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The Royal Bank of Scotland Group Pension Fund

Report for the year ended 31 December 2016

Registration number 100140634

Table of contents

CHAIRMAN’S REPORT .......................................................................................................................... 1

TRUSTEE, ADMINISTRATION AND ADVISERS .................................................................................. 2

REPORT OF THE TRUSTEE.................................................................................................................. 7

INVESTMENT REPORT ....................................................................................................................... 15

ACTUARIAL CERTIFICATIONS .......................................................................................................... 25

INDEPENDENT AUDITOR’S REPORT ................................................................................................ 27

INDEPENDENT AUDITOR’S STATEMENT ABOUT CONTRIBUTIONS ............................................ 28

SUMMARY OF CONTRIBUTIONS ....................................................................................................... 29

FUND ACCOUNT .................................................................................................................................. 30

STATEMENT OF NET ASSETS AVAILABLE FOR BENEFITS .......................................................... 31

NOTES TO THE FINANCIAL STATEMENTS ...................................................................................... 32

Chairman’s Report

The Royal Bank of Scotland Group Pension Fund Page 1

I am pleased to present the Report for The Royal Bank of Scotland Group Pension Fund (“the Fund”) for the year ended 31 December 2016*. The Fund is one of the largest pension schemes in the UK and the Trustee Board keeps the financial health of the Fund under constant review. The value of the net assets increased during the year under review by £13.3 billion to £45.3 billion at 31 December 2016. During the year the Trustee completed the actuarial valuation as at 31 December 2015. At the valuation date the ratio of assets to liabilities was 84% and the shortfall of assets relative to the liabilities was £5.9 billion. The Trustee concluded funding negotiations with the bank, which resulted in a deficit repair contribution of £4.2 billion, which was paid to the Fund in March 2016 and subsequently invested in growth assets. This contribution replaces the remaining deficit contributions set out in the recovery plan which had been agreed as part of the 2013 actuarial valuation. It was also agreed that the bank would pay higher ongoing contributions as a percentage of salary to meet the cost of accruing benefits for active members. The funding agreement and in particular the £4.2 billion contribution improves the funding position significantly and further strengthens the security of members’ benefits. The Trustee continues to proactively manage the funding, investment and risk strategies of the Fund. During 2016 the Trustee reviewed and updated its strategic business plans. In addition the Trustee maintains a regular dialogue with the bank and closely monitors the ability of the bank to support the Fund (the ‘employer covenant’) with a particular focus on the financial strength of the bank and its strategic progress. Board and Committee meetings The Trustee Board met six times during the year. There were also regular scheduled meetings of the Trustee Board’s Administration and Benefits Committee, Funding and Monitoring Committee, Risk and Audit Committee and Investment Committee, together with a number of additional committee meetings as required. Changes to the Board There have been some changes to the Trustee Board during the year. On 31 March 2016, Miller McLean retired as Bank appointed Trustee Director and Chairman of the Trustee Board. Capital Cranfield Pension Trustees Limited, represented by Nicki Mortimer, was appointed on 31 March 2016 as an Independent Trustee to replace Miller McLean. Laura Barlow resigned as a bank appointed Trustee Director on 14 September 2016. Donald Workman retired as a bank appointed Trustee Director on 15 December 2016. I am pleased to advise that Victoria North and Lisa Sewell were appointed on 15 December 2016 to replace Laura and Donald. In March 2018, two of our member appointed trustees, Stephen Fallowell and Malcolm Groves will step down, having completed four years as trustee directors. We will be holding elections later in 2017 to find replacements for Stephen and Malcolm and the members will receive more details on this process in the coming months.

Chairman – RBS Pension Trustee Limited 31 March 2017 *During 2015 the Fund changed its year-end date to 31 December from 31 March, resulting in a nine month comparative period.

Trustee, Administration and Advisers


Principal Employer National Westminster Bank plc

Corporate Trustee RBS Pension Trustee Limited 1 Princes Street London EC2R 8PB Company registration number 2726164

Trustee Directors Laura Barlow * ^ Bank appointed Trustee Director Chair of the Risk and Audit Committee Resigned 14 September 2016

Ronald Bowie * ~ (Chairman)

Independent Trustee Chair of the Funding and Monitoring Committee

Stephen Boyle # ~ Bank appointed Trustee Director Chair of the Administration and Benefits Committee

Capital Cranfield Pension Trustees Limited # ^

Independent Trustee Appointed 31 March 2016 Represented by Nicki Mortimer Chair of the Risk and Audit Committee

Stephen Fallowell # ^ Member nominated Trustee Director

George Graham * ^ Bank appointed Trustee Director Chair of the Investment Committee

Malcolm Groves* Member nominated Trustee Director

Miller McLean * ~ Bank appointed Trustee Director Chair of the Investment Committee and the Funding and Monitoring Committee Resigned 31 March 2016

Victoria North ~ ^ Bank appointed Trustee Director Appointed 15 December 2016

Ian Purves * ~ Member nominated Trustee Director

James Rowney # Member nominated Trustee Director Appointed 14 January 2016

Lisa Sewell # * Bank appointed Trustee Director Appointed 15 December 2016

Donald Workman* ~ (Deputy Chairman)

Bank appointed Trustee Director Chair of Investment Committee Resigned 15 December 2016

The Trustee directors above are members of the committees set out below as designated by the following symbols:

* Member of the Investment Committee # Member of the Administration and Benefits Committee ~ Member of the Funding and Monitoring Committee ^ Member of the Risk and Audit Committee Appointments and resignations of Trustee Directors reflect those who served during the year up to the date of signing of this Report. Committee memberships are shown at the date of this report or at the date of resignation as appropriate.



Secretary to the Trustee Wendy Tavendale

Scheme Actuary David Eteen FIA Aon Hewitt Verulam Point Station Way St. Albans Hertfordshire AL1 5HE

Administrator Administration is carried out by RBS Pension Services, a unit within HR People Services, The Royal Bank of Scotland Group plc. Any member who has questions about the Fund, their pension benefits or who would like more information should e-mail [email protected] or contact:

Pension Services The Royal Bank of Scotland Group plc Citylink House 4 Addiscombe Road Croydon CR9 5PB

Independent Auditor Deloitte LLP 110 Queen Street Glasgow G1 3BX

Legal Adviser Dentons UKMEA LLP One Fleet Place London EC4M 7WS Until 31 December 2016

CMS Cameron McKenna LLP Cannon Place, 78 Cannon Street London, EC4N 6AF Appointed 1 January 2017

Banker National Westminster Bank plc City of London Office PO Box 12258 1 Princes Street London EC2R 8PA



Consultants Investment

RBS Investment Executive Limited 24/25 St Andrew Square Edinburgh EH2 1AF

Aon Hewitt The Aon Centre, The Leadenhall Building 122 Leadenhall Street London EC3V 4AN Tax

Deloitte LLP Hill House 1 Little New Street London EC4A 3TR

Employer Covenant

Penfida Limited 1 Carey Lane London EC2V 8AE Corporate Governance Hermes Equity Ownership Services Ltd Lloyds Chambers 1 Portsoken Street London E1 8HZ

Investment Custodian Bank of New York Mellon One Canada Square London E14 5AL

AVC Providers Listed below are all the organisations who acted as AVC providers during the year:

Aviva Insurance Limited (formerly Norwich) Clerical Medical Investment Group Limited Fidelity Investments Life Assurance Limited * Standard Life Assurance Limited Scottish Widows’ Fund and Life Assurance Society The Equitable Life Assurance Society * AVCs are invested in the Royal Bank of Scotland Group Common Investment Fund (the “RBS CIF”). Under this arrangement the AVC investments are jointly held with the investment of other participating schemes of the Royal Bank of Scotland Group. Investments received from participating schemes by the RBS CIF are invested on a unitised basis in Life Insurance Investment Company Pooled Funds managed by Fidelity Investments Life Assurance Limited.



Investment Managers Listed below are all the organisations who acted as an investment manager for part or all of the year covered by this Annual Report. Further details regarding the investment strategy are included in the Investment Report. Main Fund Section Investment Managers Aalto Invest LLP AQR Capital Management LLC Axa Real Estate Investment Managers SGP Axiom International Investors LLC Bridgewater Associates Inc. Brockton Capital Fund II LP Brookfield Asset Management Inc. Comgest Asset Management International Limited DSM Capital Partners LLC Epoch Investment Partners Inc Genesis Asset Managers LLP Global Thematic Partners LLC (‘GTP’) GMO UK Limited Gramercy Funds Management LLC Hastings Funds Management (UK) Limited Hermes GPE LLP JP Morgan Chase and Co Juridica Asset Management Limited LaSalle Investment Management Leadenhall Capital Partners LLP Legal & General Assurance (Pensions Management) Limited Lindsell Train Limited Lothbury Investment Management Limited M&G Investment Management Limited MFS International (UK) Limited Navis Capital Partners Nephila Capital Limited New Forests Asset Management Pty Limited Oldfield Partners LLP Orion Capital Managers LP Partners Group Management Pathway Capital Management LLC PIMCO Europe Limited Pramerica Investment Management Inc. Pzena Investment Management LLC Sankaty Advisers LLC Southeastern Asset Management Inc. # Standard Life Pensions Funds Limited SL Capital Partners LLP * Tufton Oceanic Limited Veritas Asset Management (UK) Limited * Appointed during the year # Removed during the year



RBS AA Section Investment Managers AQR Capital Management LLC Aviva Investors Global Services Limited Gramercy Funds Management LLC JP Morgan Alternative Asset Management Legal & General Assurance (Pensions Management) Limited MFS International (UK) Limited Nephila Capital Limited New Forests Asset Management Pty Limited

Derivatives Clearing

Brokers

J.P. Morgan Securities plc

HSBC Bank plc

Report of the Trustee


Introduction

The Directors of RBS Pension Trustee Limited (“the Trustee”) have pleasure in submitting the report of The Royal Bank of Scotland Group Pension Fund (“the Fund”) which covers the year ended 31 December 2016. The purpose of the report is to describe how the Fund has been managed during the year and to advise members of any significant changes that have taken place during the year.

Following the merger of the final salary section of the RBS AA Pension Scheme with the Fund on 31 March 2012 a new section was created within the Fund known as the ''RBS AA Section”. The RBS AA Section is financially separate from the remainder of the Fund (the “Main Fund Section”) and the sections are referred to separately, where appropriate, throughout this report.

Constitution and Management of the Fund

The power to appoint or remove the Trustee of the Fund rests with National Westminster Bank plc. The power of appointing and removing Directors is contained in the Articles of Association of RBS Pension Trustee Limited. Six directors of RBS Pension Trustee Limited are appointed by the Royal Bank of Scotland Group plc and four directors are selected by and from the membership of the Fund.

The Trustee Board has four standing committees: the Investment Committee, the Administration and Benefits Committee, the Funding and Monitoring Committee and the Risk and Audit Committee. The Trustee Board sets the terms of reference for each committee.

