg S.A.

53 UC group Executive Incentive System A. QUALITATIVE INFORMATION 1. Description of payment agreements based on own equity instruments 1.1 Outstanding instruments UC Group Medium & Long Term Incentive Plans for selected employees include the following category: Equity-Settled Share Based Payments; This category includes the following: Stock Options allocated to selected Top & Senior Managers and Key Talents of the Group; Group Executive Incentive System that offer to eligible Group Executive a variable remuneration for which payment will be made within five years. The beneficiary will receive the payment by cash and/or by UniCredit shares; the payment are related to the achievement of performance condition (other than marked conditions) stated in the Plan Rules; Group Executive Incentive System (Bonus Pool) that offer to eligible Group Executives and relevant employees identified following regulatory rules, a bonus structure composed by upfront (following the moment of performance evaluation) and deferred payments in cash and in shares, to be paid over a period of ranging from 1 to 6 years (first year upfront and 4 or 5 years deferred). This payment structure will guarantee the alignment to shareholder interest and will be subjected to malus (which applies in case specific profitability, capital and liquidity thresholds are not met at both Group and Country/Division level) and claw back conditions (as legally enforceable) as defined in Plan Rules (both non-market vesting conditions); Employee Share Ownership Plan (ESOP) that offers to eligible Group employees the possibility to buy UniCredit ordinary shares with the advantages to foresee the granting of free ordinary shares ( Free Shares or rights to receive them) during the Enrolment Period. The granting of free ordinary shares is subordinated to vesting conditions (other than market conditions) stated in the Plan Rules. 1.2 Measurement model Stock Options The Hull and White Evaluation Model has been adopted to measure the economic value of Stock Options. This model is based on a trinomial tree price distribution using the Boyle s algorithm and estimates the early exercise probability on the basis of a deterministic model connected to: reaching a Market Share Value equals to an exercise price-multiple (M); probability of beneficiaries early exit (E) after the end of the Vesting Period. Economic and Equity effects will be recognized on a basis of instrument vesting period. Any new Stock Options Plans haven t been granted during Group Executive Incentive System The amount of the incentive is determined on a basis of the achievement of quantitative and qualitative goals stated by the plan. In particular, the overall evaluation of the Employee s relevant Manager expresses as a percentage, from a minimum of 0% to a maximum of 150% (non-market vesting conditions). This percentage, adjusted by the application of a risk/opportunity factor - Group Gate - at first payment multiplied by the Bonus Opportunity, determines the effective amount that will be paid to the beneficiary. Economic and Net Equity effects will be accrued on a basis of instruments vesting period. Group Executive Incentive System (Bonus Pool) The economic value of Performance Shares is measured considering the share market price at the grant date less the present value of the future dividends during the vesting period. Economic and Net Equity effects will be accrued on basis of instruments vesting period. UniCredit Luxembourg S.A Annual Report 51

54 Notes to the financial statements (Continued) Group Executive Incentive System Bonus Pool 2015 Shares The economic value of Performance Shares is measured considering the share market price at the grant date less the present value of the future dividends during the vesting period. The plan is divided into clusters, each of which can have two or three installments of share-based payments spread over a period defined according to Plan rules. SHARES GRANTED GROUP EXECUTIVE INCENTIVE SYSTEM BONUS POOL 2015 INSTALLMENT (2018) INSTALLMENT (2019) INSTALLMENT (2020) INSTALLMENT (2021) Date of Bonus Opportunity Economic Value granting 21 January January January January 2015 Date of Board resolution (to determine number of shares) 15 March March March March 2016 Vesting Period Start-Date 1 January January January January 2015 Vesting Period End-Date 31 December December December December 2019 UniCredit Share Market Price ( ) Economic Value of Vesting conditions ( ) Performance Shares Fair Value per unit at Grant Date ( ) The same Fair Value per unit are used for the quantification of costs connected to share based payments for the settlement of golden parachute. Group Executive Incentive System 2016 (Bonus Pool) New Group Incentive system 2016 is based on a bonus pool approach, aligned with regulatory requirements and market practices, it defines: sustainability, through direct link with entity results and alignment with relevant risk categories, utilizing specific indicators linked to risk-appetite; link between bonuses and organization structure, defining the pool on a country/division level with further review at Group level; bonuses allocated to Executives and other relevant employee, on a basis of European Bank Authority (EBA) rules and local regulations; payment structure has been defined in accordance with Regulatory provisions qualified by directive 2013/36/EU (CRD IV) and will be distributed in a period of six years by using a mix of shares and cash. All Profit and Loss and Net Equity effects related to the plan will be booked during the vesting period Employee Share Ownership Plan (Let s Share for 2016) The following tables show the measurements and parameters used in relation to Free Shares (or rights to receive them) connected to the Employee Share Ownership Plan approved in Measurement of Free Shares ESOP for 2016 FREE SHARES Date of Free Shares delivery to Group employees 29 July 2016 Vesting Period Start-Date 29 July 2016 Vesting Period End-Date 29 July 2017 Discount Shares Fair Value per unit ( ) 2,058 All Profit and Loss and Net Equity effects referred to free shares will be booked during the vesting period (except adjustments, according to Plan Rules, that will be booked during the next closing after vesting period). The Plan Let s Share for 2016 provides for the use of shares to be purchased on the market. To that end, Participants give a mandate to a broker (internal or external to UC Group) to purchase the shares to be transferred into an account opened in their name Annual Report UniCredit Luxembourg S.A.

55 B. QUANTITATIVE INFORMATION 1. Other information UniCredit group Employees Share Ownership Plan 2016 ( Let s Share for 2017 ) In April 2016 the Ordinary Shareholders Meeting approved the UniCredit Group Employee Share Ownership Plan 2016 ( Let s Share for 2017 ) that offers to eligible Group employees the opportunity to purchase UniCredit ordinary shares at favourable conditions in order to reinforce employees sense of belonging and commitment to achieve the corporate goals. With reference to Let s Share 2017, according to UniCredit discretionary evaluation, there may be two main election windows: 1 st election window: by the end of the second quarter of 2017; 2 nd election window: by the end of the fourth quarter of Let s Share for 2017 envisages the following elements: during the Enrolment Period, that will be communicated on due time to the Participants, they can buy UniCredit ordinary shares ( Investment Shares ) by means of monthly or one-off contributions taken from their Current Account; at the first month of the Enrolment Period, each Participant will receive, in form of shares ( Free Shares ) a discount equal to 25% of overall amount of shares purchased; the Free Shares will be locked up for one year ( Holding Period ). The Participant will lose the entitlement to the Free Share if, during the holding period, he/she will no longer be an employee of a UC Group Company unless the employment has been terminated for one of the specific reasons stated in the Rules of the Plan. In some countries, for fiscal reasons, it will not be possible to grant the Free Shares at the beginning of the Enrolment Period: in that case an alternative structure is offered that provides to the Participants of those countries the right to receive the Free Shares at the end of the Holding Period ( Alternative Structure ); during the Holding Period, the Participants can sell the Investment Shares purchased at any moment, but they will lose the corresponding Free Shares (or right to receive them). The Free Shares are qualified as Equity Settled Share-based Payments as Participants will receive UniCredit Equity Instruments as consideration for the services rendered to the legal entity where they are employed. The fair value will be measured at the beginning of Enrolment Period according to the price paid by Participants to acquire the first installment of the Investment Shares on the market. All Profit and Loss and Net Equity effects related to Let s Share for 2017 will be booked during the holding period. Effects on Profit and Loss All Share-Based Payment granted after November 7, 2002 whose vesting period ends after 1 January 2005 are included within the scope of the IFRS2. Financial statement presentation related to share based payments TOTAL VESTED PLANS TOTAL Costs connected to Equity Settled Plans connected to Cash Settled Paid amount to UniCredit S.p.A. related to vested plans Paid amount to employees related to Cash Settled Accrued Debts towards UniCredit S.p.A Accrued Debts towards employees related to Cash Settled Costs in 2015 figures is due to not achievement of performances conditions (non-market vesting conditions). VESTED PLANS (18) Provisions Present legal or constructive obligations as a result of past events involving a probable outflow of resources, and whose amount can be reliably estimated, are recognised as provisions. When assessing provisions for uncertain liabilities and anticipated losses on onerous transactions, the Bank uses a best estimate of the expenditure compliant with IAS and sequent. UniCredit Luxembourg S.A Annual Report 53

56 Notes to the financial statements (Continued) (19) Foreign currency translation The financial statements are drawn up in Euro. Foreign currency translation is carried out in accordance with the requirements of IAS 21, whereby monetary assets and liabilities not denominated in the local currency and any spot transactions not settled on the reporting date are translated using spot exchange rates prevailing on the reporting date. Non-monetary assets and liabilities carried at fair value are similarly translated into Euros using current market prices at the valuation date. Non-monetary items carried at cost are translated using the historic rate applicable at the time of acquisition. Exchange differences arising from currency translation are reflected in the corresponding line items in the statement of comprehensive income. (20) Revenues and expenses (a) Interest Interest income and expense on fixed-income securities and loans are recognised in profit or loss using the effective interest method. The effective interest rate is the rate that exactly discounts the estimated future cash payments and receipts through the expected life of the financial asset or liability (or, where appropriate, a shorter period) to the carrying amount of the financial asset or liability. When calculating the effective interest rate, the Bank estimates future cash flows considering all contractual terms of the financial instrument, but not future credit losses. The calculation of the effective interest rate includes all transaction costs and fees paid or received that are an integral part of the effective interest rate. Transaction costs include incremental costs that are directly attributable to the acquisition or issue of a financial asset or liability. Interest income and expense presented in the statement of comprehensive income include: interest on financial assets and financial liabilities measured at amortised cost calculated on an effective interest basis; interest income and expense on all trading assets and liabilities; interest on available-for-sale investment securities and loans calculated on an effective interest basis; fair value changes in qualifying derivatives, including hedge ineffectiveness, and related hedged items in fair value hedges of interest rate risk. Fair value changes on other derivatives held for risk management purposes, and other financial assets and liabilities carried at fair value through profit or loss, are presented in net income from other financial instruments at fair value through profit or loss in the statement of comprehensive income. (b) Fees and commission Fees and commission income and expense that are integral to the effective interest rate on a financial asset or liability are amortized to their maturity. Other fees and commission income, including account servicing fees, investment management fees, sales commission, placement fees and syndication fees, are recognised as the related services are performed. When a loan commitment is not expected to result in the draw-down of a loan, the related loan commitment fees are recognised on a straight-line basis over the commitment period. Other fees and commission expense relate mainly to transaction and service fees, which are expensed as the services are received. (c) Net trading income Net trading income comprises gains and losses related to trading assets and liabilities. The position includes all realised and unrealised fair value changes and foreign exchange differences. (d) Net income from other financial instruments at fair value through profit or loss Net income from other financial instruments at fair value through profit or loss relates to non-trading derivatives held for risk management purposes that do not form part of qualifying hedge relationships and financial assets and liabilities designated at fair value through profit or loss, and include all realised and unrealised fair value changes and foreign exchange differences. (e) Income tax Income tax for the period is accounted for in accordance with the principles set forth in IAS 12. Deferred tax assets and liabilities are recognised for all temporary differences between the values stated in accordance with IFRS and the values stated for tax-reporting purposes (balance sheet approach). Since the concept is based on the approach of future tax assets and liabilities under the liability method, the assets and liabilities are computed using the tax rates that are expected to apply when the differences are reversed Annual Report UniCredit Luxembourg S.A.

57 (C) Financial Risk Management Overall system for monitoring and managing risk UniCredit Luxembourg is incorporated into HVB Group system of risk monitoring and management, which in turn is a core element of the UC Group s internal planning, management and control processes. Under its risk management policy, the Bank s entire risk strategy is defined at HVB Group level. In particular, it determines the extent and form of exposure that the individual divisions can take on, on the basis of the available risk coverage. Before any risk is entered into, it is assessed as to whether it is possible, based on risk capacity calculations, and worthwhile, based on opportunity/risk analysis. The different divisions responsibly implement their predefined risk strategy in the HVB Group by means of targeted and controlled entry into risk positions under their own responsibility. Regulatory and/or economic capital is allocated under a predefined limit system. As a multidivisional unit of the HVB Group, UniCredit Luxembourg is involved in the implementation of the respective strategies and has set up an own Risk Strategy in line with Group Risk Strategy. The Group Chief Risk Officer is responsible for risk controlling and for spreading risk management across all business areas. Under this set-up, central Group Corporate Centres perform the core functions of risk identification, risk analysis and assessment, as well as on-going risk monitoring and management. The units of the Bank responsible for managing credit, operational and market risk therefore work in a fully integrated way with Group Corporate Centres. UniCredit Luxembourg as a subsidiary has implemented a risk management function which forms part of the HVB Group-wide risk controlling structure. The Bank s internal auditors also work closely with those at Group level. Both sets of auditors pursue a risk-oriented approach to their work. Risk types and risk measurement 1. Relevant risk types At UniCredit Luxembourg, the following risk types are distinguished: Credit risk; Market risk; Liquidity risk Operational risk; Business risk; Real Estate risk; Reputational risk; Strategic risk; Pension risk. 2. Risk measurement methods The risk types Credit -, Market -, Operational -, Business -, Real Estate - and Pension risk are measured using a value-at-risk approach under which potential future losses are measured on the basis of a defined confidence level. The individual risk types are aggregated as part of the internal capital calculation, applying a uniform one-year holding period and a 99.90% confidence level across all risk types. Other identified risk types are taken into consideration via dedicated methods applied to the measurement of these risk types. Group-wide System for overall bank management 1. In general The most important parameters for overall Bank management are Economic Value Added (EVA) and RARORAC (risk-adjusted return on risk-adjusted capital). The EVA expresses the extra value generated within the framework of value-based management in Euro. It is calculated as, the difference between the net profit and the return expectations on invested or allocated capital. UniCredit Luxembourg S.A Annual Report 55

