Annual Financial Report
London Stock Exchange Group plc Annual Report and Accounts, Notice of Annual General Meeting 2014 and related documents and appointment of auditor.
The Annual Report and Accounts of the London Stock Exchange Group plc (the "Group") for the year ended 31 March 2014 (the "Annual Report"), Notice of Annual General Meeting 2014 (the "AGM Notice") and related form of proxy for the Group's 2014 Annual General Meeting (the "AGM") are being mailed to shareholders today and, in accordance with paragraph 9.6.1 of the FCA Listing Rules, have been submitted to the National Storage Mechanism where they will shortly be available for inspection at www.hemscott.com/nsm.do.
Further to the announcements on 18 December 2013 and 22 April 2014 the Company announces that, following a competitive tender process, it has appointed Ernst & Young LLP (E&Y) as auditor of the Company. As resigning auditor, PricewaterhouseCoopers LLP (PwC) has provided the Company with a 'statement of circumstances' confirming that it resigned as auditor of the Company following its unsuccessful participation in the tender process. A copy of the 'statement of circumstances' is set out in the Notice of AGM. Following the resignation of PwC with effect from 12 June 2014, the Board appointed E&Y to fill the 'casual vacancy' in accordance with the Companies Act 2006 and proposes the re-appointment of E&Y as auditor of the Company at the AGM.
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London Stock Exchange Group plc |
Paul Froud - Investor Relations |
+44 (0) 20 7797 3322 |
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Gavin Sullivan - Media Relations |
+44 (0) 20 7797 1222 |
In compliance with DTR 6.3.5 and Listing Rule 9.6.3, the following information is extracted from the Annual Report and should be read in conjunction with the Group's preliminary results announcement of 15 May 2014 (the "Preliminary Results"). The information reproduced below and the Preliminary Results together constitute the material required by DTR 6.3.5 to be communicated in full, unedited text through a regulatory information service. This is not a substitute for reading the full Annual Report. Page numbers and cross references in the extracted information below refer to page numbers and cross-references in the Annual Report. The Annual Report, the Preliminary Results and the AGM Notice can be viewed and downloaded at http://www.lseg.com/investor-relations.
The Annual Report contains the following statements regarding important events that have occurred during the year on pages 14 to 15:
"Chairman's Statement
" WE NEVER LOSE SIGHT OF THE WIDER ROLE OUR BUSINESS PLAYS IN SOCIETY"
Overview/Execution of strategy
London Stock Exchange Group continued to expand its global footprint and strengthen its position as one of the world's leading, diversified exchange groups. Our portfolio of market infrastructure businesses was further strengthened with the completion of the acquisition of a majority stake in LCH.Clearnet Group, a leading provider of clearing services. We have been pleased with the progress made to date to realise the benefits of the transaction and this will be a major focus in the year ahead. We also made further progress realising the benefits of previous transactions through the global growth of businesses such as FTSE and MTS.
Over the past 12 months, there has been a sense of renewed optimism in capital markets. We have seen companies returning to the IPO markets to raise equity capital, with the highest number of flotations since 2007. 188 companies joined our markets and total money raised was over £34 billion across our equity markets in the past year. The Group provides markets that help a broad range of companies to access equity and debt capital; in particular, we support efforts to help small and medium-sized enterprises (SMEs) access finance to enable their growth and development. The recent launch of ELITE in the UK, a programme dedicated to supporting high growth private companies, builds upon the success of a similar initiative run by Borsa Italiana which has 150 participants. In April, the first 19 companies signed up to the scheme, which will run in partnership with Imperial College Business School, and is a good example of the Group's ongoing commitment to SMEs across Europe.
Our wider role
We firmly believe that the Group's open access business model, which drives a partnership approach with our customers, helps facilitate the operation of stable financial markets which benefit our customers, regulators and society at large. The model also promotes flexibility, transparency and choice which, in turn, helps drive our business forward. LCH.Clearnet Group shares our open access philosophy, and provides its customers with risk management services across a broad range of asset classes, helping them to manage their own risk positions and capital efficiencies. This contributes to a safer and more stable financial system.
We never lose sight of the wider role our business plays in society. Our support for companies of all sizes, for open access and fair and transparent markets, has a significant impact on economic business activity, as well as job and wealth creation, and is core to our approach to corporate social responsibility. In addition, the Group donated £1.66 million to charity in the past year, of which £1.01 million was donated through the Group's charitable Foundation. To celebrate our third annual charity trading day, held in March, the Group invited representatives from our partner charities Habitat for Humanity, In-Presa, Friendship Works and UNICEF to open trading in London.
London Stock Exchange Group continues to look for ways to reduce its carbon footprint and to improve its CSR activities through Group-wide initiatives such as Green Week. We summarise our Corporate Responsibility activities on pages 36 and 37 and in a fuller corporate report, which can be accessed from our website.
Strengthened board/risk management
As a trusted, global financial infrastructure provider, we must ensure that we continue to meet the highest standards of corporate governance and due process. As reported last year, the Group has split its Risk and Audit operating functions and made senior appointments within both teams. We have also operated separate Audit and Risk committees of the Board, both benefiting from contributions from Non-Executive Directors with considerable and specialist experience in these areas.
Following the Group's AGM in July 2013, Baroness (Janet) Cohen, Sergio Ermotti and Gay Huey Evans stepped down as Non-Executive Directors. The Board appreciates the valuable contributions that all three made to the successful strategic development of the business.
In June 2013, Stephen O'Connor and Stuart Lewis were appointed as Non-Executive Directors. Stephen and Stuart bring considerable experience in credit and market risk, reflecting the significant and growing proportion of the Group's overall business that post trade and risk management now represent. In January 2014, we also welcomed Sherry Coutu and Joanna Shields to the Board, both of whom bring broad international management expertise and a strong track record of entrepreneurship and building businesses.