The Investment Committee recommends to the Board the Fund’s strategic benchmark and oversees the management and performance of the assets. The Investment Committee and Trustee Board are supported by RBS Investment Executive Limited and Aon Hewitt. The Trustee Board has delegated certain responsibilities for the management of the Fund’s investments to RBS Investment Executive Limited. The Committee met five times during the year.

The Administration and Benefits Committee is responsible for considering changes to the Fund’s Rules, as they affect benefits and exercising the Trustee’s discretion in connection with the payment of benefits. Other responsibilities include monitoring the administration of the Fund and communication to members of the Fund. The Committee is supported by its legal advisers, Dentons UKMEA LLP (until 31 December 2016) and CMS Cameron McKenna LLP (from 1 January 2017). The Committee met five times during the year. The Committee also held ad hoc calls to consider member cases.

The Funding and Monitoring Committee considers all aspects of the funding and covenant including the formal actuarial valuation. Between actuarial valuations, the Committee monitors the funding position and reviews the employer covenant. The Committee is supported by Aon Hewitt as advisers on actuarial matters and Penfida Limited as advisers on the employer covenant. The Committee met six times during the year.

The Risk and Audit Committee is responsible for all aspects of financial and risk management of the Fund, including setting its risk appetite. The Committee oversees the budgetary process, the Fund’s system of financial authorities and reviews the risk register. The Committee met four times during the year.

The members of the Fund have been contracted out on the “Reference Scheme Test” basis from the State Second Pension (S2P) since 1 April 1999.

Tax Status

The Fund was approved by the Commissioners of the Inland Revenue as a retirement benefits scheme for the purposes of Chapter I, Part XIV, of the Income and Corporation Taxes Act 1988 and is treated as an “exempt approved scheme” for the purposes of the Act. The Fund was registered under the Finance Act 2004.



Trustee Training

During the year, training sessions were held for Trustee Directors covering a number of areas including administration, bank capital, banking reform, funding and actuarial valuations. These training sessions were facilitated by the Trustee’s external and internal advisers. The Trustee Board also held a strategy day in September 2016.

Financial Review

The Financial Statements for the year ended 31 December 2016 set out on pages 30 to 55 provide an overview of the income, expenditure and net assets of the Fund. The Financial Statements have been prepared and audited in accordance with the regulations made under sections 41(1) and (6) of the Pensions Act 1995.

During the year under review the net assets of the Fund increased from £32.0 billion to £45.3 billion. The Fund received contributions of £4.5 billion (nine months to 31 December 2015: £212.6 million), paid benefits to members and leavers of £1.3 billion (nine months to 31 December 2015: £783.2 million), incurred administrative expenses of £16.7 million (nine months to 31 December 2015: £16.3 million) and achieved a net gain on investments of £10.1billion (nine months to 31 December 2015: loss of £997.2 million).

Ownership of The Royal Bank of Scotland Group plc

The Principal Employer, National Westminster Bank plc, is a wholly-owned subsidiary of The Royal Bank of Scotland plc, which is in turn wholly owned by The Royal Bank of Scotland Group plc. As at 31 December 2016, HM Treasury owns 71.3% of the ordinary shares of The Royal Bank of Scotland Group plc.

Additional Member Contributions

Active members have the option to secure additional benefits on a money purchase basis by making Additional Voluntary Contributions (‘AVCs’) through the RBSelect benefits programme. The investment choices are provided to members by the Trustee via participation in the Royal Bank of Scotland Common Investment Fund. The Trustee Board retains overall responsibility for the investment options made available to members and could at any time withdraw funds from the Common Investment Fund.

Report on Liabilities and Funding Paying the promised benefits to members is the key objective for the Trustee. Under Section 222 of the Pensions Act 2004, every scheme is subject to the Statutory Funding Objective, which is to have sufficient and appropriate assets to cover its ‘technical provisions’ as calculated by the Scheme Actuary. The technical provisions represent the value of the benefits members are entitled to, based on pensionable service to the valuation date. The most recent full actuarial valuation of the Fund was carried out as at 31 December 2015. The technical provisions are assessed by the Scheme Actuary using the assumptions which are agreed between the Trustee and the bank, and are set out in the Statement of Funding Principles. Key actuarial assumptions used in the valuation are shown on the following page:



Report on Liabilities and Funding (continued)

Main Fund Section RBS AA section

Discount rate Fixed interest swap-yield curve plus

1.5% p.a. at all durations.

Fixed interest swap-yield curve plus

1.3% p.a. at all durations.

Inflation Future inflation in line with the RPI

swap-yield curve.

Future inflation in line with the RPI

swap-yield curve. CPI inflation is

assumed to be RPI inflation less 1.1%

p.a. at all durations.

Post-retirement

mortality base tables

Mortality assumptions are based on the 2SPA (light) tables from ‘S2’ Series of

Mortality Tables (based on the experience of members in Self-Administered

Pension Schemes). The probability of death in these tables is adjusted by the

actuary to reflect the specific circumstances of the Fund based on a 2015

experience investigation and postcode analysis.

Post retirement

mortality future

improvements

Improvements from the base table are in line with CMI 2014 Core Projections

Model with a long term rate to the improvements of 1.5% p.a.

Members can obtain a copy of the valuation documents by contacting RBS Pension Services using

the contact details listed on page 3.

The Actuarial Certificate in respect of the adequacy of contribution rates to meet the Statutory Funding

Objective for the Main Fund Section is included on page 25. The corresponding certificate for the RBS

AA Section is included on page 26.

Valuation Results – Main Fund Section

The most recent full actuarial valuation of the Fund was carried out as at 31 December 2015. The

valuation results are summarized below:

31 December 2015

actuarial valuation

£m

31 December 2016

interim estimate

£m

Assets 30,793 43,822

Liabilities (technical provisions) 36,654 44,256

(Deficit)/Surplus (5,861) (434)

Funding ratio 84% 99%

As part of the valuation a Schedule of Contributions was agreed under which the bank committed to

pay ongoing contributions to meet the cost of future benefits accruing for active members and

administration expenses at the following rates:

• 32.9% of basic salaries less any member contributions payable for members accruing service in

Retiring Age 65 Schedule (previously 23.9%).

• 38.6% of basic salaries less any member contributions payable for all other active members,

(previously 31.1%).

A recovery plan was also agreed with the bank to deal with the £5,861 million deficit which was

reported at the valuation date. Under the Recovery Plan the bank committed to pay a £4,200 million

deficit repair contribution to the Fund in March 2016 in lieu of future deficit contributions which were

part of the previous Recovery Plan. The Recovery Plan allowed for the remaining deficit to be

eliminated by 2025 by targeting higher investment returns than those used by the actuary in setting

the technical provisions.



Valuation Results – Main Fund Section (continued)

During 2016 the funding position improved, with the deficit falling to £434 million at 31 December

2016. The improvement in the funding position is the result of the £4,200 million deficit funding

contribution which was paid to the Fund and stronger than expected investment returns during 2016.

While the Trustee manages the strategy proactively, future investment returns could cause the funding

position to improve or deteriorate.

Valuation Results – RBS AA Section

The most recent full actuarial valuation of the Fund was carried out as at 31 December 2015. The

valuation results are summarised below.

31 December 2015

actuarial valuation

£m

31 December 2016

interim estimate

£m

Assets 897 1,149

Liabilities (technical provisions) 892 1,084

(Deficit)/Surplus (5) 65

Funding ratio 101% 106%

As part of the valuation a Schedule of Contributions was agreed between the Trustee and the bank.

The bank committed to pay ongoing contributions to meet the cost of future benefits accruing for

active members and administration expenses at the following rates:

• 44.3% of pensionable salary for employees who are active members of the RBS AA Section

Retiring Age 65 Schedule (previously 32.6%).

• 53.4% of pensionable salary for other active members (previously 42.1%).

As there was no deficit at the valuation date no Recovery Plan was necessary.

During 2016 the funding position improved, with the surplus increasing to £65 million at 31 December

2016 mainly as the result of stronger than expected investment returns during 2016. Future

investment returns could cause the funding position to improve or deteriorate. The Trustee is in the

process of evaluating the strategy in light of the current funding position.

Next valuation

The effective date of the next actuarial valuation (for both sections of the Fund) is expected to be 31

December 2018.

Transfer Values

Transfer values made during the year were calculated on the basis agreed by the Trustee having taken advice from the Scheme Actuary. No allowance is made for discretionary increases in the calculation of transfer values other than revaluation in deferment for certain members who left service prior to 1 January 1985 where the Trustee has decided to award such an increase on a discretionary basis. No transfer values were reduced during the year because of underfunding.



Pension Increases

Pensions in payment in excess of the Guaranteed Minimum Pension (GMP) are subject to annual increases in line with the Rules of the Fund. RPI inflation was 1.3% for the twelve months to January 2016. An increase of 1.3% was applied to pensions in payment for members of the Group Schedule and for former members of the National Westminster Bank Pension Fund, Royal Bank of Scotland Staff Pension Scheme and RBS AA Pension Scheme (2015: 1.1%).

There is also a legal requirement to increase GMPs earned as a consequence of being contracted out of the State Second Pension between 6 April 1988 and 5 April 1997. GMPs are increased by the lesser of 3% and the increase in the UK Consumer Prices Index (CPI) during the twelve months to the preceding September. CPI inflation was negative for the twelve months to September 2015 so no increase was applied to GMPs in payment earned after 5 April 1988 (2015: 1.2%).

Discretionary (non-guaranteed) increases have also been awarded on deferred pensions for certain members who left service prior to 1 January 1985. The Trustee exercised its discretion to award an increase of 0.8% to these deferred pensions in 2016 (2015: 2.3%).

Investments and Custodians

The Trustee is responsible for setting the investment policy and managing the assets. The Investment Committee oversees the investment arrangements. Day to day investment decisions are delegated to the investment managers under formal legal agreements between the Trustee and each investment manager.

In accordance with the Pensions Act 1995, subsequently amended by the Pensions Act 2004, the Trustee maintains a Statement of Investment Principles that describes the Fund's investment policy.

The majority of the Fund’s assets are held in custody by the Bank of New York Mellon. The investments are held in the name of The Bank of New York (Nominees) Limited. The remaining assets are held externally but are registered in the name of the Trustee. The Investment Report is included on pages 15 to 24 of this report.



Controlling Interests in Subsidiaries

The Fund invests in five entities in which it holds controlling interests as at 31 December 2016.

• West Granite Homes invests in residential property in the US and is 99.9% owned by the Fund although the Fund has 100% of the voting rights.

• Albemarle Shipping Ltd invests in shipping assets and is 100% owned by the Fund.

• Phoenix Natural Gas is a Northern Irish Natural Gas Distributor and is 50% owned as part of a joint venture.

• Brickell Key Investments LLP invests in Litigation Financing and the Fund has a partnership holding of 99.9% although the Fund ultimately controls 100% of the partnership.

• Ventus Investments Ltd invests in onshore wind generation assets and is 100% owned by the Fund.

All of these entities are considered by the Trustee to be held as part of the Fund’s investment portfolio so have been incorporated into the Financial Statements at fair value on an equity accounting basis and not consolidated with the Fund’s Financial Statements.