58 Notes to the financial statements (Continued) RARORAC is the ratio of economic value added to used core capital (allocated capital) and indicates the value created for each unit of allocated capital. The hands-on management of sales takes place within the divisions and is individually adapted to specific business needs within the overall Bankmanagement parameters. 2. Regulatory capital adequacy Used core capital For purposes of planning and controlling in accordance with Basel II, the divisions are required to have core capital backing from credit, market and operational risk. Management of regulatory capital adequacy requirements To manage the regulatory capital, the following three capital ratios which are managed on the basis of internally defined minimum levels are applied: Core capital ratio 1 (ratio of core capital to risk-weighted assets arising from credit risk positions); Core capital ratio 2 (ratio of core capital to the sum of risk-weighted assets arising from credit risk positions and the equivalent risk-weighted assets from market and operational risk positions); Equity funds ratio (ratio of equity funds to the sum of risk-weighted assets arising from credit risk positions and the equivalent risk-weighted assets arising from market and operational risk positions). 3. Economic capital adequacy/risk taking capacity As an essential part of the Risk Management System, the Bank has defined an Internal Capital Adequacy Assessment Process (ICAAP). The central risk measure is the internally-determined risk capital (economic capital), calculated in accordance with the methods laid down by the UC Group. The risk capital is set against the Available Financial Resources (AFR), enabling a statement to be made on the Bank s risk taking capacity with regard to the coverage of the economic capital by AFR. The Risk Control department is responsible for the operational implementation of the concept defined by the Management Board and as approved by the Supervisory Board. In particular, it performs the following duties: Managing risks and internal equity economic capital in accordance with the defined strategies and the equity capital (available financial resources); Ensuring appropriateness of the ICAAP process and its smooth, efficient functioning; Determining the risk profile of UniCredit Luxembourg; Planning/ensuring adequacy of internal risk capital; Equity capital policy; Impact on regulatory equity capital. As at the end of 2016 the AFR was 1,672.6 million. The risk taking capacity was always well above the defined Trigger of 110% and the fixed limit of 100% in the course of the year Risk Strategy The risk strategy consistent with the Business Strategy takes into account all risk types relevant to UniCredit Luxembourg and the internal capital. A major element of this risk strategy is maintaining the Bank s risk-taking Capacity (RTC). UniCredit Luxembourg s risk strategy is updated annually and, if necessary, during the course of the year, taking into account the current market and risk situation and developments in risk management instruments. The strategy includes both qualitative and quantitative elements. The focus is on both the risk strategy covering all divisions and risk types as well as the partial strategies geared towards an implementation that sets parameters for individual portfolios or risk types. For more information on the risk strategy, please refer to the sections on the various risk types Annual Report UniCredit Luxembourg S.A.

59 Risk types in detail 1. Credit risk Risk management Credit risk represents the risk that a change of the credit quality of counterparty might generate a change in the value of the credit exposure towards it. This change in the credit exposure value might be due to the default of the counterparty, that is not able to respect its contractual obligations or by the deterioration of the credit quality of the counterparty. The Credit risk consists of the following components: Credit default risk (including Counterparty risk, Issuer risk and Securitization risk); Country risk. Default risk Default risk is defined as the potential losses arising from commercial lending operations. It is taken into account by recognising allowances for losses on loans and advances in the balance sheet whenever specific indicators of a default have arisen in the past (incurred loss). The abstract expectation that customers could default in the future (the concept of expected loss and credit value-at-risk) must be seen separately from this. Counterparty risk Counterparty risk results from a possible depreciation in value caused by default or rating deterioration of a trading transaction s counterparty. It can be sectioned into the following risk types: Settlement risk: means the danger that the counterparty does not meet its delivery commitment or contractual obligation on the day of maturity, while the bank has already met its respective obligations. Settlement risk is divided in overdue and not overdue. The overdue Risk Settlement is part of the risk calculation in ARAMIS; Pre-Settlement risk: Also called Replacement risk or Price risk, results from the danger that the Bank needs to replace trades at worsened market conditions in case the counterparty defaults; Money Market risk: Also called Cash risk, results from the danger that the counterparty might not repay (Cash)-loans granted by the Bank. If trading transactions are concerned, this risk is relevant for money market. Issuer risk Issuer risk reflects the risk from an issuer s default or downgraded credit rating. It arises in connection with the purchase of securities for own account, securities issuance and placement transactions, and credit derivatives. Issuer risk is measured by means of the issuer exposure, which is calculated using nominal values, netting effects and loss quotas. Country risk Country risk is the risk of losses of exposures caused by measures executed by the government of a country. This implies that the repayment of assets within a specific country will be ultimately prevented by actions of the country s government (e.g. transfer risk, expropriation risk, legal risk, tax risk, security risk) or by a deterioration of the economic and / or political environment (e.g. a sharp recession, currency and / or banking crisis, disaster, war, civil war, social unrest). Credit risk strategy The credit risk strategy implemented in the Bank is characterised by both comprehensive management elements and sub-strategies for various portfolios. Limits are set for key portfolios and, in addition, instruments are specified for the management of risk concentrations (in countries, industries and for individual borrowers). Alongside these quantitative guideposts for credit risk, the willingness to assume risk is defined by standards for credit approval and credit portfolio management. Measurement methods Credit risk With regard to credit risk under Basel II, the Bank has implemented IRB-A (Internal Rating Based approach-advanced) compliant processes and was given authorisation by the regulators to use the advanced model for risk capital calculation purposes. UniCredit Luxembourg S.A Annual Report 57

60 Notes to the financial statements (Continued) Rating analysis It is vitally important for the Bank to reliably assess the default probabilities of its customers in the interest of credit decisions, pricing and regulatory capital coverage under Basel II (IRB-A approach), as well as for the Banks s internal default risk model. For this reason, particular emphasis is placed on the on-going development and fine-tuning of the internal creditworthiness analysis instruments. The Bank in conjunction with its (ultimate) parent company uses a wide range of rating and scoring processes tailored to the needs of its business and various customer groups. These systems are continually optimised, applying modern statistical processes in order to ensure the best-possible selectivity and forecasting accuracy with regard to the default probability of a customer. The result of a rating or scoring process is the classification in a rating class with a ten-point scale. Rating classes 1 7 are set aside for performing loans and classes 8 10 for non-performing loans. For some processes, finer distinctions are made by subdividing each rating class into three subclasses (notches). For rating classes 8- and higher, loan-loss provisions are created. Process-based rating classes are determined up to class 8. The rating classes 8-, 9 and 10 are determined by setting appropriate performance status flags resulting in the derivation of a default rating class. The rating and scoring processes are subject to continual monitoring. They are validated annually and are recalibrated or fundamentally revised as required. This ensures regular monitoring and review of all rating processes. In the case of new lending, a rating class must be determined for the borrower beforehand using the appropriate rating process. The rating is released by the responsible approval authority. A transformation table is used for the transformation of external issuer ratings so that internal ratings can be compared with external ratings. For this purpose, the only used ratings are from S&P, Moody s or Fitch. Rating systems used in the Bank under the IRB A approach As at year-end the Bank was authorized to use 13 IRB-A rating systems: RATING SYSTEM NUMBER OF PARTNERS AS AT NUMBER OF PARTNERS AS AT German corporates 1,387 1,366 Banks Multinational corporates Acquisition and leverage finance Commercial Real Estate finance Foreign corporate customers Small business customers Corporate treasuries/funding vehicles 6 6 Global project finance rating 7 9 Sovereign 7 8 Private customers Income producing Real Estate 2 8 Securities industries 9 10 From 2016 we consider the number of partners instead of number of ratings. Collateral and collateral management The methods used by the Bank to mitigate credit risk are based on the strict regulatory standards governing the so-called IRB-A approach. Taking the Bank s general lending policy as the guiding principle, the collateral management follows a body of regulations that begins by formulating a strategy. When procuring loan collateral from the customers or guarantors, particular care is exercised to ensure that the collateral agreement is legally enforceable. In new lending, the Bank pursues the strategy of applying all types of loan collateral that would yield an economic benefit to the Bank in case of default. This economic benefit may be derived from the liquidation of the collateral, but may also involve improving the Bank s position in dealings with third parties. This body of regulations is rounded off by various monitoring activities as well as, for example, the regular analysis of risk concentrations Annual Report UniCredit Luxembourg S.A.

61 Internal default risk model The internal default risk model is an internally devised model that offers the advantage of methodology and parameters perfectly matching Bank s portfolio. The IT platform used in connection with the internal default risk model makes it possible to determine the credit value-at-risk and regulatory capital requirements under Basel II in a manner consistent with the input parameters (PD, LGD and EAD), credit-risk reduction techniques (land charges, guarantees, etc.) and available data. Country risk is also determined by means of a portfolio model that consistently includes the corresponding risk parameters (PD, LGD) and correlations to default risk. Expected loss For purposes of default risk measurement, the Bank distinguishes between the expected loss and the unexpected loss (expressed as credit value-at-risk). The expected loss reflects the default losses expected from the current loan portfolio over the next twelve months, taking into account the assigned ratings and collateral on hand. Expected loss is a key parameter in risk management. Among other things, it is used for risk identification, as both an absolute and a relative value in pricing, and for profitability calculations. To calculate the expected loss, the exposure at default is calculated as stipulated by Basel II. For credit risk and country risk, this amount is equal to the line utilisation at the reporting date plus portions of the unused, externally committed credit lines. The calculation takes into account differences in the risk inherent in various credit types. The parameters assumed for measuring the exposure at default and the loss given default are based on long-term statistical averages derived from internal defaults and losses, and from external reference parameters. They comply with the strict quality requirements of Basel II (IRB-A approach). Credit value-at-risk The credit value-at-risk (unexpected loss) provides information about the maximum negative deviation of an actual loss from the expected loss (99.90% probability) within one year. This loss potential provides a figure that makes the inherent risk in the various sub-portfolios transparent. It is also used in pricing and in the Bank s profitability calculations. In addition, the credit value-at-risk is backed by economic capital as a safety cushion, taking portfolio effects into account. Scenario analysis The credit value-at-risk is calculated under the assumption of normal conditions. The scenario analysis helps to simulate the effects of future macroeconomic trends or exogenous shocks, and to quantify their impact on the potential losses in the credit portfolio of the Bank. In scenarios on possible economic trends, distinctions are made in terms of the severity of an economic downturn as well as regional variations. Measuring country risk In the Bank, country risk is measured mainly by using country ratings. Along with the probability of default (PD) and the loss given default (LGD), the measurement of country risk takes into account the structure of transactions in terms of its relevance to country risk. A portfolio model building on this information is used to calculate the value-at-risk (VaR) resulting from country risks for HVB Group every month, taking into account correlations to credit risk. Risk monitoring Risk monitoring takes place at the level of individual exposures. In addition, various instruments are used at the portfolio level. Individual exposures are monitored in both lending and trading operations with the aid of classical monitoring systems such as rating analysis and early warning systems. Individual exposure limits serve to limit the risks assumed. Counterparty risk and issuer risk Limit systems are used as a key element of the Bank s management and control of counterparty risk and issuer risk to prevent the unintended and uncontrolled increase of the risk positions. These systems are available online to all employees of the Bank engaged in trading activities. Each new trade is immediately entered and applied to the corresponding limit within an appropriate time frame. The nominal volume of derivatives transactions amounted to 9.6 billion (previous year: 6.8 billion). The counterparties of these derivative transactions are: HVB (nominal 6.8 billion), GELDILUX-TS-2013 (nominal 0.9 billion) and GELDILUX-TS-2015 (nominal 2.0 billion). Country Risk Country risk is managed on the basis of the measurement methods described above and geographical value-at-risk limits. VaR limits are in place for each region at HVB Group level. By taking into account the correlation to default risk, transactions with high levels of country risk and a greater correlation with the overall portfolio are given a higher weighting for inclusion in regional risk limits than transactions with lower levels. UniCredit Luxembourg S.A Annual Report 59

62 Notes to the financial statements (Continued) The internal risk management function provides support in risk monitoring particularly at the portfolio level. In compliance with the Minimum Standards for Risk Management (MaRisk) and CSSF (and/or ECB) requirements, the Supervisory and Management Board must receive a report on the risk concentration in the credit portfolio at least on a quarterly basis and on an ad-hoc basis as situations arise. Quantification and specification In the EGON portfolio there is a net decrease of 98 million compared to year-end 2015 (-1.42%), mainly determined by an increase in rating classes 1-4 of 25 million and a decrease in rating classes 5-8 of 96 million. Additionally, the volume for partners in rating class 9-10 and for partners which are not assigned to a current IRB-A rating system (not-rated partners) decreased about 5 million, respective 22 million. EGON Portfolio ( million) RATING Rating classes 1-4 4,059 4,034 Rating classes 5-8 2,721 2,817 Rating classes Not rated Total 6,796 6,894 1 Partners do not belong to an IRB-A rating method. In the Structured Finance portfolio we notice a net increase of 839 million compared to year-end 2015 (+ 4.93%), determined by an increase in rating classes 1-4 of 730 million and by 81 million in rating classes 5-8. In rating classes 9-10 an increase of 42 million could be noted. The non-rated exposure decreased by 14 million and amounts to 47 million at the end of Structured Finance Portfolio ( million) RATING Rating classes ,763 15,033 Rating classes 5-8 1,872 1,791 Rating classes Not rated Total 17,844 17,005 1 Of these rating classes an amount of 154 million (previous year: million) is collateralized. 2 Partners do not belong to an IRB-A rating method. In the Trade Finance Portfolio there is a net increase of 1,147 million compared to year-end 2015 (+56.14%), determined by an increase in rating classes 1-4 of 1,043 and by 137 million in rating classes 5-8. The non-rated exposure decreased by 33 million and amounted to 86 million at the end of Trade Finance Portfolio ( million) RATING Rating classes 1-4 2,850 1,807 Rating classes Rating classes Not rated Total 3,190 2,043 1 Partners do not belong to an IRB-A rating method Annual Report UniCredit Luxembourg S.A.