Financial performance and dividend
The Group delivered a good financial performance, with adjusted income up 42 per cent to £1.21 billion, including contribution from LCH.Clearnet for the first time. Successful delivery on our stated strategy is also reflected in the strong share price performance over the last year.
The Group is therefore proposing a 4.5 per cent increase in the final dividend to 20.7 pence per share, resulting in a full year dividend of 30.8 pence per share, a 4.4 per cent rise. The final dividend will be paid to shareholders on the register as at 25 July 2014.
Accounting reference date
In order to create alignment of the financial years of LSEG plc and LCH.Clearnet, the Board has approved a change to the Group's accounting reference date, moving from 31 March to 31 December, with effect from 1 April 2014.
Conclusion
It has been a strong year for the Group. We have further expanded our global business, building best in class capabilities as we grow. We expect the substantial benefits of the LCH.Clearnet transaction to continue to work through over the coming year and the improving economic outlook and evolving regulatory landscape present further opportunity to develop our business. We look forward to further growth in the year ahead.
Chris Gibson-Smith
Chairman"
The Annual Report contains the following statements regarding principal risks and uncertainties facing the business, with respect to principal strategic, financial and operational risks, on pages 48 to 53, and, with respect to financial risk management, on pages 113 to 117:
"Overview of Principal Risks:
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Strategic Risks |
Financial Risks |
Operational Risks |
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Global economy Competition Regulatory change and compliance Transformation risk |
Liquidity risk (Clearing) Latent market risk (Clearing) Settlement and custodial risks Capital management |
Technology Change management Security threats Employees |
Strategic Risks
Risks related to our strategy (including the implementation of strategic initiatives and external threats to the achievement of our strategy). The category also includes risks associated with reputation or brand values.
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Risk description |
Mitigation |
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Global economy
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The Group performs regular analyses to monitor the markets and the potential impacts on the business. Activities include Key Risk Indicator tracking, stress testing, and a hedging strategy.
The Financial Risk Committee closely monitors and analyses multiple market scenarios and action plans in order to minimise the potential impacts stemming from a potential deterioration of the macroeconomic environment. The Eurozone crisis and geopolitical concerns are regular items on the agenda of the Financial Risk Committee and the Group's exposure to these risks is closely monitored.
In Sri Lanka the Group maintains regular contact with key Governmental parties, and has appropriate contingency plans in place to ensure key technology operations are not dependent on a single geography. Business Continuity Management (BCM) and crisis management procedures would be invoked to manage the response to an unexpected event. |
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For more information, see Market Position and Outlook, pages 8-13, and note 2 to the accounts: Financial Risk Management on pages 113-117. |
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Competition We operate in a highly competitive industry. Continued We operate in a highly competitive industry. Continued consolidation has fuelled competition including between groups in different geographical areas. In our Capital Markets operations there is a risk that competitors will improve their products, pricing and technology in a way that erodes our businesses. There is increasing competition for primary listings from other global exchanges and regional centres. In Post Trade Services the consolidation of clients has led to a concentration of revenues. Any future loss of liquidity or reduction in volumes on exchanges may impact clearing revenues. In Information Services, consolidation within the industry is expected over the next three to five years. Client migration to competitors could lead to a loss of revenue. In Technology Services, there is intense competition across all activities and there are strong market players in some areas where we are establishing a presence. |
Competitive markets are, by their very nature, dynamic, and the effects of competitor activity can never be fully mitigated. Senior management actively engages with clients and the Group undertakes constant market monitoring and period pricing revision to mitigate risks. Commercial initiatives are aligned with our major clients and this is complemented by an ongoing focus on new technology deployment and cost reduction.
The Group's track record of innovation and diversification ensures the Group offers best in class services with a global capability.
We maintain a dedicated international marketing team focused on key target markets who promote the benefits of listing on our markets to international issuers, the global advisory community and other stakeholders. |
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Risk description |
Mitigation |
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Regulatory change The Group and its exchanges, CCPs and other regulated entities operate in industries that are highly, and increasingly, regulated by governmental, competition and regulatory bodies at European, federal, national and provincial levels. Delivery of the G20 agenda in the EU has resulted in a large number of measures which may impact our business directly or indirectly. The European Commission has adopted proposals for the regulation of financial benchmarks; to address potential issues in the system of credit intermediation ("shadow banking"), by issuing Regulations on Money Market funds (MMFs) and securities financing transactions ("SFTs"). Towards the end of 2014, it is planning to propose measures for resolving CCPs. Following political agreement of MiFID and MiFIR, the rule-making work will continue through much of 2014. In the UK, the financial services industry has been operating under a new regulatory structure since 1 April 2013 with the FSA being replaced by three separate regulatory bodies: the Bank of England, the Prudential Regulation Authority (PRA) and the Financial Conduct Authority (FCA). These bodies are now well-established and are pursuing a policy of proactive regulation. For example the FCA has recently consulted on its new remit in relation to Competition Law. The CCPs have focused on the analysis of the potential impact of the new Basel III rules on capital requirements for banks' exposure to CCPs. This could have an impact on the clearing volumes, with implications for the Group's revenues. Compliance There is a risk that one or more of the Group's entities may fail to comply with the laws and regulatory requirements to which it is, or becomes, subject. In this event, the entity in question may be subject to censures, fines and other regulatory or legal proceedings. |
Regulatory change
Changes in the regulatory environment form a key input into our strategic planning, including the impact on our growth strategies, both organic and inorganic. We monitor regulatory developments continually and engage directly with regulatory and governmental authorities at a national, EU and international level.
We continue to develop our relationships with the key political stakeholders, particularly at EU and national level. Potential impacts from regulatory change are assessed and, depending on the impact, opportunities are developed and mitigating strategies and actions are planned.
