Disposal of Government Stakes in Lloyds Banking Group and ... · Lloyds Banking Group and Royal...

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House of Commons

Treasury Committee

Disposal of Government Stakes in Lloyds Banking Group and Royal Bank of Scotland

Oral and written evidence

Tuesday 15 May 2012 Adam Young, Co-Head of Equity Capital Markets Advisory, Rothschild, Graham Webb, Director, Solid Solutions, and Manus Costello, Managing Partner, Banks Research, Autonomous, Robert Talbut, Chairman, Association of British Insurers, Keith Skeoch, Chief Executive, Standard Life, and Richard Buxton, Head of UK Equities, Schroders Ordered by The House of Commons to be printed Tuesday 15 May 2012

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Mr Andrew Tyrie MP (Conservative, Chichester) (Chairman) Michael Fallon MP (Conservative, Sevenoaks) Mark Garnier MP (Conservative, Wyre Forest) Stewart Hosie MP (Scottish National Party, Dundee East) Andrea Leadsom MP (Conservative, South Northamptonshire) Mr Andy Love MP (Labour, Edmonton) John Mann MP (Labour, Bassetlaw) Rt Hon Pat McFadden MP (Labour, Wolverhampton South West) Mr George Mudie MP (Labour, Leeds East) Jesse Norman MP (Conservative, Hereford and South Herefordshire) Teresa Pearce MP (Labour, Erith and Thamesmead) David Ruffley MP, (Conservative, Bury St Edmunds) John Thurso MP (Liberal Democrat, Caithness, Sutherland, and Easter Ross)

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List of witnesses

Tuesday 15 May 2012 Page

Adam Young, Co-Head of Equity Capital Markets Advisory, Rothschild, Graham Webb, Director, Solid Solutions, and Manus Costello, Managing Partner, Banks Research, Autonomous Ev 1

Robert Talbut, Chairman, Association of British Insurers, Keith Skeoch, Chief Executive, Standard Life, and Richard Buxton, Head of UK Equities, Schroders Ev 10

List of written evidence

1 Autonomous Ev17

2 Keith Skeoch, Standard Life Ev 18

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Treasury Committee: Evidence Ev 1

Oral evidenceTaken before the Treasury Committee

on Tuesday 15 May 2012

Members present:

Mr Andrew Tyrie (Chair)

Michael FallonMark GarnierStewart HosieAndrea LeadsomMr Andrew LoveJohn Mann

________________

Examination of Witnesses

Witnesses: Adam Young, Co-Head of Equity Capital Markets Advisory, Rothschild, Graham Webb, Director,Solid Solutions, and Manus Costello, Managing Partner, Banks Research, Autonomous, gave evidence.

Q1 Chair: Good morning. Thank you very much forcoming in and helping us with our inquiry into whatused to be known as privatisation but is now, ongrounds of fashion, more often called asset sales. It isappropriate that we should be meeting in the ThatcherRoom to discuss this, and we certainly have some bigsales to think about. I would like to begin by askingMr Young if he thinks that the current share price,particularly for RBS, is depressed to any degree bythe scale of the public ownership.Adam Young: I think it is fair to say yes. When therumour arose a few weeks ago that the Abu DhabiInvestment Authority was going to buy a big trancheof shares in RBS the share price immediately reactedon the day. I think that was a reflection of investors’—and the research and sales community amongst thebrokers—perception of risk. In particular, I think to alarge extent it embodies key-man risk, a perception ofkey-man risk, that the management of RBS wantssome more freedom to manage and that this wouldhave been the first step on the journey.

Q2 Chair: Is a key number 50%? If we get below50%, we get that lift?Adam Young: I think you get a lift in advance of that.You get a lift from starting the journey of disposalsand the first step will have an impact and further stepswill have an impact after that. Like most risk issues,it is very difficult to quantify it in terms of value thatis going to last for many months. There is definitelysome uplift there.Chair: Don’t feel the need to repeat what you havejust heard but if you disagree—either of the other twowitnesses—please say so now. Otherwise I will moveon. All right; so there is agreement on that point.

Q3 Mr Mudie: Mr Costello, should the taxpayers bepleased at the speed of progress in turning roundRBS?Manus Costello: The progress that they have madeon their strategic plan has been very impressive so far.I think there has been an enormous reduction in thenon-core assets, which has been ahead of plan andwithin their guideline of losses expected. There is a

Mr Pat McFaddenMr George MudieJesse NormanTeresa PearceMr David RuffleyJohn Thurso

different regulatory and macro environment now fromwhat there was at the start of the plan. Therefore, theyhave made a rational decision to change their strategyand for their strategy to evolve. But I think, yes, theprogress made on the balance sheet, in terms ofcapital, liquidity and de-risking, has been veryimpressive so far.

Q4 Mr Mudie: Does strategy suggest seeing a futurein the UK, an almost ring-fenced side of the Vickers’suggestion? Is that a good strategy? Would it be moredifficult to sell it if they are intending to run downtheir investment arm?Manus Costello: The changes with Vickers, and Iwould say also Basel III, and the other changes on theregulatory side that came in, led certain areas of theinvestment bank to be non-viable and I think they tooka rational decision to run those down. The fact thatthey decided to run those down was shareholder-valueaccretive. Indeed, to come back to share-pricereactions, if you look at the share price reaction tothe announcement of that plan from RBS, the marketresponded very positively to it. So reducing the sizeof the investment bank in response to the regulatoryenvironment can be a shareholder-value enhancingstrategy.

Q5 Mr Mudie: So you say even post-Vickers, alower presence in the investment side would be moreprofitable for RBS and other UK banks?Manus Costello: I was talking specifically for RBS,and I was talking specifically to the plan that they putin place to reduce their reliance on wholesale fundingand, therefore, minimise the impact from Vickers. Idon’t think that was an irrational decision. I think itwas the right one given the circumstances they foundthemselves in.

Q6 Mr Mudie: How far away from sustainedprofitability do you think RBS is?Manus Costello: On my numbers I have themreturning to sustained profitability next year. I wouldcaveat that with the fact that analysts’ estimates arevolatile; macro conditions are clearly very volatile.

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Ev 2 Treasury Committee: Evidence

15 May 2012 Adam Young, Graham Webb and Manus Costello

However, the sheer size of the losses being generatedby the non-core division should reduce substantiallynext year and I would hope that they should besustainably profitable from next year.

Q7 Mr Mudie: What more do Lloyds have to dobefore they are ready to be sold?Manus Costello: Lloyds is in a different position fromRBS, partly because of the size of the Governmentstake and partly because of the nature of the businessmodel itself. They have also made some goodprogress in reducing their funding risks. There remaina lot of risks surrounding the UK macro environmentand the asset quality of some parts of their book, andI think over the course of the next couple of yearsthey need to demonstrate that they can build theircapital ratios and manage their way out of some ofthose non-performing exposures. That is what they areon track to do, and obviously a large part of theoutcome will depend on the UK macro situation asmuch as anything else.