Responsible investment and corporate governance

The Trustee believes that environmental, social, economic and governance performance are fundamental to a company’s enduring success and therefore to its long-term financial returns. The Trustee also believes that the goal of any company should be to generate and deliver sustainable long-term financial value, which will be helped by having long-term owners to whom the company is accountable and by having owners that are clear about their expectations. The Trustee seeks to invest in companies which embrace these objectives and are able to demonstrate that they do so.

It is the Trustee’s policy to implement Responsible Ownership in its investment approach. The Trustee is a signatory to the UK Stewardship Code as a framework for its interaction with companies in which it invests, and as a framework for its expectations of how its investment management processes will take into consideration relevant environmental, social and governance issues. The Trustee acknowledges the role of the Fund as an asset owner under the Stewardship Code and therefore seeks to hold to account its fund managers and service providers in respect of their commitments to the Code. The Trustee has adopted the UN Global Compact Principles as a framework for its expectations as to the behaviours and approach of the Fund’s underlying assets.

In order to give effect to this policy, the Trustee has employed a recognised third party service provider, Hermes Equity Ownership Services Ltd (‘EOS’) to assist in its implementation. There are three major elements to this: monitoring of Fund investments, engagement with investee companies as appropriate and also with regulators and standard-setters, and voting of Fund shares.

The Trustee’s high-level investment policies, including the policies on voting and engagement are set out in the Statement of Investment Principles. The Statement of Investment Principles, the Responsible Ownership Policy and the Annual Voting and Engagement Report are available online at https://rbs.tbs.aon.com/UK-Learn-More-Home then click on the heading “Final Salary Pension Plan”, followed by “Useful Information”.



Membership Statistics

The following table shows the changes in the membership of the Fund during the year ended 31 December 2016:

At 31 December 2015

Changes in the year

At 31 December 2016

RBS Main Fund Section Active members 26,128 (4,418) 21,710 Deferred pensioners 122,613 (492) 122,121 Pensioner members 66,190 2,588 68,778

214,931 (2,322) 212,609 RBS AA Section Active members 35 (8) 27 Deferred pensioners 1,973 (68) 1,905 Pensioner members 759 35 794 2,767 (41) 2,726 Total members 217,698 (2,363) 215,335

Active members are employees accruing benefits. Deferred pensioners are those who have left the Fund with preserved pensions. Pensioner members are all those (including dependants) in receipt of a pension.

Registration

All the relevant details of the Fund and the Trustee Directors have been passed to the Pension Tracing Service, which may be able to help anyone trying to trace pension rights under a previous pension scheme. The Pension Tracing Service can be contacted by mail at The Pension Service 9, Mail Handling Site A, Wolverhampton, WV98 1LU or by phone at 0345 6002 537 or from outside the UK on +44 (0) 191 215 4491.



Statement of the Trustee’s Responsibilities

The Financial Statements, which are prepared in accordance with UK Generally Accepted Accounting Practice, including the Financial Reporting Standard applicable in the UK and Republic of Ireland (“FRS 102”), are the responsibility of the Trustee. Pension scheme regulations require the Trustee to make available to Fund Members, beneficiaries and certain other parties, audited Financial Statements for each Fund year which:

• show a true and fair view of the financial transactions of the Fund during the Fund year and of the amount and disposition at the end of that year of the assets and liabilities, other than liabilities to pay pensions and benefits after the end of the Fund year;

• state whether applicable United Kingdom Accounting Standards, including FRS 102, have been followed, subject to any material departures disclosed and explained in the financial statements; and

• contain the information specified in Regulations 3 and 3A of the Occupational Pension Schemes (Requirement to obtain Audited Accounts and a Statement from the Auditor) Regulations 1996.

The Trustee has supervised the preparation of the Financial Statements and has agreed suitable accounting policies, to be applied consistently, making any estimates and judgements on a prudent and reasonable basis. The Trustee is also responsible for making available certain other information about the Fund in the form of an Annual Report. The Trustee also has a general responsibility for ensuring that adequate accounting records are kept and for taking such steps as are reasonably open to them to safeguard the assets of the Fund and to prevent and detect fraud and other irregularities, including the maintenance of an appropriate system of internal control. Trustee Responsibilities in Respect of Contributions The Trustee is responsible under pension legislation for ensuring that there is prepared, maintained and from time to time revised a Schedule of Contributions showing the rates of contributions payable towards the Fund by or on behalf of the Employer and the active members of the Fund and the dates on or before which such contributions are to be paid. The Trustee is also responsible for keeping records in respect of contributions received in respect of any active member of the Fund and for monitoring whether contributions are made to the Fund by the Employer in accordance with the Schedule of Contributions. Where breaches of the Schedule occur, the Trustee is required by the Pensions Acts 1995 and 2004 to consider making reports to The Pensions Regulator and the members.

Approval of the Trustee Report

Approved by the Directors of RBS Pension Trustee Limited and signed on behalf of RBS Pension Trustee Limited by:

Investment Report


Investment Governance The Investment Committee oversees the management of the Fund’s investment strategy in line with objectives set by the Trustee. This includes setting the strategic benchmark for the Fund. The Investment Committee is supported by RBS Investment Executive Limited (“RIEL”) headed by the Chief Executive and Chief Investment Officer, Robert Waugh. RIEL is responsible for providing investment advice and overseeing the implementation of the investment strategy. Aon Hewitt is employed to provide additional oversight on investment matters. The assets of the Main Fund Section and RBS AA Section are sectionalised, meaning that the assets for each section have their own strategic benchmark and the assets are held separately. The Main Fund Section is able to run a more diversified range of growth assets and investment managers due its larger size compared to the RBS AA Section. Main Fund Section Investment Activity

In 2016, the Main Fund Section’s strategic benchmark was adjusted to incorporate the bank’s £4.2 billion deficit contribution, which was invested into growth assets, principally in quoted equity (an increase of £2.2 billion) and credit (an increase of £2 billion). The Trustee continued its policy of hedging 100% of the Main Fund Section’s interest rate and inflation risk. Within quoted equity, the Main Fund Section’s exposure to value factors was increased both in Developed and Emerging Market regions. This was achieved by allocating capital to Managers with a value investment philosophy and investment in passive funds with a value tilt. The Main Fund Section has a lower exposure to alternative equity than its strategic benchmark as assets have transacted above the levels at which the Trustee has been prepared to deploy capital. Further allocations were made to investment grade credit, senior loans and emerging market credit when credit spreads increased in the early part of the year. Infrastructure debt, annuities and distressed debt provided sufficient compensation for their expected risk, allowing further allocations; conversely there was a slight reduction in the allocation to property debt where the risk-adjusted expected return has fallen. The Main Fund Section added an office property in Manchester to its UK portfolio. Further allocations were made to the US residential housing portfolio, which invests in single-family homes. In litigation finance, the Main Fund Section received a return of capital following the successful settlement of some investments and further capital was deployed in new litigation opportunities. The increase in demand for assets in the catastrophe re-insurance sector has reduced the insurance premium available from the asset class and the risk-adjusted expected return has fallen as a result.

The Main Fund Section’s re-insurance mandate has been running below its normal risk profile in the expectation of more attractive pricing opportunities in this market. The Main Fund Section holds swaptions within the liability hedging portfolio alongside other hedging instruments. As yields have fallen, these have generated profits. During the year some of the swaptions matured, with the profits being used to re-invest in physical UK government bonds. This and other actions have resulted in a reduction in the leverage (total size of exposure divided by total value of assets) of the Main Fund Section.

Investment Report


Investment Performance

At 31 December 2016 the Main Fund Section’s assets totalled £44.1 billion. During the year the investment assets (excluding net current assets and AVCs) increased by £13.0 billion. Adjusting for the contributions and payments from the Fund, the investment assets returned £9.8 billion. Growth assets generated a return of £2.2 billion and liability-matching assets £7.6 billion. The Main Fund Section performed in line with the strategic benchmark return of £7.9 billion. An additional £1.8 billion was generated by gilt spread and swaptions performance which sit outside of the strategic benchmark.

Main Fund Section - Performance to 31 December 2016

Note - The stated performance for the Fund in the chart above includes the impact of gilts relative to the swaps based

liability benchmark and also the impact of swaptions which are not part of the benchmark.

29.7%

18.3%

14.1%

24.3%

15.7%

12.2%

0%

5%

10%

15%

20%

25%

30%

35%

1 Year to 31 Dec 2016 3 Years to 31 Dec 2016 5 Years to 31 Dec 2016

Pe

rfo

rma

nce

, %

pe

r a

nn

um

Fund Strategic Benchmark

£9.8bn

£16.5bn

£20.0bn

£8.0bn

£14.0bn

£17.2bn

£0.0bn

£5.0bn

£10.0bn

£15.0bn

£20.0bn

£25.0bn

1 Year to 31 Dec 2016 3 Years to 31 Dec 2016 5 Years to 31 Dec 2016


Investment Report


Investment Fees

Investment management fees are monitored closely, including fees deducted at source, to determine whether the Trustee is getting value for money from its investment managers. Estimates are used where necessary. The Trustee monitors fees in absolute terms as well as comparing fees to the value added over the benchmark i.e. outperformance. Investment management fees are compared to performance versus benchmark (including commissions, taxes, exchange and broker fees but excluding transaction costs, administration and other ancillary costs) in the chart below.

Performance versus Benchmark and Fees (Main Fund Section), 2010-2016

The fees shown in the chart above include both fees deducted at source and fees invoiced to the Fund. The fees detailed in note 9 of the accounts exclude fees deducted at source. Investment management fees (invoiced fees and fees deducted at source) are shown as a percentage of the assets in the chart below.

Fees as a Percentage of Assets (Main Fund Section), 2010-2016

0.53% 0.54%

0.48%0.50%

0.37%

0.31%0.27%

0.0%

0.1%

0.2%

0.3%

0.4%

0.5%

0.6%

2010 2011 2012 2013 2014 2015 2016

To

tal in

ve

stm

en

t m

an

ag

em

en

t fe

es

as

% o

f a

ss

et

va

lue

Calendar year

Investment Report


Asset Allocation and Strategic Benchmark

The Trustees continue to pursue a diversified investment strategy seeking asset classes and managers which lower the overall correlation with existing assets classes and with those economic factors which drive the health of the bank as sponsor of the Fund. The distribution by asset class and the list of managers employed during the year is set out below

Main Fund Section - Asset Portfolio 31 December 2016

Investment Report


The Strategic Benchmark for the Main Fund Section as at 31 December 2016 is set out in the table below.