As the various regulatory initiatives progress, there will be greater certainty about their likely final form. The Group continues to focus on remaining well positioned to respond to regulatory developments and further opportunities exist for the Group to deliver solutions to help the market address the changing regulatory environment.
The implications of capital requirements on clearing members have been analysed and future actions put in place.
The CCPs have performed analytical work to test the methodologies proposed by the Basel framework and have contributed to the consultations launched by the BCBS.
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For more information on regulatory changes see "Market Position and Outlook" on pages 10-13. |
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Transformation risk The Group is exposed to transformation risks (risk of loss or failure resulting from change/transformation) given the current levels of change and alignment activity currently taking place across the Group. As part of the alignment processes the Group targets specific cost savings and revenue increases. A failure to successfully align the businesses of the Group may lead to an increased cost base without a commensurate increase in revenue; a failure to capture future product and market opportunities; and risks in respect of capital requirements, regulatory relationships and management time. With regards to M&A and alignment activities, the additional projects and workstreams could have an adverse impact on day-to-day performance and/or key strategic initiatives and could damage the Group's reputation. The scale and complexity of the LCH.Clearnet business as part of the Group has contributed to an increase in the risk profile associated with change management and transformation risk. |
The governance of the enlarged Group is aligned and strengthened as appropriate. The Group performs regular reporting of change performance, including ongoing alignment activity. LSEG has set up a programme management framework to deliver the LCH.Clearnet transaction objectives which includes close implementation oversight by an executive team representative of LSEG and LCH.Clearnet; this steering group includes the LSEG Group CFO, CRO and COO as well as the LCH Group CEO, CFO and CRO.
The LSEG Enterprise-wide Risk Management Framework covers the whole Group, including LCH.Clearnet, and was designed to ensure appropriate risk management across the whole of the enlarged Group. |
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Financial Risks
The risk of financial failure, reputational loss, loss of earnings and/or capital as a result of investment activity, lack of liquidity, funding or capital, and/or the inappropriate recording, reporting and disclosure of financial results, taxation and regulatory information.
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Risk description |
Mitigation |
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Liquidity risk (clearing)
The Group's clearing providers hold a significant amount of cash and securities deposited by clearing members as margin or default funds. To ensure optimum ongoing liquidity and immediate access to funds, the CCPs deposit the cash received in highly liquid and secure investments, as mandated by the EMIR regulations.
Potential liquidity risks faced by the Group CCPs include: · Margin payments: Margins (Initial and Variation) are settled at least daily. The CCPs must ensure that sufficient funds are available to fulfil their obligations. · Collateral switches and excess cash margin cover: Members can choose whether to post margin in cash or securities, and may choose to over-collateralise. · Market disruptions: Such as unusual market volatility driving large margin movements; liquidity squeezes in the cash or securities markets and central bank actions. · Failed cash settlements: Arising, for instance, from mismatches in settlement dates for the CCPs' own activities.
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Under the ERMF, CCP investments must be made in compliance with the Group CCP Financial Risk Policy as well as Policies issued pursuant to the governance of the CCPs themselves. These Policies stipulate a number of risk management standards including concentration limits and minimum ratings. Committees overseeing CCP investment risk meet regularly.
Group CCPs have put in place EMIR compliant liquidity plans for day-to-day liquidity management, including contingencies for stressed conditions. Group CCPs have multiple layers of defence against liquidity shortfall including minimum cash balances, access to contingent liquidity arrangements and for certain CCPs, access to central bank liquidity.
CCP liquidity management balances and counterparty disintermediation risk is consolidated daily at the Group level and reported to the Executive Committee and Board, including limits and status rating. An enhanced report including market commentary and member health monitoring is produced each week and distributed to the LSEG Executive Committee and Board.
All four group CCPs report their liquidity position via the Group Financial Risk Committee each month. Each CCP monitors liquidity needs daily under stressed and unstressed assumptions. Breaches, if any, are reported and discussed monthly at the Committee. |
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Latent market risk (clearing)
Our clearing services guarantee final settlement of trades and manage counterparty risk for a range of assets and instruments including cash equities, derivatives, energy products and Government bonds. Therefore the Group is exposed to country risk, credit risk, issuer risk, market risk, liquidity risk, interest rate risk and foreign exchange risk.
There is a risk that one of the parties to a cleared transaction defaults on their obligation; in this circumstance the CCP is obliged to honour the contract on the defaulter's behalf and thus an unmatched risk position arises. The CCP may suffer a loss in the process of work-out (the 'Default Management Process') if the market moves against the CCP's positions. |
Under the ERMF, CCP latent market risk must be managed in compliance with the Group CCP Financial Risk Policy as well as policies issued pursuant to the governance of the CCPs themselves. Latent market risk is part of the agenda of the CCP risk Committees.
The financial risks associated with clearing operations are mitigated by: · Strict CCP membership rules including supervisory capital, technical and organisational criteria.
· The maintenance of prudent levels of margin and default funds to cover exposures to participants. Each member pays margins, computed at least daily, to cover the theoretical costs which the clearing service would incur in order to close out open positions in the event of the member's default. Clearing members also contribute to default funds.
CCP liquidity management balances and counterparty disintermediation risk is consolidated daily at the Group level and reported to the Executive Committee and Board, including limits and RAGs. An enhanced report including market commentary and member health monitoring is produced each week and distributed to the Executive Committee and Board.
Committees overseeing latent market and member risks meet on a regular basis. |
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Settlement and custodial risks
The Group offers post trade services and centralised administration of financial instruments through its CSD subsidiary, Monte Titoli. Monte Titoli offers pre-settlement, settlement and custody services. These activities carry counterparty risk (in particular asset commitment risk), operational risk and custody risk (including asset servicing risk).
Monte Titoli does not provide intraday settlement financing to its members. |
Asset commitment risk is mitigated through pre-positioning (availability of security) and pre-funding (availability of cash).