Q8 Jesse Norman: Mr Costello, can you just talk usthrough the shape of the RBS balance sheet at themoment because there are obviously severalimpediments sitting in there to possible privatisationand the challenge to it?Manus Costello: Do you mean in terms of the sharecapital structure?Jesse Norman: There are several aspects, but let usstart with the dividend access shares.Manus Costello: RBS has a number of different shareclasses, which make re-privatisation a bit morecomplicated. There are straightforward A shares.There are then the B shares, of which the Governmentowns 100%. There is then this instrument called thedividend access share, which is a very complexinstrument that I can explain the ins and outs of if youwant, but to all intents and purposes it blocks adividend for RBS being paid to equity shareholdersfor the foreseeable future. To my mind that is one ofthe key impediments to a re-reprivatisation that has tobe addressed.

Q9 Jesse Norman: Then what are the steps in orderto get rid of that? You have to get rid of that; youhave to do something about the A and B shares,presumably, or would the A shares and B shares bemerged in some way? What are the steps toprivatisation?Manus Costello: You have to get rid of the dividendaccess share and there are various ways that you coulddo that. You could simply pay a cash payment to getrid of it. You could somehow increase—

Q10 Jesse Norman: That is writing a cheque to theGovernment?Manus Costello: Correct.

Q11 Jesse Norman: How much for?Manus Costello: If the dividend access share itself isa complex instrument, the valuation of the dividendaccess share is even more complex. The last valuationthat UKFI put on it was £2.3bn in March last year. AsI say, the inputs into that valuation model are volatile

and complex, so I wouldn’t say exactly how much thatsettlement would be reached for.Once you get rid of that, the A share, B share structureis not necessarily an impediment to sale, because intheory you could sell the A shares and then move onto the B shares. In theory you could even sell the Bshares if you wanted to. From an investor perspective,I think what the markets want to see is a simple equityshareholder structure with a dividend-paying capacitythat can be sold as a clear investment case, and whileyou have these different classes of share, that isblocking that.

Q12 Jesse Norman: You also have the assetprotection scheme, don’t you? That would have to beresolved before it could be privatised. How wouldthat work?Manus Costello: Yes. The base case at the moment isthat RBS will be leaving the asset protection schemein October. That is the market’s assumption, becausefees have been prepaid up to the beginning of October.The requirement for the risk-weighting relief they getfrom the asset protection scheme and the protectionthey get from loss sharing under the scheme is muchlower now, so the base case assumption is that theasset protection scheme will no longer be part of RBSby Q4 this year.

Q13 Jesse Norman: What kind of capital would theyhave if they are getting out of the APS and writing alarge cheque for the dividend access fee?Manus Costello: Obviously, it depends on what sizeof cheque they would have to write for the dividendaccess share. On my numbers, there would be nocapital requirement from leaving the APS, and I think,depending on the range of valuations that the dividendaccess share were bought back for, if the way themarket is projecting the earnings power of RBS overthe next two or three years develops, there should beno requirement for additional capital. RBS isgenerally perceived in the market as being bottom firstquartile, upper second quartile, in terms of its capitalratios, and therefore it should be able to withstand anexit from the APS and other capital changes.

Q14 Jesse Norman: Let me understand that, becausewhat you have said in some of your research is thatthere is going to be a hit to book value by £1.3 billion.They are going to have to write a £2 billion cheque tothe Government. Are you comfortable they will beable to fund themselves? What would therequirements be on the new capital?Manus Costello: In my research I took a central rangeof scenarios for what the dividend access share mightbe paid out at. I also looked at what requirements maybe made for RBS when it leaves the APS in terms ofcontingent capital. The hit to book value, which youare referring to, the £1.3 billion that I was talkingabout was specifically about whether or not they arerequired to increase the contingent capital base thatthey have outstanding at the moment rather than theactual equity capital base.

Q15 Jesse Norman: Your view is that they wouldhave to?

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Manus Costello: My view is that it is likely that somekind of change on the contingent capital is asked forby the FSA.

Q16 Jesse Norman: Are there any other technicalrequirements that would need to proceed beforeprivatisation could take place or the sale of the shares?Manus Costello: Even these are not technicalrequirements that would need to be met; they are Ithink just in terms of developing the story for themarket, but beyond that, no. It comes back tostraightforwardly presenting a bank that has returnedto sustainable profitability and can pay an equitydividend.

Q17 Michael Fallon: Mr Young, to what extent hasthe Government’s ownership of the majority stake inRBS been corrosive?Adam Young: It is not so much the fact that the stakehas been held by the Government that has beencorrosive as much as the regulatory uncertaintygenerally. In my earlier answer, I mentioned that oneof the big worries that investors generally have aboutRBS is key-man risk, and the senior managementteam staying in place to complete the job, which theyhave started, in repairing the balance sheets, slimmingthe business down, getting the capital ratios in theright place and providing a platform for solid,sustainable returns. To the extent that the politicisationof the activities of RBS starts to threaten that, I thinkthat does pose a threat, which institutional investorsare nervous about, and I am sure that the gentlemenwho will speak to you in the next session willconfirm that.

Q18 Michael Fallon: Did the row over Mr Hester’sbonus damage investor confidence?Adam Young: It ratchets it up another level, yes.

Q19 Michael Fallon: Does retaining and recruitingkey personnel become more problematic the longerthis thing stays in public ownership?Adam Young: That does become more and more ofan issue, particularly in the very senior managementpositions that have such public focus at the momentin the media.

Q20 Michael Fallon: For example, if Stephen Hesterfelt he had to resign or was driven out by this mediahoo-ha over his bonus, how damaging would that beto the share price?Adam Young: I think it would be a real challenge tofind a replacement. Let me just rephrase that. I thinkthe perception is that there would be a struggle toreplace him, given those pressures that might haveforced him out.

Q21 Michael Fallon: What more can theGovernment do, aside from what they have done withUKFI, to reassure investors that RBS is being run oncommercial grounds?Adam Young: I do think the start of a monetisationprogramme is really the acid test, because in the finalanalysis, that is the programme that signalsnormalisation. The more that the Government can talk

in practical terms about readying the bank for thepublic markets—or the 82% that is not already held—the more people will see that Government is taking apragmatic view to studying the real issue.

Q22 Michael Fallon: Mr Costello drew attention tosome of the differences between Lloyds and RBS.Apart from the size of our stake in these banks, whatdo you see the other differences between the twobanks are so far as their ability to operate on acommercial basis is concerned?Adam Young: The Vickers Report, and theimplementation of the Vickers Report, has a fairlysignificant impact on the way that the investmentbanking and the corporate banking parts of the RBSbusiness are perceived by the marketplace, becausethere is no absolutely clear view about how theimplementation of that regime might affectmanagement’s view of the economics of that business.That is a big unknowable. It is very difficult for aninstitutional investor, whose job is to earn investmentreturns for the investors he serves, to be able to buy alarge amount of shares with that big unknowable inthe middle of the equation.For Lloyds Banking Group the impact of Vickers ismuch less profound. Clearly they are a consumer-driven bank more than a corporate-driven bank, interms of the overall business. Then when it comes todividends overall, I think it is fair to say that Lloydsare perceived to be nearer paying a dividend than RBSare. In their last results announcement, they guidedthe market to expect that Lloyds would continue touse retained income to build up their capital reservesbut, once they felt that they were in a prudent position,they would be able to start paying dividends, and theydon’t have the structural construction of the dividendaccess share.