Asset class Sub asset class Investment Managers

Strategic Benchmark

exposure at 31

December 2016

Equity Quoted equity Axiom Comgest DSM Epoch Genesis GMO GTP LGIM Lindsell Train MFS Oldfield Pzena Southeastern Veritas

£10,200m

Private equity Hermes GPE JP Morgan Navis Pathway Standard Life

Regulated utilities MFS

Infrastructure equity Hastings

Shipping Tufton

Timber and forestry LGIM New Forests

Hedge funds - macro - momentum

Bridgewater AQR

Credit Global credit LGIM M&G Pimco Pramerica Standard Life

£8,500m

Emerging markets debt Gramercy

Syndicated loans Sankaty

Distressed debt Brookfield

Real estate debt Axa

Infrastructure debt Hastings

Settled annuities Leadenhall

Property UK Brockton Lothbury Standard Life

£2,100m

Europe La Salle Orion

US residential Aalto

Global Partners

Insurance Non-life risks Nephila £1,000m

Life risks (inc. life settlements) Leadenhall

Litigation finance Juridica

Investment Report


Asset class Sub asset class Investment Managers

Strategic Benchmark

exposure at 31

December 2016

Liability hedging Liability hedging LGIM 100% of liability interest rate risk (including 8% via

swaptions). 100% of liability

inflation risk

Cash & liquidity LGIM

Collateral management LGIM

Principal Investments

The Main Fund Section’s largest exposures (“principal investments”) across equity, debt and pooled funds are shown in the charts below.

Ten largest equity issuer exposures (Main Fund Section)

Ten largest debt issuer exposures (Main Fund Section)

£14,221m

£1,331m

£317m

£215m

£180m

£113m

£106m

£99m

£96m

£87m

£0bn £3bn £6bn £9bn £12bn £15bn

UK government

Network Rail

Habitus Funding

US government

Nordic Investment Bank

AT&T Inc

German government

Verizon Communications Inc

Anheuser Busch Inbev SA

IBRD

Investment Report


Ten largest pooled fund investments (Main Fund Section)

RBS AA SECTION Investment Activity The AA section’s strategic benchmark was broadly unchanged in 2016. The Trustee continued its policy of hedging 100% of the RBS AA Section’s interest rate and inflation risk. Investment Performance At 31 December 2016 the RBS AA Section’s assets totalled £1.2 billion. The investment assets (excluding net current assets and AVCs) increased by £253 million. Adjusting for the contributions and payments from the Fund, the investment assets returned £274 million. Growth assets generated a return of £47 million and liability-matching assets £227 million.

RBS AA Section Performance to 31 December 2016

Note - The stated performance for the Fund in the chart above includes the impact of gilts relative to the swaps based

liability benchmark which are not part of the benchmark.

£2,000m

£733m

£548m

£439m

£386m

£378m

£372m

£304m

£298m

£292m

£0m £600m £1,200m £1,800m £2,400m

LGIM Sterling Liquidity Fund (cash)

LGIM FTSE RAFI 3000 Index Fund (equity)

DSM (equity)

LGIM UK Index Fund (equity)

Lothbury Property Trust (property)

Nephila Cronus Fund (reinsurance)

West Granite Homes (US residential property)

LGIM USD Liquidity Fund (cash)

AQR Fund (hedge fund)

LGIM Europe ex-UK Index Fund (equity)

30.7%

17.5%

28.3%

17.3%

0%

5%

10%

15%

20%

25%

30%

35%

1 Year to 31 Dec 2015 3 Years to 31 Dec 2016

Pe

rfo

rma

nce

, %

pe

r a

nn

um


Investment Report


Asset Allocation and Strategic Benchmark

The Trustees continue to pursue a diversified strategy seeking asset classes and managers which lower the overall correlation with existing assets classes and with those economic factors which drive the health of the Bank as sponsor of the Fund albeit a simplified version of that adopted by the Main Fund Section. The distribution by asset class and the list of managers employed during the year is set out below

RBS AA Section - Asset Portfolio 31 December 2016

The Strategic Benchmark for the RBS AA Section as at 31 December 2016 is set out in the table below.

Asset class Sub asset class Investment Managers Strategic Benchmark

exposure at 31 December 2016

Equity Quoted equity LGIM £242m

Regulated utilities MFS

Timber and forestry New Forests

Hedge funds - momentum AQR

Credit Global credit LGIM £212m

Emerging markets credit Gramercy

Property Property funds Aviva £43m

Insurance Non-life risks Nephila £24m

Litigation finance Juridica

Liability hedging Liability hedging LGIM 100% of liability interest rate and inflation risk Cash & liquidity LGIM

Investment Report


Principal Investments

The RBS AA Section’s largest exposures (“principal investments”) across equity, debt and pooled funds are shown in the charts below.

Ten largest equity issuer exposures (RBS AA Section)

Ten largest debt issuer exposures (RBS AA Section)

£2.3m

£1.2m

£1.0m

£1.0m

£1.0m

£0.9m

£0.8m

£0.8m

£0.8m

£0.7m

£0m £1m £2m £3m £4m £5m

Juridica Investments Ltd (litigation finance)

FTSE 100 Index (equity futures)

Xcel Energy Inc (quoted equity)

CMS Energy Corp (quoted equity)

Alliant Energy Corp (quoted equity)

PG&E Corp (quoted equity)

Pinnacle West Capital Corp (quoted equity)

American Water Works (quoted equity)

Eversource Energy (quoted equity)

WEC Energy Group Inc (quoted equity)

£632.0m

£2.5m

£2.4m

£2.3m

£2.2m

£2.2m

£2.2m

£2.1m

£2.1m

£2.1m

£0m £250m £500m £750m

UK government

Kraft Heinz Foods Co

Apple Inc

Duke Energy Corp

Enterprise Products Operating LLC

Energy Transfer Partners LP

Abbvie Inc

Medtronic Inc

Gilead Sciences Inc

General Motors Financial Company Inc

Investment Report


Ten largest pooled fund investments (RBS AA Section)

£54.3m

£29.2m

£18.6m

£14.9m

£10.0m

£8.8m

£8.0m

£7.5m

£5.4m

£5.3m

£0m £25m £50m £75m

LGIM Sterling Liquidity Fund (cash)

LGIM Emerging Markets Fund (equity)

LGIM Europe (ex-UK) Fund (equity)

Nephila Cronus Catastrophe Fund (reinsurance)

Gramercy Emerging Markets Debt Fund (credit)

AQR Fund (hedge fund)

Standard Life European Growth Fund (property)

Gramercy Credit Opportunities Fund (credit)

Henderson UK Property Fund (property)

Schoders Plc (property)

Actuarial Certifications


Actuarial Certifications


Independent Auditor’s Report to the Trustee of the Royal Bank of Scotland Group Pension Fund


We have audited the Financial Statements of the Royal Bank of Scotland Group Pension Fund for the year ended 31 December 2016 which comprise the fund account, statement of net assets and the related notes 1 to 29. The financial reporting framework that has been applied in their preparation is applicable law and United Kingdom Accounting Standards (United Kingdom Generally Accepted Accounting Practice), including FRS 102 “The Financial Reporting Standard applicable in the UK and Republic of Ireland.”

This report is made solely to the Trustee, as a body, in accordance with regulation 3 of the Occupational Pension Schemes (Requirement to obtain Audited Accounts and a Statement from the Auditor) Regulations 1996 made under the Pensions Act 1995. Our audit work has been undertaken so that we might state to the Trustee those matters we are required to state to it in an auditor’s report and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Trustee as a body, for our audit work, for this report, or for the opinions we have formed.

Respective responsibilities of the Trustee and Auditor

As explained more fully in the Statement of Trustee’s Responsibilities, the Fund’s Trustee is responsible for the preparation of Financial Statements which give a true and fair view. Our responsibility is to audit and express an opinion on the Financial Statements in accordance with applicable law and International Standards on Auditing (UK and Ireland). Those standards require us to comply with the Auditing Practices Board’s Ethical Standards for Auditors.

Scope of the audit of the Financial Statements

An audit involves obtaining evidence about the amounts and disclosures in the Financial Statements sufficient to give reasonable assurance that the Financial Statements are free from material misstatement, whether caused by fraud or error. This includes an assessment of: whether the accounting policies are appropriate to the Fund’s circumstances and have been consistently applied and adequately disclosed; the reasonableness of significant accounting estimates made by the Trustee; and the overall presentation of the Financial Statements. In addition, we read all the financial and non-financial information in the annual report to identify material inconsistencies with the audited Financial Statements and to identify any information that is apparently materially incorrect based on, or materially inconsistent with the knowledge acquired by us in the course of performing the audit. If we become aware of any apparent material misstatements or inconsistencies we consider the implications for our report.

Opinion on the Financial Statements In our opinion the Financial Statements:

• show a true and fair view of the financial transactions of the Fund during the year ended 31 December 2016, and of the amount and disposition at that date of its assets and liabilities, other than the liabilities to pay pensions and benefits after the end of the year;

• have been properly prepared in accordance with United Kingdom Generally Accepted Accounting Practice; and

• contain the information specified in Regulations 3 and 3A of the Occupational Pension Schemes (Requirement to obtain Audited Accounts and a Statement from the Auditor) Regulations 1996, made under the Pensions Act 1995.

Deloitte LLP Chartered Accountants and Statutory Auditor Glasgow United Kingdom

Date:

Independent Auditor’s Statement about Contributions to the Trustee of the Royal Bank of Scotland Group Pension Fund


We have examined the summary of contributions to the Royal Bank of Scotland Group Pension Fund for the year ended 31 December 2016 as set out on page 29.

This statement is made solely to the Trustee, as a body, in accordance with regulation 4 of the Occupational Pension Schemes (Requirement to obtain Audited Accounts and a Statement from the Auditor) Regulations 1996 made under the Pensions Act 1995. Our work has been undertaken so that we might state to the Trustee those matters we are required to state to it in an auditor’s statement about contributions and for no other purpose. To the fullest extent permitted by law, we do not accept or assume responsibility to anyone other than the Trustee as a body for our work, for this statement, or for the opinion we have formed.

Respective responsibilities of the Trustee and Auditor

As explained more fully in the Statement of Trustee’s Responsibilities, the Fund’s Trustee is responsible for ensuring that there is prepared, maintained and from time to time revised a Schedule of Contributions showing the rates and due dates of certain contributions payable towards the Fund by or on behalf of the employer and the active members of the Fund. The Trustee is also responsible for keeping records in respect of contributions received in respect of active members of the Fund and for monitoring whether contributions are made to the Fund by the employer in accordance with the Schedule of Contributions.

It is our responsibility to provide a Statement about Contributions paid under the Schedule of Contributions and to report our opinion to you.

Scope of work on Statement about Contributions

Our examination involves obtaining evidence sufficient to give reasonable assurance that contributions reported in the attached summary of contributions have in all material respects been paid at least in accordance with the Schedules of Contributions. This includes an examination, on a test basis, of evidence relevant to the amounts of contributions payable to the Fund and the timing of those payments under the Schedules of Contributions.

Statement about Contributions payable under the Schedules of Contributions

In our opinion contributions for the Main Fund Section for the year ended 31 December 2016 as reported in the summary of contributions have in all material respects been paid for the period 1 January 2016 to 30 June 2016 at least in accordance with the Schedule of Contributions certified by the Actuary on 27 June 2014 and for the period 1 July 2016 to 31 December 2016 at least in accordance with the Schedule of Contributions certified by the Actuary on 30 June 2016.