Operational risk is minimised via highly automated processes reducing administrative activities and formalised procedures for all services. Monte Titoli mitigates IT risks by providing for redundancy of systems, daily backup of data, fully updated remote recovery sites and SLAs with outsourcers. Liquidity for Monte Titoli's operations is provided by the Bank of Italy. |
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For more information on these risks see the "Post Trade Services" section of the Segmental Review (on pages 28-31), and Note 2 to the accounts, "Financial Risk Management" (on pages 113-117). |
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Risk description |
Mitigation |
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Capital Risk The Group incorporates a number of regulated and unregulated entities within its structure. Principal risks to managing its capital are: · In respect of regulated entities, capital adequacy compliance risk (the risk that regulated entities do not maintain and report sufficient qualifying capital to meet regulatory requirements) and capital reporting compliance risk (the risk that regulated entities fail to comply with capital reporting and regulatory obligations). If a regulated entity in the Group fails to ensure sufficient capital resources are maintained to meet regulatory requirements this could lead to loss of regulatory approvals. · In respect of regulated and unregulated entities, commercial capital adequacy and quality risk (the risk that Group and solo entities do not maintain both sufficient quantity and quality of capital to meet commercial requirements) and investment return risk (the risk that capital is held in subsidiaries or invested in projects that generate a return that is below the Group's cost of capital). · Availability of debt or equity (whether specific to the Group or driven by general financial market conditions).
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The Group's Capital Management Policy provides a framework to ensure the Group maintains suitable capital levels (both at Group and solo entity levels), and effectively manages the risks thereof. The Group's Treasury Policy recognises the need to observe regulatory requirements in the management of the Group's resources. The Group maintains an ongoing review of the capital positions of its regulated entities and operates within capital limits which are overseen by the Treasury Committee, the Financial Risk Committee, the Executive Committee and the Board. The Group can manage its capital structure by varying returns to shareholders, issuing new shares or increasing or reducing borrowings. The Board reviews dividend policy and funding capacity on a regular basis and the Group maintains comfortable levels of debt facility headroom. The Group makes regular assessments of debt and equity market conditions. To maintain sufficient financial strength to access new capital at reasonable cost, and meet its objective of maintaining an investment grade credit rating. The Group is mindful of potential impacts on its key metrics when considering changes to its capital structure. |
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For more information on this risk see Note 2 to the accounts, "Financial Risk Management" (on pages 113-117). |
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Operational Risk
The risk of loss, or other adverse consequences to the business, resulting from inadequate or failed internal processes, people and systems, or from external events.
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Risk description |
Mitigation |
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The performance and availability of the Group systems are constantly reviewed and monitored to prevent problems arising where possible and ensure a prompt response to any potential service interruption issues. The Group's technology teams mitigate this risk by ensuring prioritisation of all development and operations activities, and resource utilisation and allocation are kept under constant review.
The MillenniumIT systems are designed to be fault tolerant and alternative standby computer facilities are maintained to minimise the risk of system disruptions.
The robust change management procedures and capacity monitoring provide assurance that Group technology changes are effectively managed.
The Group actively manages relationships with key strategic IT suppliers to avoid any breakdown in service provision which could adversely affect the Group's businesses. Where possible the Group has identified alternative suppliers that could be engaged in the event of a third party failing to deliver on its contractual commitments. |
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For more information see the "Technology Services" section of the Segmental Review, on pages 34 and 35. For information on LCH.Clearnet see section of the Segmental Review on pages 30 and 31.
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Change management
The considerable change agenda is driven by both internal and external factors. Internal factors include the diversification strategy of the Group and its drive for technology innovation and consolidation. External factors include the changing regulatory landscape and requirements which necessitate changes to our systems and processes.
There are a significant number of major, complex projects and strategic actions underway concurrently, that, if not delivered to sufficiently high standards and within agreed timescales, could have an adverse impact on the operation of core services, and revenue growth, as well as damaging the Group's reputation. The volume of simultaneous change could also lead to a loss of client goodwill if the execution is not managed appropriately. Synergies and cost benefits may not be delivered to anticipated levels |
The senior management team is focused on the implementation of the Group's strategy and the project pipeline in view of their importance to the Group's future success. Each major project is managed via a dedicated project office overseen by members of the Executive Committee. Software design methodologies, testing regimes and test environments are continuously being strengthened to minimise implementation risk.
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For more information see the Chairman's statement, on pages 14 and 15, and the Chief Executive's review, on pages 16 and 17. |
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Risk description |
Mitigation |
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Security threats
The Group is reliant upon secure premises to protect its employees and physical assets as well as appropriate safeguards to ensure uninterrupted operation of its IT systems and infrastructure. The threat of cyber crime requires a high level of scrutiny as it may have an adverse impact on our business. Terrorist attacks and similar activities directed against our offices, operations, computer systems or networks could disrupt our markets, harm staff, tenants and visitors, and severely disrupt our business operations. Civil or political unrest could impact on companies within the Group.
Long-term unavailability of key premises or trading and information outages and corruption of data could lead to the loss of client confidence and reputational damage. Security risks have escalated in recent years due to the increasing sophistication of cyber crime. |
Security threats are treated very seriously. The Group has robust physical security arrangements, and extensive IT measures are in place to mitigate technical security risks. The Group is a member of the Centre for the Protection of National Infrastructure (CPNI), with both physical and IT security teams monitoring intelligence and liaising closely with police and global Government agencies.
The Group has well established and regularly tested business continuity and crisis management procedures. The Group risk function assesses its dependencies on critical suppliers and ensures robust contingency measures are in place. |
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Employees
The calibre, quality and retention of employees are critical to the success of the Group. Failure to adequately manage and retain staff resulting in unacceptable levels of staff turnover leads to increased costs of attracting replacement staff and undue distraction of senior management time in recruiting replacements. The loss of key members of staff could have an adverse impact on the Group's operations and ability to deliver its strategy.