Q23 Michael Fallon: Given that for institutionalinvestors so many of these mandates seem to be globalnow rather than national, how will that affect theperception of these two banks?Adam Young: You are absolutely right. The fundmanagement industry becomes less and less parochialby the day. These fund management institutions havethe ability to invest in banks anywhere in the world,so to the extent that an investor feels that he can gainhis access to the financial sector part of the globaleconomy through some other route, at lower risk, thenhe is going to choose that.

Q24 Chair: Following up on one point Michaelasked about UKFI, if Government share ownership isdepressing the share price then clearly the UKFIfirebreak is not as good a firebreak as it could be.What you appear to be telling us is that there isnothing that can be done about that. Is that right?Adam Young: The issues that need to be solved inorder for RBS to be privatised are beyond the UKFI’simmediate ability to resolve. I think that is thefinancial circumstance.

Q25 Chair: You are going a bit further than that,aren’t you? You are saying that there is a perceptionin the market of Government interference,




notwithstanding the arm’s length UKFI holdingarrangement.Adam Young: There is a lot of public interest in whatRBS does.Chair: Try not to be a politician. We would just liketo have an answer.Adam Young: There is a lot of comment by Membersof Parliament and by the media on what RBS does,and UKFI can’t do anything to stifle that. From thepoint of view of the financial sector’s view of UKFIas a firebreak, I think our perception is that they havedone a very, very good job out of a difficult situation,in particular taking the heat out of some of theseissues as best they can.

Q26 Chair: More power to their elbow?Adam Young: I think so.

Q27 Chair: Yes. Does anybody want to add anythingto that? Mr Webb?Graham Webb: I would just suggest it is better thatthey are there than they are not there. Governmentownership is a fact, and the UKFI consists of peoplewho understand the market. They are ex-marketparticipants themselves and they are goodinterlocutors with the market.Manus Costello: I would just add from an analyticalpoint of view, the banks have moved to disclosing alot more information. I don’t know, but I suspect thatsome of that pressure has come from UKFI, andultimately that increased disclosure should give themarket more confidence in the banks. The UK bankshave gone to very much best in class on a Europeanscale, in terms of the disclosure they now give, and Ithink UKFI probably played a role in that.

Q28 Chair: Do the markets believe that theGovernment are pulling the strings? Or is it just aconcern that they might? Or do they think UKFI reallyis running these things on behalf of the Government?Manus Costello: For example, if you look at themajor strategic decisions that have been made by RBSover the course of the last few years, whether thatwas creating a non-core division, whether that waschanging the funding structure and the recent decisionto run down the wholesale bank, I think the marketbelieves, correctly, that those were all strategicdecisions that were taken because they were the rightcommercial thing to do for RBS management and forRBS shareholders. There clearly have been somesigns that commercial strategy is being influenced bypublic pressure, the CEO’s compensation being anobvious one during the course of this year.

Q29 Chair: Public or Government pressure? I havebeen asking about the Government all the time andboth of you have been replying with the word“public”.Manus Costello: What happened earlier this year wasas much about a public reaction as it was about aGovernment reaction, to be honest. It was as muchabout a popular press reaction as it was about aGovernment reaction.

Q30 Chair: To which the Government also felt theneed to respond in some way.Manus Costello: The sequence of events is probablybetter known to you than it is to me.Chair: Okay.Manus Costello: But to your point, I do think it isimportant to stress that investors’ fears are more aboutthe potential for future interference than currentinterference. That is really where people areconcerned. There is a fear across the whole Europeanbanking sector that sovereigns and banks arebecoming more intertwined and that that will lead tonon-commercial decisions being taken.

Q31 Mr Love: Can I move us on to the sale price.There has been an almost automatic assumption thatthe only criteria to consider here is breakeven. Is thatthe best criteria? Is that the most efficient outcome forthis or should we be looking at other criteria?Adam Young: The first comment I would make is thatall Governments around the world that have had toexecute some form of bailout of banks or othercompanies through the financial crisis, are facing theissue of the breakeven price being this extremelyprominent price that everyone at least puts focus oneven if they are not explicitly saying that that is theprice that has to be met. Whatever one does, thebreakeven price is going to be an importantconsideration in the strategy, simply because membersof the media will be seeking to make a story out of iteven if Members of Parliament do not.In fairness, in a lot of the Government advisory workthat we do at Rothschild we do also try and focus onthe potential monetisation proceeds from an overallprogramme of disposals. If one is faced with adisposal programme the size that RBS and LloydsBanking Group could potentially be, probably that isgoing to have to be structured as a number of differentsales taken over a period of time probably duringwhich the economic cycle is turning to a more positivetrend than we are seeing today. The art of this is reallyto try and model scenarios under which the wholeprogramme of sale would be capable of exceedingthe breakeven.

Q32 Mr Love: I want to respond to that but before Ido, when they appeared before this Committee UKFIsaid the share price being breakeven was not the onlyfactor. Commenting on what you have said, whatother things should be taken into account?Adam Young: What I was trying to say in my lastanswer was that, throughout the whole programme ofsales, one would achieve proceeds approaching thebreakeven, but that does not necessarily mean that thefirst transaction would be at or above the breakevenprice. Clearly that whole strategy would need to beworked out in detail. I am not in charge of thatstrategy, but that would be the sort of work that Iwould typically be doing for a Government looking ata monetisation programme such as we have here.There are instruments that one can use in order toachieve a disposal price at a breakeven level that isperhaps above the current share price. There areinstruments called convertibles. Essentially these arebonds that pay income to an investor and they are




convertible into shares at a price above today’s price.Effectively what that gives the investor is extraincome today and a bit less upside tomorrow, but quitea lot of equity upside beyond that, and it reduces therisk for the investor today. Those sorts of instrumentscan be used even when the stock price is not that closeto the breakeven level.

Q33 Mr Love: Let me press you a little on what youhave said. It is clear that when the Government boughtboth RBS and Lloyds it paid different prices atdifferent times for the shares, so theoretically youcould sell the first tranche at lower than the breakevenprice and further tranches hopefully. However, thereis quite a lot of market sentiment out there suggestingthat, in the current circumstances and the climate ofuncertainty that we are in, they can never achievebreakeven. How do you respond to that concern?Adam Young: What are the unknowables? Oneunknowable is the economy, and we have had a falsedawn or two since 2009. The other unknowable is theeurozone and what that might do. If that truly causesproblems in the European banking system, whatimpact might that have on provisioning within RBSand Lloyds and the banking system overall? Then youhave regulation on top. You have lots of levels ofunknowables there, and in the situation today wewould be looking at the current share price; we wouldbe looking at the breakeven price and saying that thereis a big gap to be bridged.What I would say is that other Governments havefound—particularly when they hold cyclical stockslike banks—that if they can wait it out, at least forsome of their monetisation transactions, the economiccycle actually does have a significant impact, not onlyon the bottom line of the banks but also the multiplesthat investors are prepared to put on the bottom linein terms of valuation.