In our opinion contributions for the RBS AA Section for the year ended 31 December 2016 as reported in the summary of contributions have in all material respects been paid for the period 1 January 2016 to 30 June 2016 at least in accordance with the Schedule of Contributions certified by the Actuary on 27 June 2014 and for the period 1 July 2016 to 31 December 2016 at least in accordance with the Schedule of Contributions certified by the Actuary on 30 June 2016.

Deloitte LLP Chartered Accountants and Statutory Auditor Glasgow United Kingdom

Date:

Summary of Contributions


During the year ended 31 December 2016 the contributions payable to the Fund by the employers under the Schedules of Contributions were as follows:

Main Fund Section

£m

RBS AA Section

£m

Total year to

31 December

2016 £m

9 months to 31

December 2015

£m

Employers’ normal contributions 253.1 1.1 254.2 182.0Employers’ additional contributions 15.6 1.4 17.0 20.1Employers’ augmentations 15.4 - 15.4 6.5Deficit funding contributions 4,234.4 1.3 4,235.7 3.9

Total contributions payable under the Schedules of Contributions (as reported on by the auditor) 4,518.5 3.8 4,522.3 212.5 In addition, further contributions were payable:

Members’ additional voluntary 11.6 - 11.6 -

Contributions included in the Financial Statements 4,530.1 3.8 4,533.9 212.5

Approved by the Directors of RBS Pension Trustee Limited and signed on behalf of RBS Pension Trustee Limited by:

Fund Account for the Year Ended 31 December 2016


Notes

Main Fund Section

£m

RBS AA Section

£m

Total Year ended

31 December 2016

£m

9 months to 31

December 2015

£m

Contributions and benefits Contributions 3 Employer 4,518.5 3.8 4,522.3 212.5 Employee 11.6 - 11.6 - Transfers in 4 0.9 - 0.9 0.1

4,531.0 3.8 4,534.8 212.6 Benefits paid or payable 5 (866.5) (15.1) (881.6) (617.2) Payments to and on account of leavers

6 (406.4) (11.1) (417.5) (166.0)

Administrative expenses 7 (16.5) (0.2) (16.7) (16.3)

(1,289.4) (26.4) (1,315.8) (799.5) Net additions/(withdrawals) from dealings with members

3,241.6 (22.6) 3,219.0 (586.9)

Returns on investments Investment income 8 614.2 20.5 634.7 542.3 Investment management expenses

9 (65.6) (1.2) (66.8) (48.3)

Change in market value of investments

11 9,281.7 256.6 9,538.3 (1,482.4)

Taxes on investment income 9 (8.0) - (8.0) (8.8) Net returns on investments 9,822.3 275.9 10,098.2 (997.2) Net increase/(decrease) in the Fund during the year/period

13,063.9 253.3 13,317.2 (1,584.1)

Net assets of the Fund at beginning of year/period

31,038.7 913.6 31,952.3 33,536.4

Net assets of the Fund at end of year/period

44,102.6 1,166.9 45,269.5 31,952.3

The accompanying notes on pages 32 to 55 are an integral part of these Financial Statements.

Statement of Net Assets Available for Benefits as at 31 December 2016


Notes

Main Fund Section

£m

RBS AA Section

£m

As at 31 December

2016 £m

As at 31 December

2015 £m

Investment assets Bonds 13 25,004.0 832.6 25,836.6 18,760.6 Equities 14 6,956.9 19.4 6,976.3 5,767.2 Pooled investment vehicles

15 4,957.8 147.5 5,105.3 3,034.3

Derivatives 16 7,470.7

97.3 7,568.0 4,467.7

Property 17 1,204.4 - 1,204.4 1,163.3 Cash instruments 1,342.4 57.5 1,399.9 1,072.3 Other Investments 18 10.1 - 10.1 7.5 AVC investments 19 280.9 17.9 298.8 262.1 Cash & trading accounts with managers

20 338.7 10.2 348.9 104.1

Accrued income 122.8 3.2 126.0 137.2 47,688.7 1,185.6 48,874.3 34,776.3 Investment liabilities Derivatives 16 (2,968.9) (11.4) (2,980.3) (2,438.5) Cash & trading accounts with managers

20 (596.9) (6.4) (603.3) (369.1)

(3,565.8) (17.8) (3,583.6) (2,807.6) Total Investments 11 44,122.9 1,167.8 45,290.7 31,968.7 Current assets 25 14.9 0.5 15.4 9.3 Current liabilities 26 (35.2) (1.4) (36.6) (25.7) Net assets of the Fund at end of year/period 44,102.6 1,166.9 45,269.5 31,952.3

The Financial Statements summarise the transactions of the Fund during the year and deal with the net assets at the disposal of RBS Pension Trustee Limited as at 31 December 2016. They do not take account of obligations to pay pensions and benefits which fall due after the end of the Fund year. The actuarial position of the Fund, which does take account of such obligations, is dealt with on pages 8 to 10 in the Report of the Trustee and the Actuarial Certificates, on pages 25 and 26, of the Annual Report and these Financial Statements should be read in conjunction with them.

Notes to the Financial Statements


1 Basis of preparation

The Financial Statements have been prepared in accordance with the Occupational Pension Schemes (Requirement to obtain Audited Accounts and a Statement from the Auditor) Regulations, Financial Reporting Standard 102 – the financial reporting standard applicable in the UK and Republic of Ireland issued by the Financial Reporting Council (FRC) and with the guidance set out in the Statement of Recommended Practice (SORP) (revised November 2014).

2 Accounting Policies

2.1 Currency

The Fund’s functional currency and presentational currency is Sterling (GBP).

Transactions in foreign currencies are translated into sterling at the rate ruling at the date of the transactions. Investments, current assets and liabilities denominated in foreign currencies are translated into their sterling equivalent at the rates ruling at the Fund’s year end. Differences arising are dealt with in change in market value within the Fund Account.

2.2 Contributions and Benefits

Normal contributions from the employer have been made at the rate set out in the Schedules of Contributions in force for the Fund year. Normal contributions relating to wages and salaries earned in the Fund year have been recognised in the Financial Statements. Additional contributions from the employer and Additional Voluntary Contributions (AVCs) from members are accounted for on an accruals basis. Augmentations from the employer are accounted for when paid.

Pensions in payment and other benefits are accounted for on an accruals basis.

2.3 Transfers to and from the Fund

Individual transfer values are accounted for at the time of receipt or payment. Bulk transfers are accounted for on an accruals basis where the value has been agreed in principle by the parties involved.

2.4 Administrative, Investment Management and Other Expenses

All Administrative, Investment Management and other expenses are accounted for on an accruals basis.

2.5 Investment income

Investment income is accounted for on an accruals basis. Receipts from annuity policies are accounted for as investment income. Interest income related to the Special Purpose Vehicle is accounted for as sales proceeds. All investment income is stated inclusive of any related recoverable taxation but net of any irrecoverable tax, including overseas withholding taxes and the costs of collection. Accrued income includes outstanding dividend entitlements, accrued interest income and recoverable withholding tax.

2.6 Subsidiaries and Joint Ventures

Subsidiaries are entities of which the Fund has the power to govern the financial and operating policies of that entity. These powers generally accompany an interest in an entity of over 50%. Joint ventures are subsidiaries where the power to govern is shared jointly with other partners in an undertaking. The Trustee considers the Fund’s Subsidiary and Joint Venture holdings to be held as part of the Fund’s investment portfolio. As such these holdings have been shown in the Fund’s Financial Statements at fair value using the equity accounting method.



2. Accounting Policies (continued)

2.7 Valuation of investments

Quoted securities are valued at fair value using the closing bid price as notified by the relevant stock exchange or closing prices if these are not available.

Unquoted securities can consist of a range of different investment types. The valuation methods used in relation to these investments are set out below:

• Investments in private equities are valued at fair value by the Fund’s investment managers in accordance with International Private Equity and Venture Capital (IPEVC) guidelines based on the latest information from investment managers adjusted for any cash flows in the period between the valuation date and the year end.

• Corporate loans are carried at fair value using the latest available price in the market. Certain other unlisted loans, where there is no available price in the market, are valued using a discounted cash-flow methodology adjusted for impairment, as a proxy for fair value.

• Unitised pooled investment vehicles have been valued at the latest available bid price or single price provided by the pooled investment manager. Shares in other pooled arrangements have been valued at the latest available net asset value (NAV), determined in accordance with fair value principles, provided by the pooled investment manager.

• Properties are valued at fair value at the year end date on the basis of open market value by CBRE Ltd, Knight Frank LLP and Cushman & Wakefield. Given the scale and nature of the Fund’s US Property holdings a valuation model has been applied where all properties are individually valued over a two year cycle. Each year as at 31 December, half of the properties held are independently valued to ascertain fair value on those properties. The fair value information obtained from those valuations is then used to derive indicative prices for the remainder of the properties held. Those properties subject to indicative prices in the current year will be independently valued in the following year. Properties purchased within 3 months of the year end have been valued at cost. The Trustee does not consider that any subsequent change to the value of these properties would materially impact these Financial Statements.

• Open future contracts are included in the net asset statement at fair market value, which is the unrealised profit or loss at the current bid or offer market quoted price of the contract.

• The fair value of swaps is calculated using pricing models where inputs are based on market data at the year end.

• Options (exchange traded) are recognised at the fair value as determined by the exchange price for closing the option as at year-end.

• Forward foreign exchange contracts outstanding at the year-end are stated at fair value which is determined as the gain or loss that would arise if the outstanding contract was matched at the year end with an equal and opposite contract.

• The fair value of Special Purpose Vehicles is calculated as the current value of future cash flows arising from the agreements in place, determined by discounted cash flow models.

• Annuity policies are shown at nil value in the Net Asset statement. This is a departure from the SORP as they are not held at the amount of the related obligation, determined using the most recent funding valuation assumptions and methodology. The Trustee does not consider the difference in accounting treatment to materially impact these Financial Statements.

• Accrued interest is excluded from the market value of fixed income securities and is included in accrued income receivable.



3 Contributions

Main Fund Section

£m

RBS AA Section

£m

Total Year ended

31 December

2016 £m

9 months ended 31

December 2015

£m

Employers: Normal 253.1 1.1 254.2 182.0 Additional 15.6 1.4 17.0 20.1 Deficit funding 4,234.4 1.3 4,235.7 3.9 Augmentations 15.4 - 15.4 6.5

4,518.5 3.8 4,522.3 212.5 Members: Additional voluntary 11.6 - 11.6 -

4,530.1 3.8 4,533.9 212.5

Employers’ additional contributions in respect of the Main Fund Section include the reimbursement of Pension Protection Fund levies and the reimbursement of the capital costs of members taking early retirement. In respect of the RBS AA Section, the Employers’ additional contributions include the reimbursement of Pension Protection Fund levies and other expenses from the Employers.

To address the funding shortfalls arising from the 2015 valuation of the Main Fund Section, the Bank agreed to bring forward the deficit funding contribution previously agreed and paid a lump sum cash contribution into the Fund of £4.2 billion, which was received in March 2016. There are no additional deficit funding contributions payable under the Schedules of Contributions.