The Group's ability to attract and retain high quality individuals depends on the condition of recruitment markets and corresponding compensation packages of financial services, technology firms and regulators with which the Group competes for the same key staff. |
The Group operates a performance management and appraisal system, and Executive development opportunities are provided with the Nominations Committee responsible for considering succession plans for key senior positions.
A performance related annual bonus and pay review process is in place for all employees. Regular benchmarking of reward and incentive systems is performed to ensure they are competitive. The Group also offers Long Term Incentive Plans for high performers and critical staff and turnover is monitored. A centralised training budget allows a co-ordinated approach to development across the Group.
A programme of succession planning is operated by the Group to minimise the impact of the loss of key staff critical to the operation of the business.
We have also enhanced our talent management approach in the last year and will keep doing so while rolling out our succession plans and HR systems to LCH.Clearnet during the next 12 months. |
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For more information see "Our wider responsibility", on pages 36 and 37 and Remuneration Report, on pages 70-97. |
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2. Financial risk management
The Group seeks to protect its financial performance from exposure to capital, credit, sovereign, liquidity and market (including foreign exchange, fair value and cash flow interest rate) risks.
Financial risk management is not speculative. It is performed at a Group level, where the treasury function identifies, evaluates and hedges financial risks from a Group perspective and also locally, where operating units manage regulatory and operational risks. This includes clearing operations at LCH.Clearnet Group and CC&G that operate in accordance with local regulation and under locally approved risk and investment policies. The Financial Risk Committee (FRC), a sub-Committee of the Executive Committee, chaired by the Chief Financial Officer, meets monthly to oversee the consolidated financial risks of the Group. In addition, the Treasury Committee, a sub-Committee of the FRC which is also chaired by the Chief Financial Officer, meets regularly to monitor the management of foreign exchange, interest rates, credit risks and the investment of excess liquidity in addition to its oversight of the Group's funding arrangements. Both Committees ensure that treasury and risk operations are performed in accordance with Group Board approved policies and procedures and regular updates, on a range of key criteria as well as new developments, are provided through the Enterprise Risk Management Framework to the LSEG Risk Committee. See 'Principal Risk and Uncertainties', pages 48-53, for further detail on the Group's risk framework.
Capital risk
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Risk description |
Risk management approach |
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The Group focuses upon its overall cost of capital as it seeks, within the scope of its risk appetite, to provide superior returns to its shareholders, fulfil its obligations to the relevant regulatory authorities and other stakeholders and ensure that it is not overly dependent upon short and medium term debt that might not be available at renewal. Maintaining the flexibility to invest for growth is a key capital management consideration.
The Group can manage its capital structure by varying returns to shareholders, issuing new shares or increasing or reducing borrowings. The Board reviews dividend policy and funding capacity on a regular basis and the Group maintains comfortable levels of debt facility headroom. Regulated entities continuously monitor compliance with the capital requirements set by their respective competent authorities and the terms of reference of the FRC includes oversight of the Group's Capital Management Policy. The Capital Management Policy seeks to ensure that compliance with local regulations is maintained and that there is a robust evaluation of the impact of new investments by the Group on its capital position.
As at 31 March 2014, £803.6 million of cash and cash equivalents was held to meet a number of regulatory and operational requirements across the Group's regulated entities. This amount materially increased during the year as a result of the inclusion of LCH.Clearnet Group's total cash and cash equivalents, in addition to the existing £200 million generally set aside by other LSEG operations. We anticipate that Group companies' cash and cash equivalents are sufficient to comfortably support current regulatory frameworks, including requirements under EMIR. The level of cash set aside by the Group for these purposes remains subject to on-going review with regulators in Europe and the US.
To maintain the financial strength to access new capital at reasonable cost and meet the Group's objective of maintaining an investment grade credit rating, the Group monitors its net leverage ratio which is operating net debt (i.e. net debt excluding cash and cash equivalents set aside for regulatory and operational purposes) to adjusted EBITDA (Group consolidated earnings before net finance charges, taxation, impairment, depreciation and amortisation and non-recurring items) against a target range of one to two times. The Group is also mindful of potential impacts on the key metrics employed by the credit rating agencies (including gross debt to EBITDA and EBITDA coverage of interest expense) in considering increases to its borrowings.
As at 31 March 2014 net leverage was 1.9 times (2013: 1.2 times), towards the top end of the Group's target range but having reduced during the year following the debt funding of the majority acquisition of LCH. Clearnet Group and its subsequent capital raise in May 2013. The Group is in compliance with its bank facility ratio covenants (net leverage and debt service) and these measures do not inhibit the Group's operations or its financing plans. |
Credit and concentration risk
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Risk description |
Risk management approach |
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In their roles as central counterparty (CCP) clearers to financial market participants, the Group's CCPs guarantee final settlement of transactions acting as buyer towards each seller and as seller towards each buyer. They manage substantial credit risks as part of their operations including unmatched risk positions that might arise from the default of a party to a cleared transaction. For more information see 'Principal Risk and Uncertainties', pages 48-53.
Notwithstanding revised regulations in Europe that require CCPs to invest predominantly in secured instruments or structures (such as reverse repos), CC&G and the LCH.Clearnet Group CCPs will continue to be able to invest up to five per cent of their margin and default fund cash unsecured. Through this un-secured investment by its CCPs (as well as by certain other operations observing agreed investment policy limits), the Group will continue to face the risk of direct loss from a deterioration or failure of one or more of its unsecured deposit counterparties.
Concentration risk may arise through having large, connected individual exposures and significant exposures to groups of counterparties whose likelihood of default is driven by common underlying factors. This is a particular focus of the investment approach at the Group's CCPs.