Q34 Mr Love: The reality is that everyonerecognises if both banks were very profitable youwould see that reflected in the share price. That issomewhat away in terms of timing. Let me take ayear; 2015. Realistically, is there any possibility thatby that time we will have been able to sell the sharesof both banks at the breakeven point?Adam Young: All of them?Mr Love: All of them.Adam Young: I think there is a low probability of that.

Q35 Mr Love: So if I take the case of Sweden, whichnationalised its banks some considerable time ago andstill has a major shareholding, is that the likelyprospect for the UK?Adam Young: It is quite possible it may take seven—I am taking numbers out of the air here—but it couldbe more than five years. If one looks at internationalanalogues, and there is one that I was looking at theother day. For example, Continental Illinois Bank inthe United States went bankrupt in 1984. That was thelargest ever bankruptcy in the US. At the time it wasthe seventh largest US bank, and the US Governmenteffectively nationalised it, recapitalised it and put itback on the market. That whole sequence of eventstook seven years from start to finish, and that was in

the hands of a Government that really does not see itsjob at all as holding any sort of listed stock.

Q36 Mr Love: Can I ask the other two witnesses—Chair: Briefly. We are going to be moving on in aminute.Mr Love:—if they have any comments to make onwhether breakeven is realistically possible, and if sowhat sort of timescale are we talking about in termsof sales?Graham Webb: Not on the specific point aboutproceeds. You did mention UKFI’s earlier comments,and I would say that, in my experience, themaximisation of proceeds, whether it is abovebreakeven or not, is generally not the onlyconsideration, the only objective or measure ofsuccess of a Government when pursuing asset sales.They don’t happen in a vacuum. There is a politicalcycle. There is a business cycle. There can be aphilosophical desire not to own shares in a privatecompany, and all of these other aspects can sometimesbe weighed off against the ideal financial objectives.Chair: A quick response, Mr Costello.Manus Costello: I would just point out that mycurrent valuation of RBS is about 30p. The range ofmarket valuations for RBS is between 20p and 40p.No analysts currently value RBS at above thebreakeven price, which would suggest that it wouldbe quite a long haul to achieve the breakeven price. Iwould also point out, of course, that the further awaythe breakeven price is in terms of the realisation, theless it is worth in terms of present value today.

Q37 Mr McFadden: In this theme about therelationship between the timing of any sale and theprice, Mr Webb, could I ask you about the rumours afew weeks ago about Abu Dhabi’s investment fundbeing interested? Is it your view that an early sale,even at a loss, is an advantageous thing to do becauseit sets a sense of direction and perhaps gives a morerealistic idea of what the real price of the shares is,because at the moment we have this hugestakeholding in RBS and very small volumes of sharesbeing sold to private investors?Graham Webb: I can really only answer that as a manin the street, or perhaps as a retail investor might viewit. From a capital markets point of view, Mr Youngmay respond better than I. But from the man in thestreet and the retail investor’s point of view, a strategicstakeholder really has to be explained very carefullyas to what the benefits are for the overall sale process,and perhaps too for the beneficial effects that it willhave on the share price and the proceeds gained overthe longer term. Anything that looks as though thestrategic stakeholder is really an investor that isgetting a preferential deal in some way, and can makea relatively quick turn on it—I am thinking of theexperience of Abu Dhabi with Barclays, forexample—is not one that is going to look good in anyway, shape or form. But again, that is such an obviouspoint I am sure that it will not be a mistake that wouldbe made.

Q38 Mr McFadden: Mr Young, what is your viewof this kind of fast move, if you like?




Adam Young: Of an Abu Dhabi investment?Mr McFadden: Yes, or someone similar like that, aninstitutional stake.Adam Young: There are two angles to it. There isan overall policy-structure angle and there is also thedesirability of placing stock with funds like AbuDhabi.From the point of view of overall strategy, I think itis good strategy to start a disposal programme withthe first tranche of the disposal at the lowest price andbuild it up over time. That is the tried and tested wayof disposing of very large blocks of stock in severaltranches, and encouraging investors in the first trancheto reinvest in the second and to broaden the investorbase for the second because the first was successful.It is kind of straightforward psychology. Obviouslythere are costs, in terms of value of selling somethingearly at a cheaper price and Government will need tobe comfortable with that.From the point of view of sovereign wealth funds, ofcourse they are a new phenomenon. As early as 1987,we saw the Kuwait Investment Office buy a largestake in BP after that privatisation transaction—quitea controversial one—so they have been a feature inthe capital markets for quite some time. Nowadaysthese funds are professionally managed. They are ableto deploy very large amounts of money in singleinvestments. I think that is their use, the fact that youare effectively only having to convince one buyer thatthe risk/reward is right rather than multiple buyers ina broader offering. Sometimes—sometimes—if theyhappen to be taking a more positive view of somefactors, the price can be better than you might getfrom the broader community of institutions for whomthe lowest common denominator might prevail.

Q39 Mr McFadden: Can I ask you more about thisissue of price? As Mr Love said, the taxpayers boughtthese shares at a certain price, about 50p. Obviouslythe taxpayer wants their money back.Adam Young: Understood.

Q40 Mr McFadden: Stephen Hester said that theshare prices of Lloyds and RBS might start to improveonce the sale process begins, which is similar to whatyou were just saying in your first answer. Do youthink it is likely that an early sale, even if the taxpayeris taking a hit on that, would mean that subsequentsales would then be at an increased price? Why shouldthat be the case? Why should an early sale at a lossindicate that there would be a price increase after that?Adam Young: In isolation it would not mean thatautomatically there would be an increase in value. Ithink one would try and time the sale whenever it tookplace, such that—let me try and express it a differentway. As the manager of the sale of a stock, the UKFI,when it comes to it, will be trying to assess timing interms of: is the story and the market sentiment gettingbetter and are the risks coming down? I think theywould need to be confident that the sale at a loss wasa means to an end; that there would be later sales athigher values and that there were very clear pointersto that happening in the foreseeable future. It is notthe case that they would be just saying, “We will takea total opportunistic approach to this”. So, from a

public policy point of view, probably one would wantto try and justify that a loss is worth taking todaybecause it is part of a programme that we—

Q41 Mr McFadden: What is your view? I am afraidwe have no money to give you a fee for this advice.We are going to have to ask you for it for free today.But if you were advising the Government would yousay that that kind of approach is worth doing, giventhat the share price has failed to come anywhere nearits initial buy-in price since the state bought its stake?Adam Young: What I would say in response is if youlook at what happened in the latter half of 2009 and2010, in terms of the rise in values in UK sharesoverall—and it was a strong rise; I can’t rememberexactly how much it was, but the market rose byseveral tens of per cent.—that was a reflection ofperception that risks were declining. It may have beenerroneous but that was their perception at the time. Ithink, in terms of structuring a programme of sales,one would want to put the first sale maybe at thebottom of that ladder.