63 Analysis of the net volume by sector Producing industry LOANS AND OTHER BALANCE SHEET ITEMS COMMITMENTS AND CONTINGENT LIABILITIES OTC DERIVATIVE (POSITIVE MARKET VALUE) Agriculture 42,655 46, Automotive industry 534, ,161 1,592,239 1,359, Industry 363, ,863 1,746,236 1,073, Energy 502, , , , Construction 1,806,431 1,572, , , Other producing industry 1,785,319 1,791,175 3,028,342 3,442, Telecommunication 435, , , , Media 509, , , , Transport 317, , , , Aircraft 44,493 98, , , Tourism 95, , , , Trade 1,882,543 1,839,189 2,197,749 2,130, Other service industry 2,589,547 2,612, , , Financial sector Banks 5,038,570 4,555, , ,296 67,046 91,075 thereof affiliated Banks 3,657,265 3,404,225 1, ,046 91,075 Financial intermediaries 3,517,538 3,894, ,699 1,567, Insurance 31,323 28, Public authorities 91,261 94, Individuals 260, ,888 11, , Total 19,848,690 19,099,774 13,099,311 13,395,071 67,046 91,075 Analysis of the net volume per geographical area LOANS AND OTHER BALANCE SHEET ITEMS COMMITMENTS AND CONTINGENT LIABILITIES OTC DERIVATIVE (POSITIVE MARKET VALUE) OECD countries 19,201,734 18,654,942 13,098,668 13,395,071 67,046 91,075 Germany 12,696,761 12,033,748 7,957,292 7,181,535 67,046 91,075 Italy 246, ,880 9,283 5, of which UC Group 119, , of which public authorities 75,636 76, Luxembourg 2,575,636 3,207, ,569 1,410, Selected Eurozone debts 122, ,401 65,000 55, of which Spain 105, ,584 65,000 55, of which Portugal 16,819 13, of which Ireland - 62, Other EU 1,848,027 1,502,052 2,580,587 2,828, Other Europe (without EU) 1,339, ,161 1,661,069 1,755, North America 156, ,785 94, , Other OECD countries 215, , Non-OECD countries 646, , Europa 111,592 88, of which Russia 1 96,758 83, of which Ukraine Central and South America 56,034 57, Asia 334, , Africa 144,518 22, Total 19,848,690 19,099,774 13,099,311 13,395,071 67,046 91,075 1 In 2016 the exposure with Russia is guaranteed at 85.72% by HVB (previous year: 96.1%) and the exposure with Ukraine is fully guaranteed by UniCredit Austria. UniCredit Luxembourg S.A Annual Report 61

64 Notes to the financial statements (Continued) As part of the GELDILUX programme, all risks from a part of the on-line loans arranged by the HVB Group (EGON) with a contract volume of 2.9 billion (previous year: 2.9 billion) have been securitised, with the out-placings conducted as true sale transactions. The first loss tranches have been maintained by the Bank as indicated in Note 45. At the request of the Bank, the CSSF approved the full exemption of risks taken on UC Group in relation to the large exposure limits, in accordance with Part XVI, point 24 of the CSSF circular 10/475 (previous CSSF circular 06/273 as subsequently modified). Risk detail with selected Eurozone countries (Loans and other balance sheet items, detailed analysis) BANKS OTHER TOTAL Spain , , , , ,584 Portugal 5, ,701 13,299 16,819 13,412 Ireland ,405-62,405 Total 6,086 57, , , , ,401 Maximum exposure to credit risk at the reporting date without taking account of any collateral held or other credit enhancements Analysis of the net loan volume per balance sheet item before Specific/General Loan Loss Provision Non derivative assets 20,072,863 19,809,941 Cash and cash balances 206, ,166 Financial instruments measured at fair value 71,915 73,671 Available-for-sale financial instruments 327, ,233 Loans and receivables 19,413,862 18,616,870 with banks 4,706,869 4,149,506 with customers 14,706,993 14,467,364 thereof EGON loans 6,778,865 6,893,620 Other asstes 53,388 88,001 Derivative financial instruments 144, ,118 Financial assets held for trading 7,556 10,160 Hedging derivatives 59,490 80,915 Other 76,983 78,043 Off balance sheet items 13,099,311 13,395,071 Loan commitments 13,037,779 13,344,997 Financial gurantees 61,532 50,074 Total 33,316,203 33,374, Annual Report UniCredit Luxembourg S.A.

65 2. Market risk Risk management Market risk is defined as the potential loss arising from an adverse change in the financial market prices of the Bank s positions in the trading and banking book. Market risk comprises the risk categories: interest rate, foreign exchange, equity, credit spread and commodity risk. Measurement methods For purposes of day-to-day risk measurement and management, the Bank quantifies the value-at-risk on the basis of a confidence level of 99% and a holding period of one day. Due to the joint management of the trading and banking books, the value-at-risk is also shown as an aggregate value. The risks inherent in the trading and banking books continue to be shown separately for regulatory purposes. To determine and allocate the economic capital requirements for market risks, this value-at-risk, like other risk types, is scaled to a confidence level of 99.90% and a holding period of one year, taking diversification effects into account. To calculate the value-at-risk, the Bank uses the internal model Titan. The appropriateness of the methods used to measure market risk is checked by means of periodic back-testing that compares the value-at-risk calculations with the market value changes (hypothetical statement of comprehensive income) derived from the positions. In addition to calculating the value-at-risk, stress tests for the Bank are continually conducted to determine the potential losses in the market risk positions resulting from extreme market movements and extraordinary events. The scenarios examined range from large movements in interest rates, currency and equity markets through to disruptions in the underlying volatilities. Risk monitoring The Market risk positions in the trading and banking books are monitored using a uniform, hierarchical limit system that restricts the loss potential from market risk. The risk limits are approved annually by the Supervisory Board and adjusted as required. The overall limit of the Bank was decreased to 3 million beginning of the year 2015 due to expired bonds in the portfolio and lower credit spread risk. The risk values are reported daily along with the limit utilisation and the statement of comprehensive income figures to the Management Board and the responsible persons in the Treasury & Business Services Unit as well as to Chief Risk Officer area of HVB. Whenever limits are exceeded, an escalation process is triggered immediately and the reduction of the positions in question is monitored. Risk Control department has direct access to the front-office systems used in trading operations, and thus performs spot checks on the risk situation even during daily market trading. In 2016, one limit overdraft has been recorded. This overdraft was caused by the booking of the 2 billion pre-hedges for the TLTRO program. In addition to the daily reports, the Management Board is informed on a monthly basis on the results of the risk analysis, including the results of the back-testing and stress tests. Market risk operations are conducted by the Treasury & Business Services Unit within the prescribed limits. Structural rules imposed by HVB must be applied to own-fund operations. Based on a holding period of one day (converted to the HVB Group standard), the market risk of trading activities in 2016 (value-at-risk) was as follows: Market risk of trading activities ( million) AVERAGE FOR Interest rate positions Foreign exchange positions Total UniCredit Luxembourg S.A Annual Report 63

66 Notes to the financial statements (Continued) 3. Liquidity risk Risk Management Short-term liquidity risk For short-term Liquidity risk (the risk that the Bank will not be able to meet its payment obligations in full or in time), a cash-flow-oriented limit system is in place which tracks the relevant balances within the Bank per working day and limits the positions appropriately. In addition, stress analyses based on various scenarios enable the Bank to make projections on the impact of sudden disruptions on our liquidity position so that the Bank is in a position to take the necessary management measures as early as possible. Funding risk Funding risk (the risk of not being able to obtain sufficient liquidity or that it will be available only at higher market interest rates) of the Bank is wellmanaged due to diversified funding with regard to products, markets and investor groups. Market liquidity risk The management of Market liquidity risk (the risk that the Bank will be able to liquidate assets on the market only at a discount) is described in the section Market risk. The rules and principles of liquidity management are specified in a liquidity policy of the Bank. Measurement methods Short-term liquidity risk To measure short-term liquidity risk, cash flows are simulated on a daily basis. The resulting balances are compared with the available liquidity reserves, which consist primarily of the available highly liquid securities eligible at all times as collateral for central bank borrowings. Funding risk To measure Funding risk, long-term funding needs are determined through a coordinated process, which is based on the expected business development reported. The funding plan is updated as required. The long-term funding needs, which are used to set the funding targets, additionally take into account the assets and liabilities falling due in the period. Limiting maturity mismatches between the long-term assets and liabilities ensures a balanced funding structure in defined maturity buckets. Risk monitoring The monitoring of the HVB Group s liquidity situation is the responsibility of the Asset Liability Management unit. Monitoring the liquidity situation involves analysing and managing incongruities, which are limited for defined maturity periods through limits and refinancing targets. Compliance with the allocated limits is monitored on a daily basis and the long-term funding ratios are monitored monthly. Quantification and specification The liquidity situation of the Bank remained at an adequate level at all times. According to the new Capital requirements regulation (CRR) the Bank has to fulfil the Liquidity Coverage Ratio (LCR). At year-end the ratio was 113.6%, being well above the 70% regulatory minimum. The Bank has implemented a local ALCO (Asset Liabilities Committee). ALCO and the Management Board have approved a Liquidity policy for the Bank. The Bank is part of the liquidity management of the HVB Group Annual Report UniCredit Luxembourg S.A.

67 Structural Liquidity Ratio ( million) UP TO 1 > 1 > 2 S > 3 S > 4 S > 5 S NO IMPACT OTHER TOTAL Assets 16,760 1,249 1, , ,256 20,284 Liabilities 14,931 1,759 1,532 2, , ,215 20,284 Isolated gap 1, ,965 1,911-1, ,714 5,465 3,738 2, ,284-8,428 6,669 5,137 2,244 2,123 20,284 Cumulated gap - -1,714-1,204-1, , Ratio - 126% 122% 137% 80% 273% The Asset Liability position for the 4-5 years bucket had a larger volume shift on the liability side, moving out of the 4-5 years bucket into the 3-4y bucket, compared to the volume change on the asset side. This led to an overdraft of the given limitation. The overdraft was already expected during the month of December 2016 and properly addressed to HVB Finance. A solution is already in discussion. Encumbered and unencumbered assets ( ) Financial assets available to support future funding CARRYING AMOUNT OF ENCUMBERED ASSETS OF WHICH: CENTRAL BANK S ELIGIBLE FAIR VALUE OF ENCUMBERED ASSETS OF WHICH: CENTRAL BANK S ELIGIBLE CARRYING AMOUNT OF NON-ENCUMBERED ASSETS OF WHICH: CENTRAL BANK S ELIGIBLE FAIR VALUE OF NON-ENCUMBERED ASSETS OF WHICH: CENTRAL BANK S ELIGIBLE Assets of the reporting institution -6,166,559-3,256,177-2,122,421-2,122,421-14,152, , , ,381 Loans on demand -53, , Equity instruments Equity investments Others Other of witch: Own Shares Debt securities -2,101,742-2,101,742-2,122,421-2,122, , , , ,381 of which: covered bonds -250, , , ,871-71,915-71,915-71,915-71,915 of which: asset-backed securities -1,830,702-1,830,702-1,851,381-1,851, , ,562 - of which: issued by general governments -20,169-20,169-20,169-20,169-55,466-55,466-55,466-55,466 of which: issued by financial corporations -2,081,573-2,081,573-2,102,252-2,102, ,396-71, ,476-71,915 of which: issued by non-financial corporations , ,442 - Loans and advances other than loans on demand -4,011,816-1,154, ,360, , of which: mortgage loans -388,110-1, , Other assets , of which Equity Investments of which Others , of which Consolidation adjustments and accounts not to be deleted The table above shows the availability of the Bank s financial assets to support future funding. In 2015, the Bank has defined a dedicated risk management process specifically to identify, manage and report assets encumbrance. The monitoring framework provides timely information, at least once a year, to the Management Board and the Supervisory Board about Assets Encumbrance. UniCredit Luxembourg S.A Annual Report 65

68 Notes to the financial statements (Continued) 4. Operational risk Risk Management Operational risk is defined as the risk of losses resulting from inadequate or failed internal processes, human error, technological breakdowns or external events as well as fraud issues. Within the framework of the annually updated Risk Strategy, it is the objective of the Bank to reduce operational risk to a reasonable level from an economic standpoint meaning not necessarily to the lowest possible level. This economically optimal level depends on the underlying risk profile, the costs and the effectiveness of existing and potential measures (cost/benefit considerations), and the defined willingness to assume risk. Risks that are potentially grave or could seriously damage the bank must be subject to planned measures that go beyond mere profitability concerns. The operational risk manager is responsible for the operational implementation of the process, which involves in particular the collection, analysis, evaluation and quality assurance of risk data, and the planning of appropriate measures with continual monitoring of important risks. The departments Legal and Compliance are responsible for managing legal risk as well as strategic and operational compliance. Measurement methods With regard to operational risk under Basel II, the Bank has implemented AMA (advanced measurement approach) compliant processes and the application to use the AMA model was submitted to Bank of Italy via UC Group after sign off by the previous Board of Directors of the Bank. To quantify its operational risk the Bank was authorized to apply the Advanced Measurement Approach since beginning of Since autumn 2005, in addition to errors and faults that already occurred, all relevant risks were identified and evaluated in the course of interviews and workshops and recorded in the OpRisk ARGO-ART database of HVB. A schedule of causes, product catalogue and flow chart of measures are provided by HVB Group for this purpose. The Bank has agreed a binding OpRisk Rulebook and OpRisk Framework for his activity, laying down the basis for the handling of its operational risks. In addition, an extensive self-assessment (Internal Validation) was performed and documented in 2015 and will be updated yearly. Risk monitoring The focus in risk monitoring is on the further development of risk surveys and scenario analysis, the on-going monitoring of relevant risks and the ad-hoc analysis of current internal and external risk factors. This also reflects the areas of activity specified in our operational risk strategy. An intensive exchange takes place between the Operational Risk Management function and the relevant departments. Operational Risk Management function keeps the Management Board informed about any loss events that occur as well as important operational risks and their management through regular and comprehensive reporting. Quantification and specification For purposes of calculating regulatory capital for operational risk, UniCredit Luxembourg calculated the capital requirements for 2016 according to the Advanced Measurement Approach (AMA). The economic capital for operational risks of the Bank amounted to 56 million at the end of 2016 (year-end 2015: 80 million). 5. Business risk Risk management Business risk is defined as adverse, unexpected i.e. differing from the trend observed changes in business volume and/or margins which cannot be attributed to other types of risk. It can lead to serious losses in earnings, thereby diminishing the market value of a company. Business risk can result above all from a serious deterioration in the market environment, changes in the competitive situation or customer behaviour, and changes in the cost structure. As part of its cost and income responsibility, each business unit is responsible for the operational management of business risk Annual Report UniCredit Luxembourg S.A.