More broadly, the Group's credit risk relates to its customers and counterparties being unable to meet their obligations to the Group either in part or in full, including: · customer receivables · repayment of invested cash and cash equivalents · settlement of derivative financial instruments
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CCPs To address the market participant and latent market risk, the Group's CCPs have established financial safeguards against single or multiple defaults. Clearing membership selection is based upon supervisory capital, technical and organisational criteria. Each member must pay margins, computed and collected at least daily, to cover the exposures and theoretical costs which the CCP would incur in order to close out open positions in the event of the member's default. Margins are calculated using established international risk models and are debited from participants' accounts through central bank accounts and via commercial bank payment systems. Minimum levels of cash collateral are required and non-cash collateral is re-valued daily. As at 31 March 2014, the total aggregate margin liability of clearing members amounted to £68.3 billion, against which the Group had received £35.8 billion in cash and £34.4 billion in non-cash securities. The maximum margin liability during the year was £77.2 billion.
Clearing members also contribute to default funds managed by the CCPs to guarantee the integrity of the markets in the event of multiple defaults in extreme market circumstances. Amounts are determined on the basis of the results of periodic stress testing examined by the risk committees of the respective CCPs. As at 31 March 2014, the total of clearing member contributions to the default funds amounted to £9.0 billion in aggregate across the Group's CCPs. The maximum amount during the year was £9.1 billion. Furthermore, in accordance with recent regulatory changes, each of the Group's CCPs has reinforced its capital position to meet the more stringent requirements, including holding a minimum amount of dedicated own resources to further underpin the protective credit risk framework in the event of a significant market stress event or participant failure.
Investment counterparty risk for CCP margin and default funds is managed by investing the cash element in instruments or structures deemed "secure" by the relevant regulatory body including through direct investments in highly rated, regulatory qualifying sovereign bonds and supra-national debt, investments in tri-party and bi-lateral reverse repos (receiving high quality government securities as collateral which are subject to a "haircut" on their market value) and, in certain jurisdictions, deposits with the central bank. The small proportion of cash that is invested unsecured is placed for short durations with highly rated counterparties where strict limits are applied with respect to credit quality, concentration and tenor. The investment portfolio at 31 March 2014 totalled £47.4 billion in aggregate, of which a weighted average 99.7 per cent was invested securely with an overall maturity of 87 days, including material amounts invested over a very short timeframe to support liquidity needs. The maximum portfolio size during the year was £54.1 billion. Associated liquidity risks are considered in the investment mix and discussed further below.
To address concentration risk, the Group maintains a diversified portfolio of high quality, liquid investments and uses a broad range of custodians, payment and settlement banks and agents. The largest concentration of treasury exposures as at 31 March 2014 was 10.4 per cent of the total investment portfolio to the French Government (including cash held at Banque de France).
Group
Credit risk is controlled through policies developed at a Group level.
Group companies make a judgement on the credit quality of their customers based upon the customer's financial position, the recurring nature of billing and collection arrangements and, historically, a low incidence of default. Furthermore, the Group is exposed to a large number of customers and so concentration risk on its receivables is deemed as low.
Credit risk of cash and cash equivalents is managed by limiting the exposure to up to £50 million for 12 months with counterparties rated long term AAA (or equivalent) through to a maximum £25 million overnight with counterparties rated short term A-2 (or equivalent). Derivative transactions are undertaken with well-capitalised counterparties, authorised by policy, to limit the credit risk underlying these transactions. |
Sovereign risk
|
Risk description |
Risk management approach |
|||||||||||||||
|
Specific risk frameworks manage sovereign risk for both fixed income clearing and margin collateral and all clearing members are monitored regularly against a suite of sovereign stress scenarios. Investment limits and counterparty and clearing membership monitoring are sensitive to changes in ratings and other financial market indicators, to ensure the Group's CCPs are able to measure, monitor and mitigate exposures to sovereign risk and respond quickly to anticipated changes. Risk Committees maintain an on-going watch over these risks and the associated policy frameworks to protect the Group against potentially severe market volatility in the sovereign debt markets.
The Group has material investments of more than £1 billion in the following sovereigns as at 31 March 2014:
|
Liquidity, settlement and custodial risk
|
Risk description |
Risk management approach |
|
|||||||
|
The Group's operations are exposed to liquidity risk to the extent that they are unable to meet their daily payment obligations. In addition, the Group's CCPs and certain other subsidiary companies are required to maintain a level of liquidity (consistent with regulatory requirements) to ensure the smooth operation of their respective markets and to maintain operations in the event of a single or multiple market stress event or member failure. This includes the potential requirement to liquidate the position of a clearing member under a default scenario including covering the associated losses and the settlement obligations of the defaulting member. The Group is exposed to the risk that a payment or settlement bank could fail or that its systems encounter operational issues, creating liquidity pressures and the risk of possible defaults on payment or receivable obligations. The Group uses third party custodians to hold securities and is therefore exposed to the custodian's insolvency, its negligence, a misuse of assets or poor administration. |
Group businesses are profitable, generate strong free cash flow and operations are not significantly impacted by seasonal variations. The Group maintains sufficient liquid resources to meet its financial obligations as they fall due and to invest in capital expenditure, make dividend payments, support acquisitions or repay borrowings. With the exception of regulatory constraints impacting the Group's CCPs and certain other regulated entities, funds can generally be lent across the Group or remitted through dividend payments and this is an important component of the Group Treasury cash management policy and approach.
Management monitors forecasts of the Group's cash flow and overlays sensitivities to these forecasts to reflect assumptions about more difficult market conditions.