Q42 Mr McFadden: I am not sure if that is a “yes”or a “no”.Mr Costello, you gave us written evidence which—ifI can summarise—effectively said, “Forget about this50p. We are not likely to get it. The state has to faceup to selling these shares at a loss”. Is that your view?Manus Costello: I would not completely agree withthat summary. I would say that your question, as towhether or not an initial sale should be contemplatedat a loss, comes back to the Chairman’s questionearlier, I think, about the fear of the bank being ableto manage itself along commercial grounds. I thinkthere is a market perception that if there were anotherinvestor, or another group of investors, within RBS orLloyds, that would encourage the bank to be run morealong commercial lines, would reduce the risks offurther interference and therefore reduce the cost ofequity and therefore, hopefully, make the share pricego higher. What I was arguing in my research wasthat, in my view, if we stick to the breakeven price asthe only criteria, and don’t accept that there is any riskof achieving below the breakeven price by making aninitial sale, it will create significant problems over thelonger term.

Q43 Mr McFadden: I suppose if I can ask you thesame question I asked Mr Young, if you were sittingin front of the Chancellor, who was asking you foryour advice on this at the moment, would your advicebe you have to set aside this breakeven price andcontemplate at least an initial sale at below the 50pprice, because that is the only way you are going tobe able to start re-privatising this bank?Manus Costello: The initial piece of advice would bethat, in the current market conditions and with thecurrent capital structure of RBS, any sale is verydifficult and this is not exactly the right time to startit. But as a principle, yes, that would be my advice,that starting a sale transaction should be accretive tothe value that the taxpayers can get out of the overallinvestment in RBS, and you are more likely to get a




better value if you accept that principle rather thanhold on for breakeven as your initial sale price.

Q44 John Thurso: Mr Costello, can I ask you,virtually all the discussion this morning, and most ofthe discussion in the financial press and so on, hasbeen based around a sale by the Government of astake over a period of time and how that might bedone, but there are a number of other options that havebeen put forward, and I wanted to ask whether youhad done any research on those. The first one is theidea of breaking RBS up into its two basic componentdomestic brands, RBS and NatWest, a merchant bankand a back-of- house operation that could evenfacilitate other new entrants. Have you done anyresearch or given any thought to that possibility?Manus Costello: Not specifically, but I would notethat if you look at the capital allocation of RBS, over70% of the capital of RBS at the moment is allocatedto wholesale banking divisions in the UK andinternationally, to Ireland and to its non-core division.If you are talking about breaking up RBS, you needto bear in mind that those wholesale bankingoperations that suck up a large proportion of thecapital may be more difficult to sell and may be leftwith the state, so it is not a straightforward operation.I would also note that breaking up a large globalwholesale bank is not a straightforward operation. Ithas been tried before. Indeed, it has been tried beforeby RBS, and I am not sure it is an experience—theABN AMRO experience—which would necessarilywant to be repeated. There is a risk of significantstranded costs remaining. There is a risk of executionbeing below what you hoped for. I think it is a strategythat sounds interesting but in practice, when you lookat where the capital of the bank is actually allocated,it could be value destructive for taxpayers.

Q45 John Thurso: The real drawback to that optionis it crystallises the bad elements of the bank in anunsellable portion, it makes it very difficult to sell?Manus Costello: That is certainly one of the key risks,or that businesses, which make sense within the globaluniversal bank structure of RBS, stripped of otherelements of the bank those may not be so attractiveany more.

Q46 John Thurso: Can I ask the other twowitnesses, is that something you concur with or is itsomething that you would give thought to otherviews on?Adam Young: Certainly I would concur. As acorporate financier, I would say demergers, splittingbusinesses apart, are the most difficult and most time-consuming types of transaction we do. The process ofdoing that would take many months; many monthsunder which the staff of the bank would be concernedabout the final outcome and their future. There is alsothe element of diversification of the bank in general.RBS would argue strongly that they would operatebest as a retail and corporate bank combined—that ishow they would best produce returns in different typesof economic conditions.

Q47 John Thurso: Can I turn to Mr Webb and toanother option that has been put forward in a paperby the Centre for Policy Studies. Effectively, that is adistribution of the shares broadly to all taxpayers at aprice where they exercise the option when it crossesthe threshold. Have you had a chance to study thatoption and what would your advice be on it?Graham Webb: Yes. When this option came out intothe open and started to get a bit of traction, then weat Solid Solutions from a practical point of view, andalso Barclays Capital from a capital markets point ofview, did a bit of work with Portman Capital—whoare the originators of the scheme—to look at it andsee if it was workable at first sight. We have donesome work, and indeed it looks as though it could bemade to work. The objective that it sets out to do,which is broadly to improve the price that theGovernment might get for the shares, works in theory.I think all parties realise that there is more work to bedone to validate that at the moment, but it is an optionthat bears more work and scrutiny.

Q48 John Thurso: That is considered a viableoption?Graham Webb: Subject to getting really under thebonnet and committing quite a lot of time resource tohaving a look at it.

Q49 John Thurso: You had some experience withthe sort of “Tell Sid” right at the beginning and thewidespread retail—Graham Webb: Yes.

Q50 John Thurso: Of course the problem with thatis it tends to be sold on very quickly, and you end upwith a small gain to particular people rather than whatthis policy would seem to be wanting to do, which isactually to spread it.Graham Webb: Yes. It is very different from eventhose types of “Tell Sid” campaigns you mention ofthe late 1980s and early 1990s.

Q51 John Thurso: So your advice to the Chancellorwould be, “Don’t tell Sid”?Graham Webb: No, not at all. “Tell Sid” is a bit of acliché. If you look back, it was more than just a hugeadvertising campaign, it was an environment. It bringsto mind these old fixed-price share offers that were“priced to go” by the Government. Effectively, peoplesigned up to buy these shares and were practicallyguaranteed a profit and that is why they were sopopular. I think that type of “Tell Sid” campaign,which gave retail investing quite a bad name becausea lot of people stagged the offer, has gone forever.But I would hark back to similar types of offers—thebook-built secondary share offers of the second andthird tranches of BT and National Power andPowergen in the early 1990s. They were book-builtoffers. They were secondary offers, as RBS andLloyds Banking Group would be, and equally highlymarketed—I don’t know if you remember MaureenLipman as Beattie on television, and that sort ofthing—with incentives for retail investors —bonusshares and so on. Fewer people took part, but becausethey were book-built offers, and built against the




market price of the shares, they were much moretightly priced, therefore people did not sell out in thesame sort of way. That is a valid option. That type ofsale is a valid option for UKFI and the Treasury toconsider as part of the mix of disposals.