69 6. Real estate risk Risk Management Real estate risk is defined as the potential losses resulting from market value fluctuations of the UC Group s real estate portfolios, including real estate special purpose vehicles. It does not take into consideration properties held as collateral. Risk is measured with a Value-at-Risk (VaR) approach based on a confidence level of 99.90% and a holding period of one year. The VaR calculation is based upon the following risk factors: Fair or book value of the individual properties and land Volatility of the Real Estate indices Geographic location Property type Specific risks of the real estate holding 7. Reputational risk Risk management Reputational risk is the present or future risk to earnings or capital arising from an unfavourable view of the Bank s image by customers, counterparties, shareholders, investors and rating agencies or Supervisory Authorities. The assessment and valuation of reputational risk is a part of the Bank s general risk strategy. In the Bank s lending activities, special-sector policies are already being applied in addition to the general credit policy. The objective of these policies is to implement a particularly sensitive approach in certain industries, for instance the defence industry and utilities. This means not entering into certain business transactions in doubtful cases. 8. Strategic risk Risk management Strategic risk results from management either not recognizing or not correctly assessing significant developments or trends in the Bank s environment. As a consequence fundamental management decisions could in retrospective prove to be disadvantageous in terms of the Bank s long term goals. In addition, some decisions may be difficult to reverse or cannot be reversed at all. In the worst case this can impact earnings power and risk profile. 9. Pension risk Risk management Pension related risk results from potential changes of pension related assets and liabilities. A crucial impact factor for pension risks results from the change of market prices, e. g. the change of interest rate levels. Furthermore longevity issues are an important risk parameter (e. g. changes of the mortality table). Accordingly pension risks may be defined as the risk that a sponsor of a pension plan has to provide additional contributions in order to fulfil his commitments. Two pension arrangements are currently in place for the employees of the Bank. Risks may derive either on the asset side or on the liabilities side, e.g. a decrease of the market prices for assets but also increases of the liabilities because of lower discount rates ( Rechnungszins ). Furthermore, Longevity risks may occur within the pension plans. Accordingly, Pension risks may be defined as the risk that a sponsor of a pension plan has to provide additional contributions in order to fulfil his commitments. The arrangements in place are: A pension fund for all employees (Pension Invest) not having a special pension arrangement, which will payout the full commitment to each employee upon retirement; Special pension arrangements for 14 employees (ex UniCredit International Bank (Luxembourg) / ex Capitalia). The underlying Pension risk is estimated by the Bank and amounts to 3 million. To cover the related risks, a respective EC limit of 3 million (lump sum) was formed. UniCredit Luxembourg S.A Annual Report 67

70 Notes to the financial statements (Continued) (D) Segment reporting (21) Notes on segment reporting In 2013 the Bank, in line with the group project GOLD (Group Organization Leaner Design) redefined a new organizational set up aimed at bringing the UC Group closer to customers with the objective of getting a better performance in three ways by: improving the business model to better respond to clients needs; preserving and reinforcing the value of being part of an international group through a Holding with a strong and clearly defined role versus the regions that will be responsible for local commercial banking; simplifying activities and processes both at global and local levels, thus allowing faster decision making and maximizing group synergies. As a result, starting from 2013 the Bank is monitoring results in the following segments: Commercial Banking (inclusive Retail, Corporate and Private Banking) and Corporate & Investment Banking. Segment reporting methodology The divisions are autonomous entities, with their own equity capital allocated and responsibility for their results. They are divided up according to the customer groups that they serve. Segment reporting, defined in the Bank as internal financial reporting, is based on the before mentioned internal organisational and management structure. In accordance with IFRS 8 (Operating Segments), segment reporting thus follows the Management Approach, which requires segment information to be presented externally in the same way as regularly used by the Management Board as the responsible management body when allocating resources to the business segments and assessing profitability. In this context, the segment data is determined in accordance with International Financial Reporting Standards (IFRS). The total revenues shown in the segments, such as net fees and commissions and net trading profit, are based almost exclusively on transactions involving external customers. Net interest income is assigned to the segments in accordance with the market interest calculation method on the basis of the external interest income and interest expenses. For this reason a separate presentation broken down by external/internal revenues (total revenues) has been included. The core capital allocation to the divisions in 2016 amounts to 11.00% of their risk-weighted assets. The percentage used to charge core capital assigned to the divisions is composed by a 6-year average of reference rates and an equity risk premium depending on division. In 2016 the equity cost rate ranged between 8.70% (Commercial banking) and 9.65% (CIB). The compensatory equity benefit rate decreased from 2.38% in 2015 to 1.88% in Operating costs, which contain staff expenses, other operating costs, amortization, depreciation and impairment losses on intangible and tangible assets, are split between the divisions according to where they have incurred. For costs that are not directly allocable, overheads allocation keys are set for each division in the budgeting process and applied on the direct and indirect costs for the financial year in question. Corporate & Investment Banking Clients The range of products offered by Corporates and Investment Banking stretches from plain vanilla and core banking relationships to sophisticated structured finance solutions and advisory services offered to small and medium sized enterprises as well as to large and multinational corporate clients, equity funds and real estate clients. The Bank offers primarily structured products and tailor made services to the customers of the CIB Division, typically large multinational companies. Corporate & Investment Banking Markets Corporate and Investment Banking Markets activities are primarily dedicated to an efficient and effective management of our banking book. A special focus is also given to funding needs by the implementation of several actions for both short and medium term liquidity management and to the execution of customers orders and of derivative transactions. Commercial Banking Corporate The Bank provides specialized products and services to group corporate customers, originated by HVB. The added value which the Bank is able to contribute derives from its experience in the handling of the fully automated processing of standardised loans and deposits originated and referred to the Bank by the German branches of HVB, the so-called EGON business (EuroGeschäft ONline). A part of the EGON-loan portfolio is securitised through Europe s largest funded ABS-program known as GELDILUX. Trade financing, including supply chain finance products such as Trade/Purchase, and fiduciary arrangements are two other relevant businesses of the Bank Annual Report UniCredit Luxembourg S.A.

71 Commercial Banking Private Banking The strategy of the Private Clients Division focuses on the needs and requests of (Ultra) High Net Worth Individuals ((U)HNWI), offering specifically tailored services and solutions. The Bank s product/service approach is primarily aimed at supporting our on-shore networks and customers. The strong cooperation with the on-shore network in this field can help to improve the relation acquisition capacity for UniCredit Luxembourg Private Banking business. The real advantage of Luxembourg is not in the single product or the single service but in the global and integrated offer of them. Along various banking solutions, bank insurance and the set-up of private companies still constitute important pillars of our business. The individual solutions tailored by the Bank through life insurance policies also remained popular with its clients. The Bank will concentrate on offering to the remaining clients solutions fully aligned with the regulations of the country of residence of our customers. Income statement by division CORPORATE & INVESTMENT BANKING COMMERCIAL BANKING OTHER/ PRIVATE BANKING CONSOLI- DATION CLIENTS MARKETS CORPORATE TOTAL TOTAL REVENUES ,174 4,766 59,460 17,259 14, , ,756 3,592 56,613 18,355 13, ,974 Operating costs ,429-5,100-8,553-8,451-59,564-90, ,003-5,327-9,198-8,975-11,324-43,827 OPERATING PROFIT , ,907 8,808-44,948 45, ,753-1,735 47,415 9,380 2, ,147 Net write-downs of loans and provisions for guarantees and commitments , ,918 Other items , ,014 PROFIT BEFORE TAX , ,995 9,282-44,282 45, ,009-1,673 43,327-9,283 1,835 96,215 TAXES , ,041-2,646 12,297-9, , ,660-2, ,972 NET PROFIT , ,954 6,636-31,985 35, ,053-1,184 30,667-12, ,243 The Bank s revenue mainly arises from business relations with contracting parties in Germany. UniCredit Luxembourg S.A Annual Report 69

72 Notes to the financial statements (Continued) Income statement for CIB Clients REVENUES/EXPENSES TH QUARTER 3 RD QUARTER ND QUARTER 1 ST QUARTER 2015 Net interest income 29,409 6,028 7,679 8,269 7,433 57,867 Net commission income 9,838 2,312 2,636 2,706 2,184 10,764 Change in prices of financial instruments Net other expenses/income ,068 Net non-interest income 9,765 2,317 2,514 2,716 2,218 13,889 TOTAL REVENUES 39,174 8,345 10,193 10,985 9,651 71,756 Staff expenses -3, ,349 Other operating costs and amortisation, depreciation and impairment losses on intangible and tangible assets -2, ,333 Cost allocation -2, ,321 Operating costs -8,429-1,733-1,901-2,489-2,306-9,003 OPERATING PROFIT 30,745 6,612 8,292 8,496 7,345 62,753 Provisions for risks and charges Net write-downs of loans and provisions for guarantees and commitments ,088-1, PROFIT BEFORE TAX 31,050 6,427 9,386 7,313 7,924 62,009 TAX -5, ,427-1,645-1,762-15,956 NET PROFIT 25,298 5,509 7,959 5,668 6,162 46,053 Income statement for CIB Markets 2016 REVENUES/EXPENSES TH QUARTER 3 RD QUARTER 2 ND QUARTER 1 ST QUARTER 2015 Net interest income 4,124 2, ,380 3,045 Net commission income Change in prices of financial instruments 1, , Net other expenses/income Net non-interest income TOTAL REVENUES 4,766 3,572 1, ,592 Staff expenses -1, ,398 Other operating costs and amortisation, depreciation and impairment losses on intangible and tangible assets Cost allocation -3, ,635 Operating costs -5,100-1,101-1,338-1,326-1,335-5,327 OPERATING PROFIT , , ,735 Provisions for risks and charges Net write-downs of loans and provisions for guarantees and commitments PROFIT BEFORE TAX , , ,673 TAX NET PROFIT , , , Annual Report UniCredit Luxembourg S.A.

73 Income statement for Commercial Banking Corporate REVENUES/EXPENSES TH QUARTER 3 RD QUARTER ND QUARTER 1 ST QUARTER 2015 Net interest income 57,037 13,467 15,539 14,475 13,556 53,645 Net commission income 2, ,969 Net other expenses/income Net non-interest income 2, ,968 TOTAL REVENUES 59,460 14,134 16,107 15,200 14,019 56,613 Staff expenses Other operating costs and amortisation, depreciation and impairment losses on intangible and tangible assets -1, Cost allocation -7,056-1,346-1,585-2,036-2,089-8,326 Operating costs -8,553-1,495-1,603-2,920-2,535-9,198 OPERATING PROFIT 50,907 12,639 14,504 12,280 11,484 47,415 Provisions for risks and charges Net write-downs of loans and provisions for guarantees and commitments ,088 PROFIT BEFORE TAX 49,995 13,251 14,211 11,900 10,633 43,327 TAX -14,041-3,289-4,038-3,547-3,167-12,660 NET PROFIT 35,954 9,962 10,173 8,353 7,466 30,667 Income statement for Commercial Banking Private Banking 2016 REVENUES/EXPENSES TH QUARTER 3 RD QUARTER 2 ND QUARTER 1 ST QUARTER 2015 Net interest income 11,432 2,578 2,649 3,253 2,952 12,351 Net commission income 5,708 1,353 1,271 1,293 1,791 5,843 Change in prices of financial instruments Net other expenses/income Net non-interest income 5,827 1,353 1,350 1,299 1,825 6,004 TOTAL REVENUES 17,259 3,931 3,999 4,552 4,777 18,355 Staff expenses -1, ,175 Other operating costs and amortisation, depreciation and impairment losses on intangible and tangible assets Cost allocation -5,802-1,358-1,440-1,485-1,519-6,110 Operating costs -8,451-1,848-2,098-2,278-2,227-8,975 OPERATING PROFIT 8,808 2,083 1,901 2,274 2,550 9,380 Provisions for risks and charges ,586 Net write-downs of loans and provisions for guarantees and commitments PROFIT BEFORE TAX 9,282 2,519 2,007 2,118 2,638-9,283 TAX -2, ,869 NET PROFIT 6,636 1,876 1,415 1,488 1,857-12,152 UniCredit Luxembourg S.A Annual Report 71

74 Notes to the financial statements (Continued) Income statement for Other/Consolidation REVENUES/EXPENSES TH QUARTER 3 RD QUARTER ND QUARTER 1 ST QUARTER 2015 TOTAL REVENUES 14,616 4,362 2,588 4,035 3,631 13,658 Operating costs -59,564-55,107-1,462-1,468-1,527-11,323 OPERATING PROFIT -44,948-50,745 1,126 2,567 2,104 2,335 Provisions for risks and charges Net write-downs of loans and provisions for guarantees and commitments PROFIT BEFORE TAX -44,282-50,079 1,126 2,567 2,104 1,835 TAX 12,297 14, NET PROFIT -31,985-35, ,846 1, Volume figures by division CORPORATE & INVESTMENT BANKING COMMERCIAL BANKING OTHER/ CIB OTHER MARKETS CORPORATE PRIVATE BANKING CONSOLI- DATION Loans and receivables with banks ,492,002 2,290, , ,706, ,417 2,442, , ,140,533 Loans and receivables with customers ,160,285 2,758 8,763, ,258 2,398,226 14,706, ,539,346 19,314 8,483,861 1,042,258 2,355,959 14,440,738 Deposits from banks ,908, ,876 14,239, ,060 13,980, ,393 14,315,541 Deposits from customers , ,169 2,858,549 4,310, , , ,792 2,855,069 3,934,471 Risk-weighted assets ,263,261 42,871 3,083, , ,498 4,818, ,068,365 67,512 3,125, , ,374 4,767,114 TOTAL Annual Report UniCredit Luxembourg S.A.