Treasury policy requires that the Group maintains adequate credit facilities provided by a diversified lending group to cover its expected funding requirements and ensure a minimum level of headroom for at least the next 24 months. The financial strength of lenders to the Group is monitored regularly. During the year new, committed, revolving three and five year credit facilities totalling £700 million were arranged by LSEG to underpin the Group's financial flexibility. The new facilities extend the Group's average drawn debt maturity profile to just under 5 years and underpin facility headroom over the medium term; the next scheduled debt maturity is in July 2016. At 31 March 2014, £422 million of the Group's facilities were unutilised.
The Group's CCPs maintain sufficient cash and cash equivalents and, in certain jurisdictions, have access to central bank refinancing or commercial bank liquidity support credit lines to meet the cash requirements of the clearing and settlement cycle. Revised regulations require CCPs to arrange appropriate levels of back up liquidity to underpin the dynamics of a largely secured cash investment requirement, ensuring that the maximum potential outflow under extreme market conditions is covered (see Credit Risk section above).
In addition, certain Group companies, including the CCPs, maintain operational support facilities from banks to manage intraday and overnight liquidity. The table below analyses the Group's financial liabilities into relevant maturity groupings based on the remaining period from the balance sheet date to the contractual maturity date. The amounts disclosed in the table are the contractual undiscounted cash flows.
Where possible, the Group employs guaranteed delivery versus payment techniques and manages CCP margin and default fund flows through central bank or long-established, bespoke commercial bank settlement mechanisms. Monies due from clearing members remain the clearing members' liability if the payment agent is unable to effect the appropriate transfer.
Custodians are subject to minimum eligibility requirements and ongoing credit assessment, robust contractual arrangements and are required to have appropriate back-up contingency arrangements in place. |
|
|||||||
|
At 31 March 2014 |
Less than 1 year |
Between 1 and 2 year |
Between 2 and 5 years |
Over 5 years |
|||||
|
£m |
£m |
£m |
£m |
||||||
|
Borrowings |
278.7 |
- |
399.4 |
545.6 |
|||||
|
Trade and other payables |
401.5 |
- |
- |
- |
|||||
|
CCP liabilities |
503,747.4 |
- |
- |
- |
|||||
|
Derivative Financial Instruments |
3.4 |
- |
- |
4.0 |
|||||
|
504,431.0 |
- |
399.4 |
549.6 |
||||||
|
At 31 March 2013 |
Less than 1 year |
Between 1 and 2 years |
Between 2 and 5 years |
Over 5 years |
|||||
|
£m |
£m |
£m |
£m |
||||||
|
Borrowings |
0.4 |
- |
499.2 |
297.2 |
|||||
|
Trade and other payables |
230.0 |
3.2 |
0.2 |
- |
|||||
|
CCP liabilities |
146,088.1 |
- |
- |
- |
|||||
|
Derivative financial instruments |
0.1 |
- |
1.1 |
2.4 |
|||||
|
146,318.6 |
3.2 |
500.5 |
299.6 |
||||||
Market risk - Foreign Exchange
|
Risk description |
Risk management approach |
|
|
The Group seeks, where it can, to match the currency of its debt liabilities with its EBITDA generation in the same currency whilst endeavouring to balance the currency of its assets with the currency of its liabilities. The Group reinforces this methodology by regularly distributing its currency cash earnings in dividends and by absorbing currency earnings through interest payments on sterling debt, re-denominated through the use of cross-currency swaps or by drawing debt in the same currency, where this is practicable. A proportion of the Group's debt is held or effectively held in euro. As at 31 March 2014, £400.5 million of drawn debt was euro denominated (2013: nil) and £248.5 million (2013: £255.5 million) of cross-currency swaps, directly linked to sterling debt, were designated as a hedge of the net investment in the Italian Group. A profit of £4.3 million for the financial year (2013: profit of £5.7 million) on foreign currency borrowings, inter company loan assets and liabilities and cross-currency swap hedges was recognised in equity. The net investment hedge was fully effective.
Whilst transactional foreign exchange exposure is limited, the Group hedges material transactions in accordance with Group Treasury policy (which requires that cash flows of more than £1 million or equivalent per annum should be hedged) with appropriate derivative instruments or by settling currency payables or receivables within a short timeframe. Hedge accounting of derivatives is considered to mitigate material levels of income statement volatility.
The Group reviews sensitivities to movements in exchange rates which are appropriate to market conditions. As at 31 March 2014, the Group has considered movements in the euro over the last year and has concluded that a 10 per cent movement in rates is a reasonable level to measure the risk to the Group. At 31 March 2014, if sterling had weakened or strengthened by 10 per cent against the euro with all other variables held constant, post tax profit for the year would have been, respectively, £0.3 million higher or £0.4 million lower (2013: £0.4 million higher and £0.3 million lower); however, equity would have been £19.0 million lower (2013: £5.7 million lower) and £23.2 million higher (2013: £7.0 million higher). This reflects foreign exchange gains or losses on translation of euro denominated trade receivables, trade payables, financial assets at fair value through profit or loss including euro denominated cash and borrowings. If, on the other hand, the average sterling : euro exchange rate for the year had moved €5 cents, this would have changed the Group's operating profit for the year before amortisation of purchased intangibles and non-recurring items by approximately £12 million. |
Market risk - Cash Flow and Fair Value Interest Rate Risk
|
Risk description |
Risk management approach |
|
The Group's interest rate risk arises through the impact of changes in market rates on cash flows associated with cash and cash equivalents, investments in financial assets and borrowings held at floating rates.
The Group's CCPs face interest rate exposure through the impact of changes in the reference rates used to calculate member liabilities versus the yields achieved through their investment activities. |
Group interest rate management policy has been updated recently to reflect the change in the Group's net debt dynamic following the majority acquisition of LCH.Clearnet Group Limited (which maintains a significant net cash position). The revised policy focusses on protecting the Group's credit rating and requires a minimum coverage of interest expense by EBITDA to be maintained of 7 times and a maximum floating rate component of 50 per cent of total debt. As at 31 March 2014, interest expense cover was at 8.0 times (2013: 9.9 times) and the floating rate component of total debt was 23 per cent.