In relation to the RBS AA Section, £1.3 million (2015: £3.9 million) was received during March 2016 with no further future deficit funding contributions required.

Further details can be found on pages 8 to 10.

4 Transfers in

Main Fund Section

£m

RBS AA Section

£m

Total Year ended

31 December

2016 £m

9 months ended 31

December 2015

£m

Individual transfers from

other schemes 0.9 - 0.9 0.1



5 Benefits paid or payable

Main Fund Section

£m

RBS AA Section

£m

Total Year ended

31 December

2016 £m

9 months ended 31

December 2015

£m

Pensions 717.9 13.7 731.6 534.8 Commutations and lump

sums on retirement 142.5 1.3 143.8 78.5 Lump sum death benefits 5.3 0.1 5.4 3.4 Lifetime allowance charge 0.8 - 0.8 0.5

866.5 15.1 881.6 617.2

6 Payments to and on account of leavers

Main Fund Section

£m

RBS AA Section

£m

Total Year ended

31 December

2016 £m

9 months ended 31

December 2015

£m

Individual transfers to other

schemes 406.4 11.1 417.5 166.0

7 Administrative expenses

Main Fund Section

£m

RBS AA Section

£m

Total Year ended

31 December

2016 £m

9 months ended 31

December 2015

£m

Trustee Directors’ fees (see below)

0.2 - 0.2 0.2

Pension Protection Fund Levy

1.2 - 1.2 9.8

Administration and professional fees including irrecoverable VAT

15.1 0.2 15.3 6.3

16.5 0.2 16.7 16.3

Included within Employer contributions remitted to the Fund are amounts used to offset administrative costs. The Trustee has agreed that the Fund will reimburse The Royal Bank of Scotland Group plc for its administration costs incurred by Pension Services and RBS Investment Executive. It also reimbursed the employers for costs incurred in processing the pensioner payroll. For the year ended 31 December 2016 this amounted to £3.8 million (9 months to 31 December 2015: £3.5 million) Trustee Directors who are not current employees of the bank are paid a fee to compensate them for their time. Details of the fees paid in fulfilling their duties as a Trustee Director are detailed on the following page.



7 Administrative expenses (continued)

Trustee Director

Year ended 31

December 2016 £

9 months ended 31 December

2015 £

Ronald Bowie (Independent Trustee) 89,524 52,520

Stephen Fallowell 14,999 11,110

Malcolm Groves 14,999 11,110

Miller McLean 29,974 67,440

Ian Purves 14,999 11,110

Capital Cranfield (Independent Trustee) 38,911 -

203,406 153,290

Trustee Directors’ fees include Employer’s National Insurance Contributions where applicable.

8 Investment income

Main Fund Section

£m

RBS AA Section

£m

Total Year ended

31 December

2016 £m

9 months ended 31

December 2015

£m

Bonds 475.4 12.5 487.9 333.4 Equities 197.2 0.7 197.9 116.0 Pooled investment vehicles 110.8 6.7 117.5 68.6 Derivatives (210.3) (0.8) (211.1) (15.2) Interest on cash deposits 12.8 0.3 13.1 9.1 Property 28.2 - 28.2 29.4 Annuity income 0.1 1.1 1.2 1.0

614.2 20.5 634.7 542.3

9 Investment management expenses

Main Fund Section

£m

RBS AA Section

£m

Total Year ended

31 December

2016 £m

9 months ended 31

December 2015

£m

Investment managers fees 62.0 1.0 63.0 45.7 Custody fees 1.9 0.1 2.0 1.1 Other investment fees 1.7 0.1 1.8 1.5

65.6 1.2 66.8 48.3



10 Taxation

The Royal Bank of Scotland Group Pension Fund is a registered pension scheme for tax purposes under the Finance Act 2004. The Fund is therefore exempt from taxation except for certain withholding taxes relating to overseas investment income. Tax charges are accrued on the same basis as the investment income to which they relate.

11 Reconciliation of Net Investments

Value at 1 January

2016 £m

Purchases at cost and

derivative payments

£m

Sales proceeds

and derivative

receipts £m

Change in Market

Value £m

Value at

31 December

2016 £m

Main Fund Section

Bonds 18,093.7 13,749.4 (11,525.0) 4,685.9 25,004.0

Equities 5,750.0 3,464.0 (3,792.6) 1,535.5 6,956.9

Pooled investment vehicles

2,889.9 2,666.7 (1,103.8) 505.0 4,957.8

Derivatives 2,020.7 3,470.0 (3,328.9) 2,340.0 4,501.8

Property 1,163.3 11.2 (34.5) 64.4 1,204.4

Cash Instruments

1,015.7 44,359.5 (44,082.1) 49.3 1,342.4

Other Investments

7.5 - (0.8) 3.4 10.1

AVC & similar investments

245.8 30.1 (35.8) 40.8 280.9

31,186.6 67,750.9 (63,903.5) 9,224.3 44,258.3

Cash & trading accounts with managers

(265.4) 45.6 (258.20)

Accrued income

133.9 11.8 122.8

Main Fund Section Total

31,055.1 9,281.7 44,122.9

Included in the above are unconsolidated subsidiaries of the Fund. As at 31 December 2016 the aggregate net asset value of the subsidiaries amounted to £839 million (2015: £695 million).



11 Reconciliation of Net Investments (continued)

Value at

1 January 2016

£m

Purchases at cost and

derivative payments

£m

Sales proceeds

and derivative

receipts £m

Change in Market

Value £m

Value at

31 December

2016 £m

Main Fund Section b/f 31,055.1 9,281.7 44,122.9

RBS AA Section

Bonds 666.9 45.5 (52.0) 172.2 832.6

Equities 17.2 8.9 (11.5) 4.8 19.4

Pooled investment vehicles

144.4 66.2 (81.5) 18.4 147.5

Derivatives 8.5 60.5 (38.9) 55.8 85.9

Cash Instruments

56.6 224.4 (224.4) 0.9 57.5

AVC & similar investments

16.3 - (0.9) 2.5 17.9

909.9 405.5 (409.2) 254.6 1,160.8


0.4 1.7 3.8

Accrued income

3.3 0.3 3.2

RBS AA Section Total

913.6 256.6 1,167.8

Fund Total 31,968.7 9,538.3 45,290.7

The change in market value of investments during the year include all increases and decreases in the market value of investments held at any time during the year, including profits and losses realised on sales of investments during the year.

The change in market value for cash and near cash assets is due to net foreign exchange gains and losses.



12 Transaction costs

Transaction costs are included in the cost of purchases and deducted from the sales proceeds disclosed in the reconciliation in note 11. Direct transaction costs incurred are analysed as follows:

Other*

£m

Derivatives

£m

Equities

£m

Year to 31 December

2016 Total

£m

9 months to 31 December

2015 Total

£m

Commissions 0.3 0.4 5.8 6.5 4.0

Fees/Taxes 0.1 0.6 3.3 4.0 1.5

31 Dec 2016 Total

0.4 1.0 9.1 10.5

31 Dec 2015 Total

0.2 0.6 4.7 5.5

Transaction costs disclosed above cover commissions, fees and taxes paid for quoted equity and credit segregated mandates. Transaction costs do not include costs for assets not held by the Fund’s custodian. In addition to the direct transaction costs disclosed, indirect transaction costs are incurred through the bid-offer spread of certain pooled investment vehicles. The Trustee monitors all fees as described on page 17 and Note 9.

*Includes Pooled investment vehicles, Cash Instruments and Fixed Interest Investments.

13 Bonds

Main Fund Section

£m

RBS AA Section

£m

Total as at

31 December 2016

£m

Total as at

31 December 2015

£m

UK public sector quoted 14,230.6 629.6 14,860.2 10,186.3 UK corporate quoted 2,505.4 39.5 2,544.9 2,434.7

UK quoted – other 618.10 - 618.10 539.3

UK unquoted 90.3 - 90.3 90.3

Overseas public sector quoted

685.4 2.9 688.3 618.5

Overseas corporate quoted 5,227.3 145.0 5,372.3 3,657.9

Overseas quoted - other 1,496.5 15.6 1,512.1 1,107.5

Overseas unquoted 150.4 - 150.4 126.1

25,004.0 832.6 25,836.6 18,760.6



14 Equities

Main Fund Section

£m

RBS AA Section

£m

Total as at

31 December 2016

£m

Total as at

31 December 2015

£m

UK quoted 1,003.2 1.3 1,004.5 930.7 UK unquoted 382.6 - 382.6 174.1 Overseas quoted 5,363.8 18.1 5,381.9 4,448.4 Overseas unquoted 207.3 - 207.3 214.0

6,956.9 19.4 6,976.3 5,767.2

15 Pooled investment vehicles

Main Fund Section

£m

RBS AA Section

£m

Total as at

31 December 2016

£m

Total as at

31 December 2015

£m

Private Equity 1,005.8 2.2 1,008.0 1,005.2 Equity 2,373.8 66.1 2,439.9 658.5 Property 614.8 41.2 656.0 592.4 Hedge Funds 783.1 17.5 800.6 710.6 Insurance 148.0 20.5 168.5 - Infrastructure 32.3 - 32.3 54.3 Bond - - - 13.3

4,957.8 147.5 5,105.3 3,034.3

16 Derivatives

Main Fund Section

£m

RBS AA Section

£m

Total as at

31 December 2016

£m

Total as at

31 December 2015

£m

Assets Futures contracts 25.7 2.7 28.4 63.2 Options 799.2 - 799.2 745.8 Swaps 6,455.1 91.7 6,546.8 3,632.8 FX forward contracts 190.7 2.9 193.6 25.9

7,470.7 97.3 7,568.0 4,467.7 Liabilities Futures contracts (3.6) (0.3) (3.9) (1.3) Options (3.0) - (3.0) (12.7) Swaps (2,825.9) (7.3) (2,833.2) (2,176.8) FX forward contracts (136.4) (3.8) (140.2) (247.7)

(2,968.9) (11.4) (2,980.3) (2,438.5)

4,501.8 85.9 4,587.7 2,029.2



16 Derivatives (continued)

16.1 Analysis of futures

No of

contracts Expiration Dates

Underlying Investment

Economic Exposure

£m Asset

£m

Liability £m

Market Value

31 Dec 2016

£m

28,375 26/01/2017-17/07/2017

Overseas Equities 1,725.6 17.7 (0.4) 17.3

4,638 17/03/2017 UK Equity 327.0 8.2 - 8.2

6,984 08/03/2017-31/03/2017

Overseas Bonds 772.7 2.4 (1.2) 1.2

1,106 29/03/2017 UK Bonds 139.2 0.1 (2.2) (2.1)

108 15/03/2017 UK Interest Rates 13.4 - - -

985

13/03/2017-14/03/2017

Overseas Interest Rates

199.9 - (0.1) (0.1)

28.4 (3.9) 24.5

Futures facilitate more efficient portfolio management and are used to manage exposures and for hedging. All Futures detailed above are Exchange Traded.