75 (E) Notes to the statement of comprehensive income (22) Net interest income Interest income from Central Bank of Luxembourg balances from held-for-trading financial instruments 2,612 6,412 from financial instruments measured at fair value through profit and loss 1,879 2,328 from available-for-sale financial instruments 1,570 3,696 from loans and receivables 331, ,157 from hedging derivatives 26,094 35,549 other interest income 16,823 10,483 Interest expense from Central Bank of Luxembourg liabilities from held-for-trading financial instruments -20,009-10,178 from financial instruments measured at fair value through profit and loss -1,835-2,113 from financial instruments measured at amortised cost -64, ,647 from hedging derivatives -12,260-10,934 other interest expense -175, ,323 Net interest income 105, ,987 Interest income includes fees that are an integral part of the effective interest rate of a financial instrument. Other interest expense includes as well the amounts paid to HVB for the mediation of structured finance business ( thousand, previous year: 78,891 thousand). The Interest income from this business is recognized in Interest income from loans and receivables (see above). The Bank recognized grants (investment tax credits) according to IAS 20 in profit and loss as interest income on a systematic basis over the same periods in which the entity recognized as expenses the related costs (funding costs and participation fee) for which the grants are intended to compensate. In 2016 an amount of 3,671 thousand (previous year: 7,955 thousand) was recognized as interest income and an amount of 2,806 thousand (previous year: 4,543 thousand) as interest expenses with regard to these grants. Interest income on impaired loans amount to 0.4 thousand (previous year: 1.1 thousand). (23) Net commission income Fee and commission income from lending business 16,642 24,767 Fee and commission income from asset management Other fee and commission income 15,150 12,684 Fee and commission expense -11,909-16,036 Total 20,452 21,811 UniCredit Luxembourg S.A Annual Report 73

76 Notes to the financial statements (Continued) Fee and commission income from lending business Commitment fee 7,323 7,597 Participation fee 3,370 4,921 Arrangement fee 96 5,148 Utilisation fee - 2 Underwriting fee Management fee Guarantee fee 1,755 2,931 Agency fee 845 2,794 Upfront fee 2,983 - Event fee Transfer fee Other Total 16,642 24,767 Other fee and commission income Servicing fee GELDILUX 5,819 3,407 Advisory fee funds Custody fee 2,590 2,592 Account management fee Insurance products 3,187 3,938 Commission fee on transactions 1,937 2,206 Commission income Treasury Commission on security lending Other Total 15,150 12,684 Fee and commission expense includes the amounts paid to HVB for the mediation of structured finance business ( 4,128 thousand, previous year: 11,020 thousand after restatement). The fee and commission income from this business is recognized in fee and commission income from lending business (see above). Additionally the fees for bond lending and custody fees are disclosed in this position ( 4,924 thousand, previous year: 2,334 thousand). (24) Net income from investments Loans and receivables - 58 Total - 58 (25) Net trading income Held for trading Interest rate instruments and related derivatives Foreign exchange trading 1, Fair value option Financial instruments measured at fair value through profit and loss Total 1, The net income from those portfolios measured at fair value through profit and loss (held for trading, fair value option) contains only changes in fair value taken through the statement of comprehensive income. Interest income from these portfolios is shown under net interest income Annual Report UniCredit Luxembourg S.A.

77 (26) Net other expenses/revenues Other income 9,323 12,701 Other expenses -1,339-3,225 Total 7,984 9,476 Other income consists principally of claims for reimbursements arising from securitisation transactions (GELDILUX true sale). It also includes income from the Bank s service provider function and rental income. Other expenses consist mainly of current expenses (including repairs and maintenance) of investment property. (27) Operating costs Staff expenses -71,896-26,039 Wages and salaries -68,570-22,345 Social security costs -1,883-2,002 Pension costs -1,179-1,232 Share based payments Other employee benefit costs Other operating costs -15,312-15,152 Amortisation, depreciation and impairment losses -2,889-2,636 on property, plant and equipment -1,487-1,410 on investment property on software and other intangible assets excluding goodwill Total -90,097-43,827 Staff expenses include a provision of 52.0 million restructuring costs related to staff reductions in line with the Group wide strategic plan Transform Other operating costs include provisions for 1.9 million restructuring costs related to the Group wide strategic plan Transform Please refer to note 66 for further details. Pension costs include 336 thousand for the benefit pension plan (see Note 51, previous year: 342 thousand) and 479 thousand for the contribution pension plan (previous year: 486 thousand). Cash-settled share-based payments of 108 thousand have been booked in 2016 (previous year: 118 thousand). See Note 17 for more information on employee benefit plans of the Bank. Lease payments relating to operating leases of company cars for selected employees where the Bank acts as lessee are recognized in other operating costs. The corresponding leased assets are not recognised in the statement of financial position. Contracts in which the Bank acts as lessee are comparatively insignificant. (28) Provisions for risks and charges This position includes mainly the release of the AGDL provision. An amount of 662 thousand has been reversed in 2016 (previous year: 493 thousand). The AGDL provision is at 31 December 2016 fully reversed. UniCredit Luxembourg S.A Annual Report 75

78 Notes to the financial statements (Continued) (29) Net write-downs of loans and provisions for guarantees and commitments Loans & Receivables Addition to loan loss provisions Reversal of loan loss provisions Addition to general loan loss provisions ,849 Total ,918 (30) Income tax for the year Current taxes -22,380-31,872 Deferred taxes 11, Adjustments for prior years Total -9,998-31,972 The tax rate applicable for current taxes in the year under review was constant at 29.22%. The tax rate applicable for deferred taxes in the year under review is 27.08% (previous year: 29.22%). Reconciliation of effective tax rate % MILLION % MILLION Profit before income tax Income tax using local tax rate Tax exempt income/expense Non-tax deductible provisions or costs Tax incentives Other Deferred tax Total income tax expense (current and deferred taxes without adjustments for prior years) Current taxes Current year -22,380-31,872 Adjustments for prior years Total -21,527-32,016 Deferred taxes Temporary differences 11, Total 11, Annual Report UniCredit Luxembourg S.A.

79 In 2016, the Bank decided to reverse in its fiscal balance sheet an amount of 38.8 million from the item Special items with a reserve quota portion (article 54 of the Luxembourg Income Tax Law) into its fiscal statement of comprehensive income, as the reinvestment to which the capital gains realized in the past were allocated, has been terminated and no new reinvestment has been assigned. As consequence, the neutralized capital gains realized in the past became taxable and the related deferred taxes ( 11.4 million) have been transferred from deferred to current taxes. Deferred tax assets and liabilities are measured at the tax rates that are expected to apply to the period when the asset is realized or the liability is settled, based on tax rates/laws that have been enacted or substantively enacted by the end of the reporting period. On 14 December 2016, the Luxembourg parliament voted the 2017 tax reform bill. The aggregate tax rate applicable to the Bank decreases from 29.22% to 27.08%. The impact on the deferred taxes amounts to 0.7 million. Income tax recognized in other comprehensive income Cash flow hedge reserve Before tax 7,942 4,223 Deferred taxes (see Note 49) -2,151-1,234 Net of taxes 5,791 2,989 Available for sale reserve Before tax 2,067 4,357 Deferred taxes (see Notes 43 and 49) ,273 Net of taxes 1,507 3,084 Remeasurement of defined benefit liability Before tax 1,392 1,323 Deferred taxes (see Notes 43 and 49) Net of taxes 1, UniCredit Luxembourg S.A Annual Report 77

80 Notes to the financial statements (Continued) (F) Notes to the statement of financial position (31) Cash and cash balances with central banks Cash and cash equivalents include cash on hand and in central bank accounts. To improve its LCR-ratio the Bank maintained in 2016 an appropriate balance with central banks. Cash on hand Cash balances with central banks 206, ,034 Total 206, ,166 (32) Financial assets held for trading Positive fair values from derivative financial instruments 7,556 10,160 Total 7,556 10,160 The financial assets held for trading do not include any subordinated assets. They include assets of 7,556 thousand from the parent company (previous year: 10,160 thousand). (33) Financial instruments measured at fair value through profit and loss Fixed-income instruments 71,915 73,671 Total 71,915 73,671 The financial assets measured at fair value through profit and loss do not include any subordinated assets. They include assets of 71,915 thousand (previous year: 73,671 thousand) from the parent company. (34) Available-for-sale financial instruments Fixed-income instruments 326, ,441 Equity instruments Total 327, ,233 As in the previous year the available-for-sale financial assets do not include any subordinated assets or any overdue financial instruments. They include assets of 250,871 thousand (previous year: 332,273 thousand) from related entities, thereof 250,871 thousand from the parent company ( 252,282 thousand in previous year) Annual Report UniCredit Luxembourg S.A.

81 (35) Loans and receivables with banks Current accounts 83,019 31,308 Other loans and receivables 4,623,850 4,109,225 Total 4,706,869 4,140,533 As in previous year no subordinated loans and receivables were held. The portfolio of loans and receivables with banks contains overdue loans and receivables of 1,145 thousand on which no impairment has been made (previous year: 0 thousand). The amount has been repaid beginning of January Loans and receivables with banks, by term Repayable on demand and indefinite term 92, ,800 With residual maturities 4,613,958 4,017,733 up to 3 months 2,313,937 1,948,130 from 3 months to 1 year 1,226, ,570 from 1 year to 5 years 603, ,944 over 5 years 470, ,089 Total 4,706,869 4,140,533 Loans and receivables with banks are disclosed net of impairments. They break down as follows: UNIMPAIRED LOANS AND RECEIVABLES IMPAIRED LOANS AND RECEIVABLES ALL LOANS AND RECEIVABLES CARRYING AMOUNT BEFORE ALLOWANCE FOR LOSSES ALLOWANCE FOR LOSSES CARRYING AMOUNT CARRYING AMOUNT BEFORE ALLOWANCE FOR LOSSES ALLOWANCE FOR LOSSES CARRYING AMOUNT CARRYING AMOUNT BEFORE ALLOWANCE FOR LOSSES ALLOWANCE FOR LOSSES CARRYING AMOUNT ,150,691 10,158 4,140, ,150,691 10,158 4,140, ,716,964 10,095 4,706, ,716,964 10,095 4,706,869 Loans and receivables with related parties Related parties 3,334,479 2,998,281 thereof parent company 2,972,340 2,701,835 Total 3,334,479 2,998,281 (36) Loans and receivables with customers Current accounts 156, ,563 Mortgage loans (only employees) Debt securities 2,201,466 2,154,195 Other loans and receivables 12,348,677 11,597,878 Total 14,706,993 14,440,737 The previous year figures were adjusted by an amount of 272,569 thousand. Loans and receivables with customers include 59,033 thousand (previous year: 23,933 thousand) of subordinated assets. The portfolio of loans and receivables with customers contains 0 thousand overdue loans and receivables on which no impairment has been made (previous year: 644 thousand). UniCredit Luxembourg S.A Annual Report 79

82 Notes to the financial statements (Continued) Loans and receivables with customers, by term Repayable on demand and indefinite term 164, ,746 With residual maturities of 14,542,132 13,447,991 up to 3 months 4,667,985 4,317,640 from 3 months to 1 year 1,554,579 1,180,322 from 1 year to 5 years 7,386,592 4,793,490 over 5 years 932,976 3,156,539 Total 14,706,993 14,440,737 Loans and receivables with customers are disclosed net of impairments. They break down as follows: UNIMPAIRED LOANS AND RECEIVABLES IMPAIRED LOANS AND RECEIVABLES ALL LOANS AND RECEIVABLES CARRYING AMOUNT BEFORE ALLOWANCE FOR LOSSES ALLOWANCE FOR LOSSES CARRYING AMOUNT CARRYING AMOUNT BEFORE ALLOWANCE FOR LOSSES ALLOWANCE FOR LOSSES CARRYING AMOUNT CARRYING AMOUNT BEFORE ALLOWANCE FOR LOSSES ALLOWANCE FOR LOSSES CARRYING AMOUNT ,485,559 44,822 14,440, ,485,572 44,835 14,440, ,747,890 45,107 14,702,783 4, ,209 14,752,300 45,307 14,706,993 Loans and receivables with related parties Related parties 2,700,835 2,706,358 Total 2,700,835 2,706,358 (37) Allowances for losses on loans and receivables with banks and customers Changes in volume SPECIFIC LOAN-LOSS PROVISIONS 2015 PORTFOLIO LOAN-LOSS PROVISIONS Balance at ,136 50,373 Changes affecting income Gross additions -- 4,849 4,849 Reversals Changes not affecting income Utilisation of existing allowances for losses Balance at ,985 54,998 TOTAL Changes in volume SPECIFIC LOAN-LOSS PROVISIONS 2016 PORTFOLIO LOAN-LOSS PROVISIONS Balance at ,985 54,998 Changes affecting income Gross additions Reversals Balance at ,207 55,407 TOTAL The portfolio loan-loss provisions include the maintained lump sum provision ( provision forfaitaire ) Annual Report UniCredit Luxembourg S.A.