Q52 Stewart Hosie: Mr Young, you spoke about anumber of sales over a period of time. I am going tobe very brief with these questions. Does that give methe impression that you would not want to see a bigbang, one-off disposal? That you would prefer to seethe disposal in a number of tranches?Adam Young: Given the amount of stock that is forsale in both of these two banks, in terms of absolutenumbers, it would be quite difficult to foresee theideal market conditions that would permit a big bangsale—as you put it—at a price that was acceptable, Isuspect—that is my gut feel. Having said that, in aGovernment privatisation programme, it is totallyconventional to have one or two of the disposals as avery large transaction in the middle. As Graham said,one can involve retail as part of that formula, maybeusing the Portman structure, maybe not. The key pointis that the very large sales tend to be possible onlywhen all the different risk elements are pointing in theright direction, so fund managers generally have cashto invest, retail investors generally have cash to invest,and the market outlook doesn’t look too bad so thereis some appetite to put more money in; from the pointof view of the performance of the two banks, thereturns are on the rise, the internal risks are seen tobe generally on the decline and one can project returnswith a bit more confidence. If all of those things cometogether, then those are the circumstances when onecan attempt a very large transaction, multi-billions ofpounds’ worth of offering.

Q53 Stewart Hosie: I understand that. You are rightthat everything needs to be pointing in the samedirection. In terms of doing it in tranches, whichseems the most likely thing to do, what would thebalance be? How many tranches would youanticipate? Is there space for a retail offering, whetherit was a straight sale or the Portman option? What sortof proportion would be on the retail side and whatwould be on an institutional placement?Adam Young: Can you remind me, the first part ofyour question was?Stewart Hosie: If it was to be done in tranches, whichseems likely—Adam Young: Yes, how many tranches?Stewart Hosie:—how many tranches would there beand how big would the retail offering be in amongthat?Adam Young: Just talking about general precedent, itis quite rare that one sees an individual transaction ofmore than £5 billion. Maybe you could stretch that, ifthe conditions were completely in line, to £6 or £7billion, but I don’t think you would really becontemplating transactions a lot larger than that.

Q54 Stewart Hosie: But that implies 10 tranches.Adam Young: That implies a lot of tranches for thesetwo banks.

You asked me a question about retail. The precedentfor mass retail equity offerings is that when they aredone and they are done with some intensity, meaningthat there is a publicity programme, an advertisingprogramme that accompanies the sale, then you canrely on between 40% and 60% of the overall offeringbeing accounted for by retail. The sorts of transactionsthat I would refer to as relevant precedents would bea very large sale that the Australian Government didin 2006 with Telstra their telecommunicationscompany, and also privatisation transactions, like theprivatisation of Electricité de France in 2005, so bothwithin reasonably recent memory.Stewart Hosie: Just one final question.Chair: With a quick answer, please.

Q55 Stewart Hosie: If there were these multipletranches, which took a significant amount of time,what does that do in terms of adding risk to peoplewho are further down the chain who want to buy asegment from a subsequent tranche, because marketconditions can change? What does it do in terms ofrisk? How would you weigh that, measure that, storethat?Adam Young: In terms of your retail offering, youdon’t want that to be the last trade you do. You wantthat to be one of the earlier trades that you do, whenthe risks are lowest and the growth is most evident.From the point of view of the latter trades, one canbe very much more opportunistic. Generally speaking,Governments will be very, very quick to markettransactions for the last tranches, quite often they canbe underwritten by banks at very short notice.Graham Webb: Can I just add to that?Chair: Very briefly.Graham Webb: No matter how many tranches youhave it is possible to have retail involvement in all ofthem. They don’t have to be the big all-singing, all-dancing set piece events, which we discussed earlier.They can be much more finely tuned to the sort ofquick offers, which—Chair: Okay.

Q56 Mr Ruffley: Mr Webb, you talked about thePortman Capital model and you said that there was alot more work to be done on it. Overall, it is quiteplausible, but one objection might be from theGovernment, which is that they don’t know when theyare going to get the money back. What otherobjections, technically, could you outline for theCommittee to the Portman Capital model?Graham Webb: Very briefly, there is one of scale.Clearly the scheme works best if you try to engage asmany people as possible in it. Similar transactions todate, in terms of involving people, have been about 8million; the demutualisation of Halifax BuildingSociety, that sort of scale. You might be talking aboutinvolving three or four times as many people if it wasincredibly popular. Having said that, there is nothingnew about the process, it is just a question ofupscaling everything.Secondly, there is time. We have talked about complexretail offers, which generally take about six months toorganise and are probably out in the public domain fora couple of months before pricing. With the Portman




scheme, again, because of the scale and some of theother novel features, I would expect that you wouldprobably have to be pressing the button to proceedwith it almost up to a year in advance, and the schemeitself might be out in the public domain for up to fiveor six months. In other words, it is very difficult tostop it and change your mind once you have started.There is a reputational risk there. The scheme has tobe made watertight. If it is seen to be easy to defraud,non-existent people signing up for it, or missingpeople out that deserve to be in it, that has to becombated.You mentioned the uncertainty in terms of timing ofreceipts. That actually implies that there has to be anequally rigorous and plausible plan for winding thescheme up. At the end of the day, you don’t want itactually extending out for decades as people just siton their shares and don’t get rid of them. Again, thathas to be worked through in a very plausible andrigorous way.None of those things are insurmountable. I wouldguess if I was sitting in the UKFI’s chair, their concernmight be the lead times because, as Adam hasmentioned, signalling what you are going to be doingto the market is not something that is generallybeneficial.Having said that, the structure of thePortman Scheme is supposed to be that by making theinstitutional offer the last institutional offer there willever be, that actually gets over some of these issues.It turns it into a sellers’ market rather than a buyers’market, if I can put it in banking terms.

Q57 Mark Garnier: Adam Young, Graham Webb,you have a lot of experience in this realm oftransaction, what do you think the fees would bechargeable on a disposal?Adam Young: Low.

Q58 Mark Garnier: How much? Either a percentageor an absolute value?Adam Young: Generally speaking, the fee scales onprivatisation transactions are a fraction of what yousee in the private sector.Mark Garnier: You are avoiding the answer.Adam Young: No. I am going to answer. For example,thinking of the very large Telstra offering thathappened in Australia in 2006, on which I worked,the fee for that was 0.5%. Even in America, on theGeneral Motors IPO that happened at the end of 2010,where normally fees are huge—

Q59 Mark Garnier: Corporate finance fees,underwriting fees, brokerage fees, clearing fees, legalfees. The whole lot. All of the fees have been comingin at 0.5%? You are saying that the entire fee scalewould be 0.5%, for everything?Adam Young: In that region.

Q60 Mark Garnier: It is still quite a lot of money.Adam Young: It is a lot of money.Chair: It is £250 million on £5 billion.Mark Garnier:£250 million you are looking at.Chair: On £5 billion.

Q61 Mark Garnier: On £5 billion, and this is, what,potentially a £45 billion transaction, potentially?Adam Young: But what I would say is that theGovernment will use the full force of its position toget every single investment bank to compete, and theywill compete on fees.

Q62 Chair: What, so they charge 249?Adam Young: Well, no, I—Chair: You would do it for 200, wouldn’t you?Adam Young: I would do it for 200.