Group interest rate risk on cash and cash equivalents and investments in financial assets reflects underlying investments generally over short durations and so the Group is more exposed to movements in short term rates.
In the Group's CCPs, interest bearing assets have generally been invested for a longer term than interest bearing liabilities, whose interest rate is generally reset daily. This makes investment revenue vulnerable to volatility in overnight rates and shifts in spreads between overnight and term rates. Interest rate exposures (and the risk to CCP capital) are managed within defined risk appetite parameters against which sensitivities are monitored daily.
In its review of the sensitivities to potential movements in interest rates, the Group has considered interest rate volatility over the last year and prospects for rates over the next 12 months and has concluded that a one percentage point upward movement (with a limited prospect of material downward movement) reflects a reasonable level of risk to current rates. At 31 March 2014, at the Group level, if interest rates on sterling-denominated and euro-denominated cash and borrowings had been 1 percentage point higher with all other variables held constant, post-tax profit for the year would actually have been £6.5 million higher (2013: £6.3 million higher) mainly as a result of higher interest income on floating rate cash and cash equivalents.
At 31 March 2014, at the CCP level (in aggregate), if interest rates on the common interest bearing member liability benchmarks of Eonia, Fed Funds and Sonia, for euro, US dollar and sterling liabilities respectively, had been one percentage point higher, with all other variables held constant, the daily impact on post-tax profit for the Group would have been £0.8 million lower. This deficit would be recovered as investment yields increase as the portfolio matures and is re-invested. |
"
The Annual Report contains the following statements regarding responsibility for financial statements on page 101:
"Statement of directors' responsibilities
The Directors are responsible for preparing the Annual Report, the Directors' Remuneration Report and the financial statements in accordance with applicable law and regulations.
Company law requires the Directors to prepare financial statements for each financial year. Under that law the Directors have prepared the Group and Company financial statements in accordance with International Financial Reporting Standards (IFRSs) as adopted by the European Union. Under company law the Directors must not approve the financial statements unless they are satisfied that they give a true and fair view of the state of the affairs of the Group and the Company and of the profit or loss for that period.
In preparing those financial statements, the Directors are required to:
· select suitable accounting policies and then apply them consistently;
· make judgements and accounting estimates that are reasonable and prudent
· state whether applicable IFRSs as adopted by the European Union have been followed, subject to any material departures disclosed and explained in the financial statements; and
· prepare the financial statements on the going concern basis, unless it is inappropriate to presume that the Group will continue in business.
The Directors confirm that they have complied with the above requirements in preparing the financial statements.
The Directors are responsible for keeping adequate accounting records that are sufficient to show and explain the Company's transactions and disclose with reasonable accuracy at any time the financial position of the Company and the Group and to enable them to ensure that the financial statements and the Directors' Remuneration Report comply with the Companies Act 2006 and, as regards the Group financial statements, Article 4 of the IAS Regulation. The Directors are also responsible for safeguarding the assets of the Company and the Group and for taking reasonable steps for the prevention and detection of fraud and other irregularities.
The Directors are responsible for the maintenance and integrity of the Company's website. Legislation in the United Kingdom governing the preparation and dissemination of financial statements may differ from legislation in other jurisdictions.
The Group's business activities, together with the factors likely to affect its future development, performance and position are set out in the Overview and Strategic Report sections of the Annual Report on pages 2-53. In particular, the current economic conditions continue to pose a number of risks and uncertainties for the Group and these are set out in Principal Risks and Uncertainties on pages 48-53.
The financial risk management objectives and policies of the Group and the exposure of the Group to capital risk, credit risk, market risk and liquidity risk are discussed on pages 114-17. The Group continues to meet Group and individual entity capital requirements and day-to-day liquidity needs through the Group's cash resources and available credit facilities. Committed term funding at 31 March 2014 was £1,649 million which is committed until July 2016 or beyond (2013: £1,650 million, £1,400 million of which was committed until December 2014 or beyond), described further in the Financial Review on pages 38-43.
The Directors have reviewed the Group's forecasts and projections, taking into account reasonably possible changes in trading performance, which show that the Group has sufficient financial resources. On the basis of this review, and after making due enquiries, the Directors have a reasonable expectation that the Company and the Group have adequate resources to continue in operational existence for the foreseeable future. Accordingly, they continue to adopt the going concern basis in preparing the financial statements.
Each of the Directors, whose names and functions are set out on pages 54-55 of this Annual Report confirm that, to the best of their knowledge and belief:
· the Group financial statements, which have been prepared in accordance with IFRSs as adopted by the EU, give a true and fair view of the assets, liabilities, financial position and profit or loss of the Company and the Group taken as a whole;
· the report of the Directors' contained in the Annual Report includes a fair review of the development and performance of the business and the position of the Company and the Group taken as a whole, together with a description of the principal risks and uncertainties that they face; and
· they consider that the Annual Report and Accounts 2014, taken as a whole, is fair, balanced and understandable and provide the information necessary for shareholders to assess the Company's performance, business model and strategy.
By Order of the Board
Lisa Condron
Group Company Secretary
15 May 2014"
The Annual Report contains the following statements regarding details of certain related party transactions on page 140:
"31. Transactions with Related Parties
Key management compensation
Compensation for Directors of the Company and key personnel who have authority for planning, directing and controlling the Group:
|
2014 |
2013 |
||
|
£m |
£m |
||
|
Salaries and other short term benefits |
9.9 |
8.9 |
|
|
Pensions |
0.9 |
0.5 |
|
|
Share based payments |
10.7 |
4.6 |
|
|
21.5 |
14.0 |
||
"
This information is provided by RNS
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