83 The carrying volume of loans whose terms have been renegotiated and that would otherwise be past due or impaired amounts to 176,979 thousand (previous year: 147,777 thousand). Additions and reversals affecting income are shown under net write-downs of loans and provisions for guarantees and commitments. (38) Hedging derivatives This item shows positive (assets) or negative (liabilities) fair values of interest rate swaps used as hedging instruments against interest rate risk. 59,490 thousand from the assets (previous year: 80,915 thousand) and 71,262 thousand of the liabilities (previous year: 73,755 thousand) are from the parent company. (39) Fair value changes of the hedged items in portfolio hedge of interest rate risk The fair value changes of the hedged items in portfolio hedge are not attributable to individual assets or liabilities and therefore are accounted for in separate line items in the statement of financial position. (40) Property, plant and equipment PROPERTY, PLANT AND EQUIPMENT USED FOR OPERATIONAL PURPOSES Land and buildings 27,757 28,592 Plant and office equipment 2,602 2,698 Total 30,359 31,290 Changes in property, plant and equipment LAND AND BUILDINGS 2015 PLANT AND OFFICE EQUIPMENT PROPERTY, PLANT AND EQUIPMENT Acquisition cost at ,963 10,873 54,836 Write-downs and write-ups from previous years -14,626-8,592-23,218 Carrying amount at ,337 2,281 31,618 Additions Purchases ,082 Decreases Depreciation ,410 Carrying amount at ,592 2,699 31,290 Depreciation on sales - -2,372-2,372 Revaluations/impairments from previous years and the reporting year 15,484 9,143 24,628 Acquisition cost at ,076 9,470 53,546 UniCredit Luxembourg S.A Annual Report 81

84 Notes to the financial statements (Continued) Changes in property, plant and equipment LAND AND BUILDINGS 2016 PLANT AND OFFICE EQUIPMENT PROPERTY, PLANT AND EQUIPMENT Acquisition cost at ,076 9,470 53,546 Write-downs and write-ups from previous years -15,484-6,771-22,255 Carrying amount at ,592 2,699 31,291 Additions Purchases Decreases Depreciation ,487 Carrying amount at ,757 2,603 30,360 Depreciation on sales Revaluations/impairments from previous years and the reporting year 16,350 7,392 23,742 Acquisition cost at ,107 9,679 53,786 Depreciation on property, plant and equipment is shown under amortisation, depreciation and impairment losses on intangible and tangible assets, which falls under operating costs. (41) Investment property The fair value of investment property, which is measured at amortised cost, totalled 52 million (previous year 52 million). The appraisals prepared to calculate the fair values are based on recognised appraisal methods used by external assessors, primarily taking the form of asset-value and grossrental methods. Investment property Land and buildings 22,446 23,214 Total 22,446 23,214 Acquisition cost at ,052 58,005 Write-downs and write-ups from previous years -34,838-34,240 Carrying amount at ,214 23,765 Additions Purchases Decreases Depreciation Carrying amount at ,446 23,214 Depreciation on sales Revaluations/impairments from previous years and the reporting year 35,665 35,061 Acquisition cost at ,111 58,052 The rental income from investment property amounted to 3,114 thousand (previous year: 3,114 thousand). The direct operating expenses (including repairs and maintenance) arising from investment property, generating rental income, was 817 thousand (previous year: 923 thousand). The direct operating expenses, not generating rental income, amounted to 235 thousand (previous year: 239 thousand). Depreciation on investment property is shown under amortisation, depreciation and impairment losses on intangible and tangible assets which falls under operating costs Annual Report UniCredit Luxembourg S.A.

85 (42) Intangible assets Intangible assets consist of software. Changes in intangible assets Acquisition cost at ,037 9,112 Write-downs and write-ups from previous years -6,215-8,191 Carrying amount at , Additions Purchases 118 1,306 Decreases Depreciation Impairments Carrying amount at ,365 1,822 Depreciation on sales ,381 Revaluations/impairments from previous years and the reporting year 6,791 8,596 Acquisition cost at ,977 8,037 Depreciation on intangible assets is shown under amortisation, depreciation and impairment losses on intangible and tangible assets, which falls under operating costs. (43) Tax assets Since 2014 the Bank offsets deferred tax assets and deferred tax liabilities by applying the netting conditions of IAS (44) Other assets Other assets consist principally of accruals, claims from non-banking business and reimbursement claims arising from securitisation transactions. Furthermore, this position includes tax receivables of 15,007 thousand (previous year: 52,610 thousand) and accruals of 12,546 thousand (previous year: 8,306 thousand) for the arrangement fee of four structures in connection with grants (investment tax credit). The Bank recognized these accruals according to IAS 20 in the statement of comprehensive income as interest expenses on a systematic basis over the same periods in which the entity recognized the grants as interest income (see Note 22). (45) Securitisation Securitisation is the full or partial transfer of credit risks pertaining to a loan portfolio defined precisely in advance to the capital market. The objective of the Bank s securitisation programme is to reduce the credit risk of the lending portfolio as well as the capital requirements and/or to obtain medium/long-term financing. This risk transfer and the consequent easing of capital requirements is achieved in the case of traditional securitisations through the true sale of balance sheet assets. As at 31 December 2016, the lending volume of the Bank s entire ongoing securitisation programme stood at 2,852 million (previous year: 2,852 million), without reduction of risk-weighted assets (as in previous year). The loans and receivables included in the true sale transactions continue to be shown in full in the balance sheet at their carrying amount. In securitisation programmes, a small portion of the risks are retained by the originator in the form of first and second loss pieces (the most subordinated tranches). The first and second loss pieces retained by the Bank for the securitisation tranches listed below are 78 million in total (previous year: 78 million). UniCredit Luxembourg S.A Annual Report 83

86 Notes to the financial statements (Continued) NAME OF TRANSACTION MATURITY EXPECTED MATURITY TYPE OF LOAN/ RECEIVABLE LENDING VOLUMES (IN MILLION) REDUCTION IN RISK- WEIGHTED ASSETS (IN MILLION) GELDILUX-TS Euroloans GELDILUX-TS Euroloans 2,000 - Total 2,852 - (46) Liabilities to banks Liabilities to central banks 2,800,000 1,900,026 Liabilities to banks 11,439,678 12,415,515 Current accounts 1,631 65,697 With agreed maturities 11,438,047 12,349,818 Total 14,239,678 14,315,541 Liabilities to banks include 320,875 thousand of subordinated liabilities towards the parent company (previous year: 322,393 thousand), see Note 53. Liabilities to banks, by term Liabilities to banks include 322,393 thousand of subordinated liabilities towards the parent company (previous year: 323,718 thousand, see note 55). Repayable on demand and indefinite term 15, ,518 With residual maturities of 14,223,946 14,016,023 up to 3 months 3,570,888 6,782,331 from 3 months to 1 year 4,430,307 3,294,583 from 1 year to 5 years 5,445,976 3,250,500 over 5 years 776, ,609 Total 14,239,678 14,315,541 Liabilities to related parties Related companies 10,938,075 11,532,195 thereof parent company 10,938,052 11,530,635 Total 10,938,075 11,532,195 (47) Deposits from customers Current accounts 547, ,206 Other deposits 3,763,247 3,487,265 Total 4,310,355 3,934,471 The previous year figures were adjusted by an amount of 272,569 thousand Annual Report UniCredit Luxembourg S.A.

87 Deposits from customers, by term Repayable on demand and indefinite term 1,075, ,350 With agreed maturities of 3,234,531 3,017,121 up to 3 months 65, ,568 from 3 months to 1 year 309,702 37,992 from 1 year to 5 years 2,857, ,461 over 5 years 1,969 2,002,100 Total 4,310,355 3,934,471 Deposits from related parties Related companies 2,865,334 2,864,311 Total 2,865,334 2,864,311 (48) Financial liabilities held for trading Financial liabilities held for trading consist solely of negative fair values of derivative financial instruments, of which 84,339 thousand are from the parent company (previous year: 37,197 thousand). (49) Tax liabilities Current taxes 5,155 45,672 Deferred taxes 2,892 14,228 Total 8,047 59,900 Detail of deferred taxes Cash flow hedge reserve (see Note 30) 2,150 1,234 AfS reserve (see Notes 30 and 43) 560 1,273 Other reserves ,721 Total 2,892 14,228 Since 2014 the Bank offsets deferred tax assets and deferred tax liabilities by applying the netting conditions of IAS (50) Other liabilities Other liabilities consist substantially of accruals of commissions to be paid or retroceded in the context of structured finance transactions. The position includes also an amount of 306 thousand for share-based payments (previous year 427 thousand). Furthermore this position includes accruals of 8,887 thousand for grants (investment tax credit, previous year 15,658 thousand). The Bank recognized these accruals according to IAS 20 in the statement of comprehensive income as interest income on a systematic basis over the same periods in which the entity recognized the related costs (funding costs and participation fee) for which the grants are intended as interest expenses (see Note 22). UniCredit Luxembourg S.A Annual Report 85

88 Notes to the financial statements (Continued) (51) Provisions Provisions for pensions and similar obligations 1,427 1,402 Provisions for restructuring 59,131 5,797 Other provisions 2,376 23,585 Deposit guarantee fund (AGDL) Total 62,934 31,446 Changes in provisions PROVISIONS FOR PENSIONS AND SIMILAR OBLIGATIONS PROVISIONS FOR RESTRUC- TURING OTHER PROVISIONS DEPOSIT GUARANTEE FUND (AGDL) As at ,403 5,797 23, ,446 Changes arising from currency translation Additions 93 53, ,195 Reversals , ,883 Utilisation , ,755 As at ,427 59,131 2,376-62,934 TOTAL Provisions for restructuring are principally due to staff downsizing measures of the previous year and the additions to the Group wide strategic plan Transform Please refer to note 66 for further details. Other provisions consist of provisions for claims of damages and litigation costs. The law dated 18 December 2015 transposed into Luxembourg law EU Directive 2014/59/EU establishing a framework for the recovery and resolution of credit institutions and investment firms ( BRRD ) and EU Directive 2014/49/EU on deposit guarantee schemes ( DGSD ). The significant changes introduced by the law were the following: implementation of the resolution chapters of BRRD governing the resolution of banks and certain investment firms; the Commission de Surveillance du Secteur Financier (CSSF) has been designated as a resolution authority for Luxembourg ( conseil de résolution ); a Luxembourg resolution fund ( Fonds de résolution Luxembourg ) has been created as Luxembourg resolution financing tool; a new public deposit guarantee system under the name Fonds de garantie des dépôts Luxembourg (FGDL) replaced the previous system of the Association pour la Garantie des Dépôts Luxembourg (AGDL), both ex-post funded system; functions carried out in the past by the AGDL in the field of investor protection have been taken over by the Système d indemnisation des investisseurs Luxembourg (SIIL) (Investor Compensation Scheme Luxembourg). The remaining AGDL provision was reversed by end of 2016 in agreement with CSSF Circular letter dated 18 January 2017 and used for the 2016 contribution to the Single Resolution Fund Annual Report UniCredit Luxembourg S.A.

89 Provisions for pensions and similar obligations 2014 Balance sheet obligations for pension benefits 3,155 2,962 2,893 Income statement charged for pension benefits The amounts recognised in the statement of financial position are determined as follows: Present value of funded obligations 4,582 4,365 4,837 Fair value of plan assets -3,155-2,962-2,893 Present value of net obligations 1,427 1,403 1,944 Liability in the balance sheet 1,427 1,403 1,944 Other comprehensive income 1 1,392 1, The movement in the defined benefit obligation is as follows: Beginning of year 4,365 4,837 4,977 Interest cost Employer service cost Actual benefit payments by the fund Actuarial (Gain) or loss End of year 4,582 4,365 4,837 The movement in the fair value of plan assets of the year is as follows: Beginning of year 2,962 2,893 2,317 Actuarial (losses)/gains Expected return on plan assets Actual bank contributions (including benefits paid directly by the bank) Benefits paid End of year 3,155 2,962 2,893 The charges recognised in the income statement are as follows: Current service cost Interest cost Expected return on plan assets Total charges recognised and included in staff costs Actual return on plan assets The actuarial assumptions used are as follows: Inflation rate 1.70% 1.60% 2.00% Discount rate as at 31 December 1.90% 2.30% 2.45% Expected return on plan assets at 1 January 3.25%-3.50% 3.25%-3.50% 3.25%-3.50% Expected return on plan assets over the next year %-3.50% 3.25%-3.50% 3.25%-3.50% Expected rate of salary increases 2.00% 2.00% 2,50% Expected rate of social security increases 1.70% 1.60% 2.00% Expected increases in maximum benefits and compensation/salary limits None None None 1 Due to new IAS19R recognition rules as at unrecognised actuarial gain/losses have to be presented as revaluation reserve in other comprehensive income (OCI). Deferred taxes for 377 thousand have been booked (previous year: 387 thousand). 2 Since 2009 UC Group in Luxembourg (ex Banco di Roma International, ex Banco di Santo Spirito (Luxembourg) and ex UniCredit International Bank (Luxembourg)) has outsourced the existing Pension plans to Foyer Vie S.A. For the year 2013 the expected return on assets for the Group is 3.25% (ex UniCredit International Bank (Luxembourg S.A.), but ex Banco di Roma and ex Banco di Santo Spirito Pension plans have a minimum return on assets guaranteed at 3.50%, therefore the two different figures. Assumptions regarding future mortality are based on published statistics and mortality tables. The average life expectancy for individual retiring at age 65 is for males and for females according to the mortality tables ERM 90 (for males) and ERF 90 (for females). The Bank expects to pay contributions of 261 thousand to this defined benefit plan for the year 2017 (previous year: 272 thousand for the year 2016). UniCredit Luxembourg S.A Annual Report 87