Q63 Chair: It is a big demand facility, my underlyingpoint behind this actually is that there is a certainamount of friction between the wider public and theinvestment banking world.Adam Young: That is understood.

Q64 Chair: Here is a perfect opportunity for theinvestment banking world to demonstrate goodwill forthe wider public and offer to do a transaction like thisfor cost price, which would obviously not be £250million.Adam Young: Can I respond slightly differently? Ifyou are talking about a very large complex offeringwith lots of moving parts and lots of people involved,then maybe that 50 basis points is the sort of quantumthat that type of transaction might require. If you werelooking at something smaller in scale, and moreopportunistic in terms of the market execution, itwould be perfectly possible to get banks effectively tounderwrite scales for fees that are very, very slim basispoints. Effectively, they would take the risk off theGovernment for the block and take responsibility foron-selling it. On those sorts of transactions, those sortsof risk transactions, I am sure what UKFI will bedoing is getting banks to compete with each other tounderwrite—

Q65 Mark Garnier: Yes. For the non-risktransactions, though. Clearly you have some basecosts, but with the non-risk brokerage transactions, asopposed to the underwriting transactions, clearly thereis scope for actually doing it at cost price in order tobuy goodwill. Graham Webb, do you want tocomment on that?Graham Webb: Yes. In terms of retail tranches on pastprivatisations, the Treasury got itself into a positionwhere these were not underwritten by the investmentbanking syndicate, so the costs were entirely those ofdistributing the shares to the general public, andsimilarly I would guess that would be about 0.5%.

Q66 Chair: Thank you very much for enabling us toget down to brass tacks before we finish and discussfees. I want to ask, Mr Costello, if you would beprepared to flesh out the point you make—in writing,perhaps, to the Committee—the obvious point aboutthe confusion between the 50p and the 41p as thestrike price. The entry price that people should beusing as the base price for working out—Manus Costello: The entry price and the NationalAccounting price, absolutely.




Chair: Yes, that issue. That would be very helpful ifwe could have that unambiguously set out for us.

Examination of Witnesses

Witnesses: Robert Talbut, Chairman, Association of British Insurers, Keith Skeoch, Chief Executive, StandardLife, and Richard Buxton, Head of UK Equities, Schroders, gave evidence.

Q67 Chair: Thank you very much for coming to giveevidence to us this morning. How many of you holdshares in RBS or Lloyds? Perhaps I can just gothrough—all of you? Is that in tracker bonds becauseof their position in the FTSE 100 or from a moredirect choice?Richard Buxton: It is direct choice in our case. Wedon’t run tracker bonds.Robert Talbut: In my case I am here representing asingle institution, which is the Royal London. We holdthem as a passive. But I am also here as arepresentative of the ABI, who hold them both in anactive and passive nature.Keith Skeoch: It is a direct choice. We are an activemanager.

Q68 Chair: Have you been listening to the evidencethat has just been given about the depression of theshare price caused by the size of the Governmentownership? Do you all agree with that?Richard Buxton: I have listened to half of it.Chair: Do you agree with the half you heard? I wouldnot ask you to agree with the half you did not hear.Richard Buxton: I think it is one of the elements,but it is only one of many elements that affect theshare price.

Q69 Chair: Do all of you agree that if a way couldbe found of making UKFI demonstrably moreindependent of Government that in some way thatmight bolster the share price?Robert Talbut: That would be one positive, but ifmore of the shares of the two banks were to be inprivate hands I think that would similarly be taken asa good thing by the markets.

Q70 Chair: Is there agreement on that point by all?Keith Skeoch: There are two other issues that need tobe taken into account.

Q71 Chair: Before we just move onto those, are weagreeing with that point? That is the thing I am asking.Keith Skeoch: In terms of?Chair: The point was: if we could make UKFIdemonstrably more independent, would that itselfmake some contribution to dealing with the depressionin the share price, which you agreed a moment agois present.Keith Skeoch: It would make a modest difference. Ithink there are two other things that need to happenfor it to make a substantial difference.

Q72 Chair: Those are?Keith Skeoch: First of all, markets and share pricesare partly driven by sentiment, so tone is very, very

Thank you very much for coming. It was extremelyinteresting.

important, and the tone of course is set at a very highlevel. For understandable reasons, the tone has beenvery anti-bank. If that tone persists it will make quitea sharp difference on the price. I think the other—

Q73 Chair: So taxpayers are losing out because theyare bashing banks?Keith Skeoch: Yes, essentially.Chair: Your second point?Keith Skeoch: The quality and clarity about theregulatory environment, which you spoke about atlength. The clarity about the regulatory environment isincredibly important, and I think it is worth making—

Q74 Chair: We are talking about Vickers here,primarily, are we, or are we talking about Basel III?Keith Skeoch: A combination of both. I think the UKis seen to be slightly more strident in its views andthe timetable is seen as more stretching. It isnoticeable that that has an impact on other UK banks,relative to their international comparators not justsimply those with a certain danger.

Q75 Chair: So it is the whole sector?Keith Skeoch: Yes.Chair: It is not really a point directly on the UKFIpoint I asked, but it is useful to have anyway.

Q76 Mr Mudie: Just pushing a bit, the Chair did askabout UKFI. Where have you found a misguided tonefrom that organisation that sends the wrong messageto the City and the market?Keith Skeoch: I don’t think there was any—Mr Mudie: No, but that was the question youanswered with tone, and you gave it a different tone,and I find them incredibly independent of Governmentand this Committee, and I was wondering what theywere saying to you that they are not saying to us.Keith Skeoch: No. I was trying to make a differentpoint, that simply creating greater independence forUKFI would not make a significant fix, in terms ofthe impact on the share price. Tenor and tone, and theview taken by Government and society on theirattitude to the banks, as well as the issue about clarity,about regulation, those are two things that in order fora share price offer to be well taken and wellunderstood, they are two foundations for improvementin sentiment.

Q77 Mr Mudie: So the general public have to stopwhining, is that the tone? If you come north, and yousee the unemployment and the depressed communitiesand the bad future and the houses being repossessed,they have a right to. So to sell RBS we should startspeaking nicely about you?



15 May 2012 Robert Talbut, Keith Skeoch and Richard Buxton

Keith Skeoch: No, no, I think I am trying to make—

Q78 Mr Mudie: Don’t the banks in the Cityunderstand what the commercial banks have done toordinary people in this country?Keith Skeoch: As I said earlier, I believe the anger isunderstandable, but I think what we have, with thereturn of these stakes to the private sector, is asignificant opportunity to suggest that the process ofrepair, and being able to look forward, is beginning.Certainly our attitude, as a long-term shareholder, istrying to be supportive of management.