16.2 Analysis of options

No of contracts

Expiration Dates

Underlying Investment

Notional amount of

outstanding contract Millions

Asset £m

Liability £m

Market

Value 31 Dec

2016 £m

29 20/01/2016 - 01/04/2043

Interest Rate Swaps (OTC)

5,887.2 GBP 797.3 (2.3) 795.0

6 20/01/2016 - 16/03/2016

Equity Market Volatility (ET)

39.4 USD 1.9 (0.7) 1.2

1 29/01/2016 - 19/02/2016

Interest Rate Swaps (OTC)

220.5 USD - - -

799.2 (3.0) 796.2

Options allow the Fund to benefit from potentially greater returns or reduced risk through efficiently increasing or reducing exposure to bond and equity markets.

ET – Exchange traded

OTC – Over the counter




16.3 Analysis of swaps

No of

contracts Expiration Dates

Nature of Swap

Notional principal

£m Asset

£m

Liability £m

Market Value 31

Dec 16 £m

904 19/01/2017-05/10/2066

Interest Rate

41,283.2 6,173.2 (2,136.4) 4,036.8

215 21/02/2017-01/03/2068

Inflation 11,838.7 305.6 (553.1) (247.5)

31 23/01/2017-18/03/2023

Currency 1,749.7 39.6 (129.0) (89.4)

93 20/12/2017-20/03/20124

Credit Default

1,885.4 28.3 (14.7) 13.6

1 15/01/2017 Total Return 41.0 0.1 - 0.1

6,546.8 (2,833.2) 3,713.6

Swaps are used to offset the sensitivity of the Fund’s actuarial liability to changes in interest rates, inflation rates and currency exchange rates.




16.4 Analysis of forwards

No of

contracts Settlement Dates

Currency sold

Millions

Currency bought

Millions Asset

£m

Liability £m

Market Value

31 Dec 2016

£m

173 03/01/2017-30/06/2023

13,376.4 USD 10,744.1 GBP 47.8 (119.5) (71.7)

51 05/01/2017-02/04/2017

672.3 GBP 830.3 EUR 43.0 (5.6) 37.4

68 06/01/2017-12/01/2021

993.5 GBP 1,268.0 USD 31.0 (1.0) 30.0

49 05/01/2017-13/02/2020

1,596.6 EUR 1,386.3 GBP 30.3 (8.2) 22.1

10 10/01/2017-07/02/2017

21,981.8 JPY 169.9 GBP 17.2 - 17.2

13 10/01/2017-07/02/2017

367.9 AUD 226.5 GBP 11.3 - 11.3

3 07/02/2017 148.9 CHF 122.9 GBP 4.2 - 4.2

6 07/02/2017 123.8 GBP 1221.0 HKD 3.6 - 3.6

13 07/02/2017 3,022.2 HKD 318.3 GBP 3.1 - 3.1

13 06/01/2017-02/02/2017

177.1 USD 167.2 EUR 1.3 (1.9) (0.6)

46 Various contracts with values of less than £1m 0.8 (1.7) (0.9)

10 10/01/2017-10/03/2017

9.6 GBP 1,226.8 JPY - (1.0) (1.0)

1 02/02/2017 114.5 EUR 119.3 USD - (1.3) (1.3)

193.6 (140.2) 53.4

The Fund uses forward currency contracts to manage the currency risk which arises from holding investments which are not denominated in Sterling.

17 Property

Main Fund Section

£m

RBS AA Section

£m

Total as at

31 December 2016

£m

Total as at

31 December 2015

£m

UK 838.2 - 838.2 863.2 Overseas 366.2 - 366.1 300.1

1,204.4 - 1,204.4 1,163.3



18 Other investments

Main Fund Section

£m

RBS AA Section

£m

Total as at

31 December 2016

£m

Total as at

31 December 2015

£m

Special purpose vehicles 10.1 - 10.1 7.5

19 AVC investments

Main Fund Section

£m

RBS AA Section

£m

Total as at

31 December 2016

£m

Total as at

31 December 2015

£m

Fidelity Investments Life

Assurance Limited* 261.7 14.9 276.6 237.8

Standard Life Assurance Limited*

11.3 0.3 11.6 13.0

Scottish Widows’ Fund and Life Assurance Society

3.6 - 3.6 3.7

The Equitable Life Assurance Society *

0.7 2.7 3.4 3.5

Clerical Medical Investment Group Limited *

2.8 - 2.8 3.1

Aviva Insurance Limited (formerly Norwich) *

0.8 - 0.8 1.0

280.9 17.9 298.8 262.1

* These managers hold assets derived from RBSelect contributions and AVCs.

The Trustee holds assets invested separately from the main Fund in the form of individual accounts securing additional benefits on a money purchase basis for those members electing to pay additional voluntary contributions. Members participating in this arrangement each receive an annual statement confirming the amounts held to their account and the movements in the year.

AVCs invested in Fidelity Life Assurance Limited are invested in the Royal Bank of Scotland Group Common Investment Fund (the “RBS CIF”). Under this arrangement the AVC investments are jointly held with the investment of other participating schemes of the Royal Bank of Scotland Group. Investments received from participating schemes by the RBS CIF are invested on a unitised basis in Life Insurance Investment Company Pooled Funds managed by Fidelity Investments Life Assurance Limited.



20 Cash & trading accounts with managers

Main Fund Section

£m

RBS AA Section

£m

Total as at 31

December 2016

£m

Total as at 31

December 2015

£m

Assets Cash with managers 183.8 6.0 189.8 94.7

Variation margins with brokers

58.0 4.2 62.2 0.4

Cash in transit 96.9 - 96.9 9.0

338.7 10.2 348.9 104.1

Liabilities

Variation margins with brokers

(521.7) (6.4) (528.1) (308.7)

Cash in transit (75.2) - (75.2) (60.4)

(596.9) (6.4) (603.3) (369.1)

(258.2) 3.8 (254.4) (265.0)



21 Investment Fair Value Hierarchy

The fair value of investments have been determined using valuation techniques that utilise various inputs and these inputs have been categorised as set out below:

Level 1 – the unadjusted quoted price in an active market for identical assets.

Level 2 – inputs other than quoted prices included within Level 1 that are observable (i.e. developed using market data).

Level 3 – inputs are unobservable (i.e. for which market data is unavailable).

The Fund’s investment assets and liabilities have been fair valued using the above hierarchy categories as follows:

Level 1

£m

Level 2

£m Level 3

£m

As at 31 December

2016 Total

£m

Main Fund Section

Bonds 0.8 23,368.0 1,635.2 25,004.0

Equities 6,295.6 11.9 649.4 6,956.9

Pooled investment vehicles 48.7 2,635.5 2,273.6 4,957.8

Derivatives 22.2 4,479.6 - 4,501.8

Property - - 1,204.4 1,204.4

Cash instruments (1,817.2) 3,159.6 - 1,342.4

Other investments - - 10.1 10.1

AVC investments - 261.8 19.1 280.9


(258.2) - - (258.2)

Accrued income 122.8 - - 122.8

4,414.7 33,916.4 5,791.8 44,122.9

RBS AA Section

Bonds - 832.6 - 832.6

Equities 19.4 - - 19.4

Pooled investment vehicles - 62.6 84.9 147.5

Derivatives 2.4 83.5 - 85.9

Cash instruments - 57.5 - 57.5



3.8 - - 3.8


28.8 1,051.1 87.9 1,167.8

4,443.5 34,967.5 5,879.7 45,290.7



21 Investment Fair Value Hierarchy (Continued)

Analysis for the prior period is as follows:

Level 1

£m

Level 2

£m Level 3

£m

As at 31 December

2015 Total

£m

Main Fund Section

Bonds - 17,171.3 922.4 18,093.7

Equities 5,312.8 - 437.2 5,750.0

Pooled investment vehicles 3.7 571.6 2,314.6 2,889.9

Derivatives 62.0 1,958.7 - 2,020.7

Property - - 1,163.3 1,163.3

Cash instruments 8.1 1,007.6 - 1,015.7

Other investments - - 7.5 7.5



(265.4) - - (265.4)


5,255.1 20,933.7 4,866.3 31,055.1

RBS AA Section

Bonds - 666.9 - 666.9

Equities 17.2 - - 17.2

Pooled investment vehicles - 65.5 78.9 144.4

Derivatives 1.6 6.9 - 8.5

Cash instruments - 56.6 - 56.6



0.4 - - 0.4


22.5 809.2 81.9 913.6

5,277.6 21,742.9 4,948.2 31,968.7



22 Investment risks

FRS 102 requires the disclosure of information in relation to certain investment risks. These risks are set out by FRS 102 as follows:

Credit risk: this is the risk that one party to a financial instrument will cause a financial loss for the other party by failing to discharge an obligation.

Market risk: this comprises currency risk, interest rate risk and other price risk.

• Currency risk: this is the risk that the fair value or future cash flows of a financial asset will fluctuate because of changes in foreign exchange rates.

• Interest rate risk: this is the risk that the fair value or future cash flows of a financial asset will fluctuate because of changes in market interest rates.

• Other price risk: this is the risk that the fair value or future cash flows of a financial asset will fluctuate because of changes in market prices (other than those arising from interest rate risk or currency risk), whether those changes are caused by factors specific to the individual financial instrument or its issuer, or factors affecting all similar financial instruments traded in the market.

The Fund has exposure to these risks because of the investments it makes to implement its investment strategy described in the Trustee’s Report. The Trustee manages investment risks, including credit risk and market risk, in line with a strategic benchmark. The strategic benchmark is set taking into account the Fund’s risk appetite and strategic investment objectives. These investment objectives are implemented through the investment management agreements in place with the Fund’s investment managers. The performance of investment managers is monitored by the Trustee and its advisers with regular reviews of the investment portfolios.

Further information on the Trustee’s approach to risk management and the Fund’s exposures to credit and market risks are set out below. This does not include AVC investments whose value is not material in relation to the overall investments of the Fund.