90 Notes to the financial statements (Continued) (52) Subscribed capital As at 31 December 2016, the Bank s subscribed capital of 238 million (previous year: 238 million) was divided into 929,043 non-par-value shares. All issued shares are fully paid. The additional paid-in capital contains the premium earned on the issue of own shares. The other reserves contain the retained earnings of the Bank and the effects of the initial application of IFRS. Of these reserves, million are tied up for tax purposes. The available-for-sale reserve contains valuation effects not taken through the statement of comprehensive income on available-for-sale financial instruments. The hedge reserve shows the effective portion of cash flow hedge accounting. Due to the change of the Bank s hedge accounting from cash flow hedge to portfolio fair value hedge this reserve will be amortized through the residual lifetime of the hedging instruments. During the year the Bank hedged a forward transaction with interest rate swaps as cash flow hedge. At the value date of the forward transaction, the interest rate swaps were transferred into the Portfolio Fair Value Hedge. The fair value of the interest rate swaps booked in the cash flow hedge reserve will be amortized through the residual lifetime of the underlying transaction. Both reserves are disclosed net of deferred taxes. The Bank manages its capital base, in line with the capital risk bearing allocation, and by respecting externally imposed capital requirements (see Note 58). (53) Subordinated capital The subordinated capital included under liabilities to banks consists of a Shareholder s loan totalling nominal 306,775 thousand with profit-related interest payments and a notice period of five years and one day counts for supervisory purposes as part of tier 2 (secondary) capital. As in the previous year, in accordance with the banking supervisory regulations, these subordinated liabilities are treated in full as equity funds. Interest and other financial expenses paid in the financial year in respect of subordinated liabilities totalled 14,100 thousand (previous year: 15,618 thousand), and are included under interest payable and similar charges in the statement of comprehensive income Annual Report UniCredit Luxembourg S.A.

91 (G) Notes on financial instruments under IFRS 7 (54) Fair values of financial instruments The fair values of financial assets and liabilities, together with the book values shown in the statement of financial position, are as follows: ASSETS BOOK VALUE FAIR VALUE BOOK VALUE FAIR VALUE Cash and cash balances 206, , , ,146 Financial assets held for trading 7,556 7,556 10,160 10,160 Financial instruments measured at fair value through profit and loss 71,915 71,915 73,671 73,671 Available-for-sale financial instruments 327, , , ,233 of which measured at fair value 327, , , ,233 Loans and receivables with banks 4,706,869 5,002,841 4,140,533 4,226,778 Loans and receivables with customers 14,706,993 14,943,863 14,440,737 14,621,002 Hedging derivatives 59,490 59,490 80,915 80,915 Fair value changes of the hedged items in portfolio hedge of interest rate risk 76,983 76,983 78,043 78,043 Other assets 108, , , ,833 Total assets 20,271,668 20,834,736 20,000,505 20,297,781 LIABILITIES BOOK VALUE FAIR VALUE BOOK VALUE FAIR VALUE Deposits from banks 14,239,678 14,325,704 14,315,541 14,525,288 Deposits from customers 4,310,355 4,233,281 3,934,471 3,816,025 Financial liabilities held for trading 84,339 84,339 37,197 37,197 Hedging derivatives 71,262 71,262 73,755 73,755 Fair value changes of the hedged items in portfolio hedge of interest rate risk 48,134 48,134 66,496 66,496 Other liabilities 167, , , ,462 Total liabilities 18,921,067 18,930,019 18,622,922 18,714,223 The difference between the fair value and the book value is 563,068 thousand for assets and 8,952 thousand for liabilities. The balance of these figures is 554,116 thousand (previous year: 205,975 thousand). The fair values of certain financial instruments shown at nominal value are closely equivalent to their carrying amounts. These include cash and cash balances with central banks, and receivables and liabilities without agreed maturity or interest rate. For other receivables and liabilities, the net present value of estimated future cash flows is calculated by discounting at current interest rates, using the relevant credit spread. Quoted market prices are used for securities and derivatives traded on an exchange (Level 1 of the fair value hierarchy). The fair value of listed bonds and other securities is deemed to be the net present value of estimated future cash flows (Level 2). The fair values of interest rate swaps, cross-currency interest rate swaps and interest rate forwards and futures contracts are determined on the basis of discounted cash flows (Level 2). The market interest rates applicable to the financial instruments residual maturity are used here. The fair value of forward foreign exchange positions is determined using current forward prices (Level 1). Options are measured using quoted prices (Level 1) or recognised option pricing models (Level 2). For simple European options, the widely used Black-Scholes model (equity, foreign exchange and index instruments) and a log-normal model (interest rate instruments) are applied (Level 2). Where fair values cannot be reliably determined for unlisted assets, they are carried at amortised cost. The fair values of Level 3 assets or liabilities cannot be calculated exclusively on the basis of observable market data (non-observable input date). Thus, the respective fair values also incorporate valuation parameters based on model assumptions. If the value of a financial instrument is based on nonobservable input parameters, the value of these parameters may be selected from a range of possible appropriate alternatives at the reporting date. Appropriate values are selected for these non-observable parameters when the annual financial statements are prepared, reflecting the predominant market conditions and the valuation control approach of HVB Group. UniCredit Luxembourg S.A Annual Report 89

92 Notes to the financial statements (Continued) (55) Fair value hierarchy The table below analyses financial instruments carried at fair value, by valuation method (fair value hierarchy, Level 1 to Level 3, see note 3): ASSETS LEVEL 1 LEVEL 2 LEVEL 3 TOTAL LEVEL 1 LEVEL 2 LEVEL 3 TOTAL Central bank - 6, , , , ,980 Financial assets held for trading - 7,556-7, ,160-10,160 Derivative instruments - 7,556-7,556-10,160-10,160 Financial instruments measured at fair value through profit and loss - 71,915-71,915-73,671-73,671 Available-for-sale financial instruments - 327, , , ,233 Loans and receivables with banks - 83,078 4,919,763 5,002,841-31,308 4,195,470 4,226,778 Loans and receivables with customers - 2,379,372 2,564,491 14,943,863-2,849,802 11,771,200 14,621,002 Hedging derivatives - 59,490-59,490-80,915-80,915 Total assets - 2,934,960 17,684,256 20,619,216-4,067,069 15,966,670 20,033, LIABILITIES LEVEL 1 LEVEL 2 LEVEL 3 TOTAL LEVEL 1 LEVEL 2 LEVEL 3 TOTAL Deposits from banks - 265,792 14,059,912 14,325,704-2,634,870 11,890,418 14,525,288 Deposits from customers - 1,079,849 3,153,432 4,233, ,460 2,897,565 3,816,025 Financial liabilities held for trading - 84,339-84,339-37, ,197 Derivative instruments - 84,339-84,339-37,197-37,197 Hedging derivatives - 6,286 64,976 71,262-1,103 72,652 73,755 Total liabilities - 1,436,266 17,278,320 18,714,586-3,591,630 14,860,635 18,452,265 There have been no transfers in either direction in 2016 and (56) Undiscounted cash flows The undiscounted cash flows of financial assets and liabilities, including estimated interest payments, as at December 31, 2016 are classified according to their remaining contractual maturities into time bands. Assets LONGER THAN 1 MONTH TO INCL. 3 MONTHS LONGER THAN 3 MONTHS TO INCL. 1 LONGER THAN 1 TO INCL. 5 S ON DEMAND 1 DAY TO INCL. 1 MONTH LONGER THAN 5 S UNDEFINED MATURITY TOTAL Loans and receivables with customers 193,289 3,414,922 1,339,603 1,657,504 7,410, , ,730 14,828,424 Loans and receivables with banks 299,249 1,434, ,730 1,253, , ,234 5,039,670 Financial assets held for trading thereof derivatives 7,556 7,556 Financial assets afvtpl 71,915 71,915 Available-for-Sale financial assets ,792 75, , ,313 Held-to-maturity financial assets Hedging derivatives ,193 22,159 43,001 1,693 69,214 Liabilities LONGER THAN 1 MONTH TO INCL. 3 MONTHS LONGER THAN 3 MONTHS TO INCL. 1 LONGER THAN 1 TO INCL. 5 S ON DEMAND 1 DAY TO INCL. 1 MONTH LONGER THAN 5 S UNDEFINED MATURITY TOTAL Deposits from customers 1,079,847 64, ,374 2,855,732 1,978 4,314,795 Deposits from banks 436 2,108,333 1,469,488 4,467,158 5,538, , ,000 14,434,420 Financial liabilities held for trading thereof derivatives 84,339 84,339 Hedging derivatives ,375 84,123 1, , Annual Report UniCredit Luxembourg S.A.

93 (H) Other information (57) Structured entities A structured entity according to IFRS 12 is a company that has been designed so that voting or similar rights are not the dominant factor for a control. Structured entities are often characterized by limited activities, a tight and well defined corporate purpose, insufficient equity or financing in tranches (Waterfall). Structured entities may be consolidated or non-consolidated, depending on whether the Bank has control over the company or not. Transactions with structured entities can be classified into the following categories on the basis of the objective pursued by the Bank s business model: ABS-vehicles; Refinancing vehicles for customers; Some investment funds; Other structured entities. Investments in unconsolidated structured entities include any contractual relations, from which the Bank can draw variable income and risk of loss from the structured entities. Such investments may be equity and debt instruments, derivatives, liquidity facilities or guarantees. ABS-vehicles The Bank invests in ABS-vehicles and uses ABS-vehicles for own securitization transactions. These vehicles buy loans or receivables and are funded by issuing securities on the money or capital market. The securities are collateralized by the purchased assets. The Bank can provide these vehicles for their financing in the form of liquidity facilities. ABS-vehicles that are fully consolidated in the consolidated financial statements do not belong to those shown under unconsolidated structured entities. Thus, only those ABS-vehicles are considered in unconsolidated structured entities in which the Bank is involved exclusively as an investor Number of unconsolidated ABS-vehicles (only investor positions) 2 Refinancing vehicles for customers Customers use these vehicles for refinancing. These funding vehicles buy short-term receivables and lease receivables from customers and are funded by issuing securities on capital and money markets (mostly commercial paper conduits). The Bank can provide these vehicles for their financing in the form of liquidity facilities Number of unconsolidated refinancing vehicle for customers 3 Aggregated total assets of unconsolidated refinancing vehicles for customers in thousand 938,911 Nominal value of securities issued by the unconsolidated refinancing vehicles for customers issued in thousand 826,155 Some mutual funds Investment funds are considered as structured entities if they are not controlled through voting rights or similar rights. Investment funds invest in a variety of assets and can be financed by debt in addition to those funds contributed by investors under its investment principles. Investment funds are used to achieve certain specified objectives. The Bank offers mutual funds to its clients Number of unconsolidated investment funds 3 of which managed by the bank 1 Aggregate Net Asset Value (including minority interests) of investment funds in thousand 483,716 of which managed by the Bank 11,563 In contrast to previous year the number of unconsolidated investment funds and Aggregate Net Asset Values are restricted to the investment funds, where the bank has investments and risks as mentioned in the introduction of this paragraph. Hence relationships to investment funds only depositing money are no more considered. UniCredit Luxembourg S.A Annual Report 91

94 Notes to the financial statements (Continued) Other structured entities Structured units that can be assigned to any of the other categories fall into this category. These companies are mainly leasing vehicles that have only insufficient equity and are economically dominated by the lessee. Such vehicles are not primary component of the business model of the Bank Number of other structured units 13 Aggregated total assets / Aggregate Net Asset Value in thousand 2,433,402 Risks related to unconsolidated structured entities The following table shows the carrying amounts of assets and liabilities and off-balance sheet exposures of the Bank as at 31 December 2016 in connection with unconsolidated structured entities: ABS-VEHICLES REPACK- AGING- VEHICLES VEHICLES USED FOR CUSTOMERS FUNDING PURPOSES SOME INVESTMENT FUNDS OTHER STRUC- TURED ENTITIES Assets Financial Assets held for trading Financial assets at FVTPL AfS- Financial Assets Investments in Associates and Joint Ventures HTM Financial Instruments Loans and Receivables with banks Loans and Receivables with customers -2,138, ,953-92,009-30,836 Hedging-Derivatives Other Assets TOTAL ASSETS -2,139, ,953-92,009-30,836 Liabilitites Deposits from banks Deposits from customers 2,856, , Debt securities in issue Financial liabilities held for trading 65, Hedge-Derivatives Other liabilities Provisions TOTAL LIABILITIES 2,921, , Off-Balance Exposures , Commitments , Guarantees Maximum Exposure to Loss -2,139, ,021-92,009-30,836 The maximum exposure to loss from unconsolidated structured entities results from the sum of assets and off-balance sheet exposures in relation to structured entities. This perspective is not, however, the economic risk again because collateral held or other hedging instruments are not taken into account. There was no financial or other support for unconsolidated structured entities without a contractual obligation ( implicit support ) in the reporting year. Concrete plans for future support measures for unconsolidated structured entities do not exist as well Annual Report UniCredit Luxembourg S.A.

95 (58) Ratios required under the Luxembourg capital adequacy rules Own funds and capital requirements break down as follows: Own funds and capital requirements break down as follows: OWN FUNDS 1,637,369 1,638,512 TIER 1 CAPITAL 1,330,594 1,331,737 Paid up capital instruments 238, ,000 Share premium 421, ,043 Retained earnings 647, ,596 Other reserves 25,708 25,708 Accumulated other comprehensive income 8,313 8,395 Deductions from TIER 1 Capital -9,960-9,005 TIER 2 CAPITAL 306, ,775 Paid up capital instruments and subordinated loans 306, ,775 Deductions from core and supplementary capital - - Capital requirements 5,160,312 5,209,452 Total capital requirements for standardised approach 829,785 1,089,822 Public sector entities Institutions 185, ,159 Corporates 376, ,840 Retail 39,580 51,205 Secured by mortgages on immovable property 4,133 8,796 Claims on institutions and corporates with a short-term credit assessment 49,905 15,094 Collective investments undertakings (CIU) Other Items 172,535 90,772 Total capital requirements of IRB approaches when own estimates of LGD 3,988,574 3,677,292 Central governments and central banks Institutions 418, ,944 Corporates - SME 838, ,587 Corporates - Specialised Lending 30,538 35,746 Corporates - Other 2,648,913 2,385,207 Retail - Secured by real estate SME 4,035 5,072 Retail - Secured by real estate non-sme 3,591 8,923 Retail - Other SME 18,421 16,794 Retail - Other non-sme 26,431 29,611 TOTAL RISK EXPOSURE AMOUNT FOR OPERATIONAL RISK (OPR ) 329, ,998 TOTAL RISK EXPOSURE AMOUNT FOR CREDIT VALUATION ADJUSTMENT 12,293 41,340 Standardised method - 41,340 CET1 capital ratio 25.8% 25.6% Total capital ratio 31.7% 31.5% The table is adapted to the new EBA-form for common reporting (COREP). Figures are based on FINREP figures and can deviate from the figures presented in the financial statements (LuxGaap plus IAS option). A reconciliation of the financial statement figures to the FINREP figures is shown in the management report. Since 2011 the Bank applies the Advanced Internal Rating Based Approach (IRB-A approach) for credit risks for exposures on banks, multinational corporations, mid-size corporations, acquisition & leverage finance and commercial real estate finance and since 2013 the Bank additionally uses the following internal rating systems: Income Producing Real Estate, Foreign Corporate Customer, Small Business Customer, Private Wealthy Customer (only EGON business), Global Project Finance, Corporate Treasury/Funding vehicles) and Securities Industry. Additionally the European Central Bank authorized the Bank in 2015 to use IRBA methods for its Trade Finance portfolio and CSSF allowed the Bank to use own estimates of volatility adjustments for the purpose of determining its own funds requirements for loans subject to credit risk mitigation arrangements. About 88% of the Bank s loan exposure is covered by internal rating systems (previous year: 88%). The minimum requirement of 11.75% for the total capital ratio was met at the reporting date and for the whole financial year UniCredit Luxembourg S.A Annual Report 93

96 Notes to the financial statements (Continued) (59) Transfer of financial assets Assets assigned or pledged as security for own liabilities Assets were deposited with the Central Bank of Luxembourg as security for borrowing in open market transactions. These remain part of the Bank s assets, i.e. are loaned securities. The assets assigned or pledged as security for own liabilities break down as follows: Financial instruments measured at fair value through profit and loss - 73,671 Available-for-sale financial instruments 271, ,593 Loans and receivables with customers 1 2,985,136 1,955,754 Total 3,256,177 2,302,018 1 The bank pledges best rated loans as collateral with the Central Bank of Luxembourg. In 2016 the assets pledged by the Bank as security relate to liabilities to central banks and amount to 2,800,000 thousand (previous year: 1,900,026 thousand). Compliant with IFRS 7.14, we are disclosing the carrying amount of the financial assets which we provide as security. Securitisation In its Securitisation transactions (see Note 45), the Bank retains the risks and rewards of the transferred assets. The Bank thus not derecognises assets amounting to a carrying amount of 2,852 million from its financial statements (previous year: 2,852 million). Securities lending Bond borrowing from the parent company had a carrying amount of 1,825 million (previous year: 2,475 million). (60) Contingent liabilities, commitments and other commitments Contingent liabilities They consist exclusively of guarantees in the structured finance business and break down as follows: Guarantees and other direct credit substitutes (including repurchase agreements) 61,532 50,074 thereof related parties 1, thereof parent company 1, Total 61,532 50,074 The breakdown by residual term of guarantees is as follows: With residual maturities of 61,532 50,074 up to 3 months from 3 months to 1 year 45,761 40,427 from 1 year to 5 years 12,041 7,833 over 5 years 2,958 1,814 Total 61,532 50, Annual Report UniCredit Luxembourg S.A.

97 Commitments They consist of irrevocable credit commitments mainly in the structured finance business totalling 13,037.8 million (previous year: 13,345.0 million). As in the previous year, there were no forward purchases. The breakdown of commitments by residual term is as follows: Repayable on demand and indefinite term 24,060 - With residual maturities of 13,013,719 13,344,997 up to 3 months 276, ,191 from 3 months to 1 year 885,531 1,916,151 from 1 year to 5 years 11,699,888 11,069,007 over 5 years 151, ,648 Total 13,037,779 13,344,997 Furthermore, the Bank granted additional loan facilities of 1,387.4 million to customers (previous year: 1,166.1 million). These loan facilities (ancillary loans) were provided by HVB and were offset against the open loan commitments of the Bank. Other commitments Payment commitments from rental and leasing agreements (undiscounted) totalled 616 thousand (previous year: 945 thousand). These commitments are calculated up to the end of the agreement or the first termination date. (61) Trust business Assets Loan and receivables with customers 137, ,100 Total 137, ,100 Liabilities Deposits from banks 137, ,817 Deposits from customers - 5,283 Total 137, ,100 (62) Governing bodies Transactions with senior managers, members of the Management Board and Supervisory Board are always conducted at market rates. These persons were remunerated as follows: 2016 PEOPLE 2015 PEOPLE Seniors managers (members of Management Board and department heads) 5, , Members of the Supervisory Board The remuneration of senior managers includes payments amounting to 336 thousand for pension commitments (previous year: 342 thousand) and share-based payments amounting to 50 thousand (previous year: 238 thousand). The cost for the social compensation plan for former departments heads amount to 157 thousand (previous year: 317 thousand). No loans were granted to senior managers (previous year: 0 thousand) and no loans were granted to members of the Management Board and Supervisory Board (previous year: 14 thousand). There are guarantee commitments with respect to the above bodies of the Bank totalling 14 thousand (previous year: 39 thousand). Loans to senior managers and members of the Management Board and Supervisory Board are made at market rates. UniCredit Luxembourg S.A Annual Report 95

98 Notes to the financial statements (Continued) (63) Remuneration of the auditors The fee (VAT included) recorded in the financial year under other administrative expenses for the independent statutory auditor Deloitte Audit S.à r.l., Luxembourg and for the affiliated companies of its international associations breaks down as follows: Audit of financial statements Other audit services Tax declaration review Total (64) Our employees The average headcount during the financial year was as follows: Top Management 3 3 Department heads Salaried employees Total (65) Related parties disclosures Related parties of UniCredit Banking Group (UC Group) are: Controlled companies, joint ventures and associated companies of UC Group managers with strategic responsibilities (those include: UC Board of Directors, Executive Management Committee, Head of Internal Audit and Board of Statutory Auditors); Close relatives which might influence the manager of a company by his/her relation with UniCredit (those could be spouses and live-in partners, own children and children of spouses and live-in partners); Companies which are controlled by people out of the UC Group who may have significant influence; Pension funds of UniCredit S.p.A.. UC Group discloses an updated list of related parties for accounting purposes at least twice a year. A report showing transactions with related parties is sent to HVB. The Bank enters into relations to entities of HVB Group and UC Group on different levels. Primarily banking transactions are contracted. The amounts of outstanding balances and the categories are disclosed in the relevant notes. The loan business acquired and placed from HVB has been guaranteed by them in an amount of 14.5 billion (previous year: 14.0 billion). For some related parties the Bank is service provider, for example for Structured Invest S.A., located in Luxembourg. Transactions with related parties are always conducted at market rates. Additionally the Bank receives services from other entities of HVB Group, for example an automatic order routing service or various IT-services Annual Report UniCredit Luxembourg S.A.

99 (66) Significant events after the balance sheet date In December 2016 a major client managed within the Private Banking business unit of UniCredit Luxembourg S.A. decided to fully reimburse and close his existing lombard loan before contractual expiry. At the beginning of 2017 a new revolving credit facility with a different structure was granted to the aforesaid major client. In line with the principles defined in the UniCredit Group wide strategic plan Transform 2019 presented in London on December 13th, 2016, the Group is going to strengthen and optimize capital, improve asset quality, cost discipline and enhance efficiency measures to significantly reduce cost income ratio and transform business. The strategic plan also includes the restructuring of activities in Luxembourg. The sole shareholder of UniCredit Luxembourg S.A. therefore took the decision to significantly restructure the Bank with the aim to cease all business activities by the end of December A first step is the transfer of the Italian Private Banking activities to UniCredit International Bank (Luxembourg) S.A. scheduled for April 1st, The Corporate business is planned to be transferred to UniCredit Bank AG by the end of 2018 at the latest. With regard to the business relationship with the corporate clients in Luxembourg nothing will change as they already have been customers of UniCredit Bank AG. The remaining part will be restructured. The Supervisory Board of the Bank took note of the decision. A communication to the staff and the staff representatives has taken place on March 6th, The Bank has entered into negotiations with the works council. The outcome for the settlement of the remaining activities is still under analysis. (67) Executive Management bodies In 2012, the Bank adopted a new Governance Model discussed and approved by the CSSF. In order to have a clear segregation between the day-to-day management and the control/supervision of the Bank, the Extraordinary General Assembly held on 30 August 2012 approved by-laws introducing a Two-Tier- Board-Model, with a Corporate Governance organized via a Management Board and a Supervisory Board. Since then the Bank is managed by a Management Board which exercises its functions under the control of a Supervisory Board. The Management Board is in charge of taking any actions necessary or useful to fulfil the Company s corporate object, with the exception of the actions reserved by Luxembourg Law or by the Articles to the General Meeting or to the Supervisory Board. The Supervisory Board is in charge of the supervision and control of the Bank s administration by the Management Board. The composition of the two Boards as at 31 December 2016 is as follows: Supervisory Board From 1 January 2016 to 30 September 2016: Lutz Diederichs, Chairman, Member of the Management Board of UniCredit Bank AG, Munich (till September 30, 2016); Andrea Varese, Vice-Chairman, Member of the Management Board of UniCredit Bank AG, Munich; Dr. Bernhard Brinker, Divisional Board member Private Banking of UniCredit Bank AG, Munich; Stephanie Kraus, Managing Director Corporate & Investment Banking Financial Institutions Group of UniCredit Bank AG, Munich; Dr. Andreas Mayer, Executive Vice President and Co-Head of Global F&A of UniCredit Bank AG, Munich; Patrick Santer, Partner, Elvinger, Hoss & Prussen, Luxembourg, member of the Council of State of Luxembourg. From 1 October 2016: Andrea Varese, Chairman, Member of the Management Board of UniCredit Bank AG, Munich, Chief Risk Officer; Dr. Bernhard Brinker, Vice-Chairman, Divisional Board member Private Banking of UniCredit Bank AG, Munich; Stephanie Kraus-Nijboer, Managing Director Corporate & Investment Banking Financial Institutions Group of UniCredit Bank AG, Munich; Dr. Andreas Mayer, Executive Vice President and Co-Head of Global F&A of UniCredit Bank AG, Munich; Patrick Santer, Partner, Elvinger, Hoss & Prussen, Luxembourg, member of the Council of State of Luxembourg. Management Board Michaela Ehrhardt, Chief Executive Officer of UniCredit Luxembourg S.A.; Dr. Joachim Beckert, Chief Operating Officer, Chief Risk Officer and General Manager of UniCredit Luxembourg S.A.; Giovanni Giallombardo, Head of Private Banking and General Manager of UniCredit Luxembourg S.A. In its meeting on 21 March 2017 the Management Board has approved the annual financial statements, and the Supervisory Board has reviewed them on 24 March At the same date, the Supervisory Board has approved the proposal of the appropriation of profits to the Annual General Meeting of Shareholders. UniCredit Luxembourg S.A Annual Report 97

100 Execution & Discipline We know that to do well we must be extremely disciplined in the execution of everything we do. In addition to our strategic plan, we have performance measures in place which provide all our teams with clear targets and regularly follow-up on progress to ensure we are always on track Annual Report UniCredit Luxembourg S.A.

101 Management TOP MANAGEMENT HEADS OF DEPARTMENTS Michaela Ehrhardt Chief Executive Officer Dr. Joachim Beckert Chief Operating Officer Chief Risk Officer General Manager Giovanni Giallombardo General Manager HEADS OF BUSINESS UNITS Flavio Bonomo Private Banking International Mario Tommasi Chief Financial Officer Wolfgang Krammel Treasury & Business Services Holger Möller Financing & Advisory Kirsten Maas Operations & ICT Alessandro Piva Private Banking Italy Flavio Bonomo Products & Services Sascha Apitz Global Investment Strategy Gianluca Cratassa Insurance Marc Theis Accounting & Nostro Luigi Colavolpe Planning & Reporting Andreas Fisch Financing Services Silke Jacobs Agency Services Brigitte Reichert Documentation & Transaction Coordination Robert Reidenbach Senior Advisory Kirsten Maas Operations Romain Risch ICT Mario Bosmanic Administration & Logistics Uwe Ewen Organization Information Security Officer Roberto Morocutti Organization Special projects Erwin Moos Credit Risk Management Dr. Joachim Beckert Risk Control Friedrich von Preussen Compliance Ulrich Kunath Tax & General Affairs Roland Lindner Human Resources Frank Reuter Internal Audit Anaëlle Rouby Legal UniCredit Luxembourg S.A Annual Report 99

102