22 Investment risks (continued)

22.1 Credit risk

The Fund is subject to credit risk through its bonds, derivatives and cash balances. The Fundalso invests in pooled investment vehicles and is therefore indirectly exposed to credit risks arising on the financial instruments held by the pooled investment vehicles. A summary of the exposures to credit risk is given in the following table, the notes below explain how this risk is managed and mitigated for the different classes of investment:

Main Fund Section

£m

RBS AA Section

£m

Total as at 31

December 2016

£m

Total as at 31

December 2015

£m

Bonds 25,004.0 832.6 25,836.6 18,760.6 Pooled investment vehicles - direct & indirect risk - 17.5 17.5 13.3 - direct risk only 4,957.8 130.1 5,087.9 3,021.0 Derivatives - assets 7,398.1 94.6 7,492.7 4,402.4 - liabilities (2,919.6) (11.1) (2,930.7) (2,436.5) Other investments 10.1 - 10.1 7.5 Cash instruments 1,342.4 57.5 1,399.9 1,072.3 Cash & trading accounts

with managers - assets 338.7 10.2 348.9 104.1 - liabilities (596.9) (6.4) (603.3) (369.1)

35,534.6 1,125.0 36,659.6 24,575.6

The Fund is exposed to credit risk which can take the form of an adverse change in credit spreads which reduces the market value of the bonds or higher than expected defaults on bonds the Fund holds. The exposure to credit spreads is illustrated in the sensitivity analysis below: Scenario

Main Fund Section Change in Assets

£m

RBS AA Section Change in Assets

£m

0.10% increase in credit spreads on all bonds (excluding sovereign bonds)

(510.4) (18.6)



22.1 Credit risk (continued)

The credit ratings of the bonds held by the Fund are analysed below:

Credit rating Main Fund Section as at 31 December 2016

Main Fund Section as at 31 December 2015

£m % £m %

Investment grade 21,266.4 86.3 15,542.5 85.9

Non-investment grade 921.0 3.7 615.6 3.4

Unrated 2,470.0 10.0 1,935.6 10.7

24,675.4 100.0 18,093.7 100.0

Credit rating AA Section as at 31 December 2016

AA Section as at 31 December 2015

£m % £m %

Investment grade 827.2 99.3 665.5 99.8

Non-investment grade 4.0 0.5 - -

Unrated 1.4 0.2 1.4 0.2

832.6 100.0 666.9 100.0

‘Investment grade’ bonds are those which rank in the higher tiers of credit quality by either Moody’s or S&P. ‘Non-investment grade’ bonds are those which either Moody’s or S&P have classified in the lower tiers of credit quality but which may still provide a good investment opportunity on a risk-adjusted basis. ‘Unrated bonds’ may be deemed to be of equivalent credit quality to investment grade by the investment manager.

Credit risk is mitigated by employing investment managers who have a high level of expertise in managing such investments and applying restrictions to the agreements with investment managers which require the portfolios to be highly diversified, thereby avoiding inappropriate risk concentrations.

Direct credit risk arising from pooled investment vehicles (the risk that a loss arises from a failure of the vehicle or structure, rather than loss arising from the underlying assets) is mitigated by the underlying assets of the pooled arrangements being ring-fenced from the pooled manager, the regulatory environments in which the pooled managers operate and diversification of investments amongst a number of pooled arrangements. Due diligence checks are carried out on the appointment of new pooled investment managers with on-going monitoring thereafter.

Credit risk arising on derivatives depends on a number of factors including whether the derivative is traded on or cleared through an exchange or, alternatively, over the counter (OTC) on a bilateral basis between the Fund and a counterparty. OTC derivative contracts are not guaranteed by any regulated exchange and therefore the Fund is subject to risk of loss in the event of failure of the counterparty; however, this credit risk is reduced to very low levels by collateral arrangements. Credit risk also arises on forward foreign currency contracts. There are no collateral arrangements for these contracts but the contracts tend to be short term and the counterparties are selected carefully by the investment managers based on assessments of creditworthiness.

Cash and cash instruments are held either directly with institutions which have a high degree of creditworthiness or are invested in pooled funds which hold a diversified portfolio of cash instruments secured against companies with strong credit ratings.



22.2 Currency risk

The Fund is subject to currency risk because some of the Fund’s investments are held in overseas markets, either as segregated investments or via pooled investment vehicles.

The Fund’s total asset exposure by major currency at the year end (excluding currency hedges) was as follows:

Main Fund Section

£m

RBS AA Section

£m

Total as at 31

December 2016

£m

Total as at 31

December 2015

£m

USD 10,256.1 184.4 10,440.5 7,336.8 EUR 2,569.3 42.3 2,611.6 2,623.2 Other 2,288.7 12.3 2,301.0 1,804.0

15,114.1 239.0 15,353.1 11,764.0

Currency risk is managed with a currency hedging program:

• Global equities: 50% hedge on USD currency exposure (2015: 0%), 50% hedge on all major developed market currencies through global equities (2015: 50%). Emerging market currencies are not hedged.

• Private equity: partially hedged

• Alternative equity: 100% hedged.

• Credit: 100% hedged, except for emerging market local currency debt which is not hedged.

• Property: 100% hedged.

• Insurance: 100% hedged.



22.3 Interest rate risk

The Fund is subject to interest rate risk because the value of the Fund’s liabilities and some of the Fund’s investments are sensitive to interest rates. The table below shows the market value of instruments used for managing interest rate risk, not sensitivity to interest rates.

Main Fund Section

£m

RBS AA Section

£m

Total as at 31

December 2016

£m

Total as at 31

December 2015

£m

Bonds 25,004.0 832.6 25,836.6 18,760.6 Pooled investment vehicles - 17.5 17.5 13.3 Derivatives - assets 7,209.8 91.8 7,301.6 4,377.4 - liabilities (2,786.7) (7.3) (2,794.0) (2,189.5) Other investments 10.1 - 10.1 7.5 Cash instruments 1,342.4 57.5 1,399.9 1,072.3 Cash & trading accounts

with managers - assets 338.7 10.2 348.9 104.1 - liabilities (596.9) (6.4) (603.3) (369.1)

30,521.4 995.9 31,517.3 21,776.6

Interest rate and inflation risk are managed as part of the Fund’s liability hedging programme.

The Trustee has a policy of hedging 100% of the Main Fund and AA Section’s interest rate and inflation risk.

22.3 Other price risk

Other price risk arises principally in relation to the Fund’s growth asset portfolio which includes listed equities, private equity, credit (corporate bonds), property and alternative investments held in pooled investment vehicles.

The Fund manages this exposure to other price risk by constructing a diverse portfolio of investments across various markets.

23 Concentration of investment

The Fund held no investments that represented more than 5% of the net asset value of the Fundas at 31 December 2016 nor as at 31 December 2015.

24 Stock lending

Certain Investment Managers of the Fund are authorised to release stocks to a third party under a sale and repurchase arrangement (Repo). At the year-end there were no Fixed Interest assets on loan. Stock lending may be undertaken within pooled investment vehicles as part of normal investment activities.



25 Current assets

Main Fund Section

£m

RBS AA Section

£m

Total as at 31

December 2016

£m

Total as at 31

December 2015

£m

Cash balances 13.7 0.3 14.0 8.6

Employer contributions due 0.2 - 0.2 -

Other debtors and prepayments

1.0 0.2 1.2 0.7

14.9 0.5 15.4 9.3

The employer contributions due for the Main Fund Section were not received in accordance with the time frame stipulated in the Schedule of Contributions.

26 Current liabilities

Main Fund Section

£m

RBS AA Section

£m

Total as at 31

December 2016

£m

Total as at 31

December 2015

£m

Employer contributions

prepaid - (0.4) - (0.7)

Unpaid benefits (3.7) - (3.7) (1.1)

Accrued expenses (27.9) (1.0) (28.9) (20.1)

Sundry creditors (3.6) - (4.0) (3.8)

(35.2) (1.4) (36.6) (25.7)

27 Employer related investments

There were no material employer related investments in the current year or prior period. The Fund holds no direct investment in the Royal Bank of Scotland Group plc, although indirect holdings are possible through the pooled investment vehicles. The Fund operates certain interest rate swaps, inflation swaps, credit derivatives, cross-currency swaps and forward exchange rate agreements where the Royal Bank of Scotland Group plc acts as counterparty. These transactions are on commercial terms and carried out on an arms-length basis. Self investment arose during the year due to employer contributions of £0.2 million not being received until March 2017.



28 Capital commitments

The following capital commitments held at the year-end are in relation to the Fund’s investments in Private Equity Funds and Property Funds. These assets are disclosed under pooled investment vehicles in note 11.

As at 31 December

2016 £m

As at 31 December

2015 £m

SL Capital Partners LLP 191.1 - New Forest Property Funds* 77.7 24.6 Tufton Oceanic Limited* 73.7 79.3 Hermes Private Equity 72.5 74.2 Pathway Private Equity* 32.4 33.5 Orion European Real Estate Fund III C.V* 18.0 16.2 JP Morgan Private Equity* 16.1 24.0 Brockton Capital Fund II L.P 8.7 8.2 Partners Group Real Estate Secondary 2009 (Euro) S.C.A. 2.2 1.9 Brookfield Asset Management, Inc.* 1.7 8.7 Navis Private Equity Fund* - 0.3

494.1 270.9

* Commitments denominated in overseas currencies which have been converted into Sterling at an exchange rate ruling at the respective period/year end.



29 Related party transactions

The following information is provided in accordance with FRS 102 Section 33, "Related Party Disclosures":

a) Certain Directors of RBS Pension Trustee Limited are active or pensioner members of the Fund. Contributions received and pensions paid in respect of these Trustee Directors are made in accordance with the Schedules of Contributions and Trust Deed and Rules.

b) Directors and Executives of The Royal Bank of Scotland Group plc and senior managers within areas of the Bank responsible for pensions administration, policy and Trustee support were active members of the Fund during the year.

c) The cost of the services of RBS Pension Trustee Limited has been charged directly to the Fund. The fees and expenses payable to the Directors for the year ended 31 December 2016 are disclosed in note 7.

d) Certain costs of administering the Fund were borne directly by The Royal Bank of Scotland Group plc during the year.

e) The Fund operates bank accounts held with The Royal Bank of Scotland Group plc. At 31 December 2016 these balances amounted to £14.0m (2015: £8.6m).

f) The Fund operates certain interest rate swaps, inflation swaps, credit derivatives, cross-currency swaps and forward exchange rate agreements where the Royal Bank of Scotland Group plc acts as counterparty. These transactions are on commercial terms and carried out on an arms-length basis.

g) On 1 December 2008, the UK Government through HM Treasury became the ultimate controlling party of The Royal Bank of Scotland Group plc. The UK Government’s shareholding is managed by UK Financial Investments Limited, a company wholly owned by the UK Government. As a result, the UK Government and UK Government controlled bodies became related parties of the Fund. The Fund had transactions with UK Government bodies on an arms length basis and investments in government securities (either held directly or as part of a pooled fund) during the year, and are included in note 12. The volume and diversity of such transactions in the Fund is such that disclosure of their amounts in the year ended 31 December 2016 is impractical.

h) The Fund invests in five entities in which it holds controlling interests as at 31 December 2016. West Granite Homes invests in residential property in the US and is 99.9% owned by the Fund although the Fund has 100% of the voting rights. Albemarle Shipping Ltd invests in shipping assets and is 100% owned by the Fund. Phoenix Natural Gas is a Northern Irish Natural Gas Distributor and is 50% owned. Brickell Key Investments LLP invests in Litigation Financing and the Fund has a partnership holding of 99.9% although the Fund ultimately controls 100% of the partnership. Ventus Investments Ltd invests in onshore wind generation assets and is 100% owned by the Fund. All of these entities are considered by the Trustee to be held as part of the Fund’s investment portfolio so have been incorporated into the Financial Statements at fair value on an equity accounting basis and not consolidated with the Fund’s Financial Statements.

Documents

The Royal Bank of Scotland Group Pension Fund Report … Pension Plan... · The Royal Bank of Scotland Group Pension Fund Report for the ... of the year covered by this Annual Report