Q79 Mr Mudie: I think we all understand that, but Ithink with the ordinary person—if I can class myselfas an ordinary person, and I am—if there was any signthat the banking world accepted the blame, shared theblame, admitted to the blame and gave any indicationto the British public that they had changed their ways,you might get a better press. Moving away from that,what key indicators would you want to see to indicatethat RBS is ready for sale. There were two mentionedearlier: one was improved market conditions; the otherwas the removal of the DAS. Do you agree with thosetwo and are there any others?Keith Skeoch: I certainly agree with the removal ofthe DAS. Also, I think, to get an equitable treatmentbetween A and B shares would be a technical issue,so that any cash flows are available either fordividends for investors, or indeed to be reinvested tocreate a return. From an investor perspective, the mostcritical thing is that we can see the prospect of anattractive return for our investors and savers.

Q80 Mr Mudie: Mr Talbut, the RBS that is going tobe sold will be a different animal from the one beforeit was taken over. They have a different strategy andthey are placing less importance on the investmentside. Does that not militate against the Governmentgetting back the price they paid for it because, to mymind, they are selling something that is muchdiminished, probably, in terms of profit?Robert Talbut: We would take the view that thechange in strategy, which has been implemented bythe company, and is continuing to be implemented bythe company, is entirely appropriate, given the newenvironment in which banks are operating, the newregulatory environment.

Q81 Mr Mudie: No, it may be appropriate, MrTalbut, but does it affect the sale price in an adverseway?Robert Talbut: I don’t necessarily think that it does,no. We have to judge the share price against thestrategy that is now being implemented, withouttrying to take account of what the price was at somestage in the past.

Q82 Mr Mudie: Yes. What about you, Mr Buxton?Richard Buxton: Patience is the key to rewardinginvestment, and I think you could get back to makinga profit against the 41p if you are prepared to be verypatient. I completely agree that, in the Royal Bank’scase, you have to restructure the capital base, thedividend access there, the A and B shares and so on.

You have to get back to a situation where you can seethe prospect of dividends if not dividends themselves.But, yes, doing it over time, doing it in tranches, youraverage exit price over many, many years could wellbe above 41p.

Q83 John Thurso: Can I start with you, Mr Buxton,and come back to the question of the structure of thebalance sheet? We have already heard that thedividend access share is something of a deterrent. Youalso have the A, B structure. How important is it forthe shares to become a commodity worth purchasingfor the A, B share structure and the dividend accessto be sorted out to or to be clarified?Richard Buxton: It is important. I think Manus haswritten the definitive note explaining why you haveended up in a vicious circle rather than a virtuous one,and why, yes, the A shares will end up being dilutedin some means by a restructure in the capital base, butin a way that then could accelerate the process ofgetting to dividend payments and returns of capitalfrom the sales of, say, citizens down the line. I thinkit is really important in the Royal Bank’s case that thatis addressed, whether it is alongside coming out ofthe asset protection scheme this year or not. Lloyds isclearly a different animal.

Q84 John Thurso: To you as a buyer of shares, anowner at the moment, how much of a barrier is it toyou to the buying of further stakes? I put this to all ofyou. What I am trying to get a feel for is: are yousaying, “What we would really like is, but we willbuy them if it doesn’t happen” or, “Actually, guys, weare just not going to buy any more unless you sortthis out”?Richard Buxton: As I say, we already take intoaccount the potential dilution from a future sorting outof the capital structure, but when shares are lowenough, driven by sentiment, then we will continue toadd to positions. In effect, though, you need to beasking the people who aren’t in this room because weare all holders and we are in the minority. It is themajority of institutional investors who won’t touchthese things with a barge pole because of concernabout double dip; lack of regulatory clarity; it can’tsee a prospect of dividends and so on.

Q85 John Thurso: Would either of you like to addanything to that or is that pretty straightforward?Robert Talbut: All I would add is that as shareholderswe generally do not like investing in companies wherethere are differential positions between oneshareholder and another. It does not make a companyattractive.

Q86 John Thurso: So no investment in Facebookthen?Robert Talbut: Probably not. No.

Q87 John Thurso: Well done, you, by the way forthat. Sorry, completely off piste there.What about the asset protection scheme? To whatextent is it vital that RBS needs to exit before anyrealistic tranche of share sale can take place?




Richard Buxton: In that the asset protection schemewas put in place to guard against tail risks from amassive economic downturn, you have to get them outof the asset protection scheme as part and parcel ofthe, “Well, it is strong enough to stand on its own now,even against a very difficult economic environment, ina major double dip recession”. So it is important.Robert Talbut: Yes, I think it is a significant signal toeverybody outside that the company is emerging fromthe emergency ward.

Q88 John Thurso: So it is a core build of sentimentin the virtuous circle?Robert Talbut: I think that is right, yes.John Thurso: Okay. Thank you very much indeed.

Q89 Andrea Leadsom: Good morning. Jim O’Neil,who is Head of Market Investments at UKFI, has toldus that, “If investors feel that the banks are not beingrun in a commercial way, then that would reduce theirincentive to buy shares but also the price that theymight pay for shares”. Is it your view that RBS isbeing run in a commercial way, Mr Talbut?Robert Talbut: I think it is being run not in an entirelycommercial way. It is quite clear, through evidenceover the last 12 months or so, that the company is stillsusceptible to being seen as a political football, whentimes get tough or when difficult decisions are beingreached or when the company are attempting to makecalls that could affect, say, employment orrestructuring or the strategy of the group goingforward, so I think that perception is there. I think itis a reasonable one. Within some of those constraintsthe management are trying to run it as best they canwith a realisation that there are still going to be someconstraints when there is a single shareholder whoowns over 80% of the shares.

Q90 Andrea Leadsom: Mr Skeoch, would youagree?Keith Skeoch: I would agree with most of that. I thinkmanagement are trying to run the bank in acommercial way in the most extraordinarily difficultcircumstances, both in political, and indeed—we findourselves—in very strained economic circumstancesas well. Their attempt to turn round their core bookof business and the commercials is verycommendable, and the progress they are making withthe disposals of so called non-core assets acquired byprevious managements is moving along quite nicely,given the underlying conditions.

Q91 Andrea Leadsom: Mr Buxton, would you saythat it could be the non-commerciality of the way inwhich RBS is being run that reflects in the weakershare price?Richard Buxton: No. I would agree with mycolleagues that the entirely new senior management ofthe Royal Bank of Scotland, post-collapse, are doing afantastic job of trying to manage the business backinto a sensible shape and to generate returns on equitythat will ultimately lead to dividends for shareholders.If we are tiptoeing around the elephant in the room ofHester’s bonus, that is clearly an issue that is one thatbecame a political football. The man was invited to

do this job. He is doing it extremely well. The bankis deleveraging. It is making progress, but there is apolitical sensitivity that means that at present he can’tbe paid a commercial rate for that job.

Q92 Andrea Leadsom: Mr Talbut, would you saythat Stephen Hester’s bonus has reduced investorconfidence in the commerciality of RBS? What I amtrying to get at is, do you think that in some way theGovernment ownership is acting as a drag on RBSshare performance?Robert Talbut: The simple answer to your lastquestion is yes. The overhang or the presence of asingle Government shareholder owning over 80% ofthe shares is an inhibiting factor on other commercialorganisations wanting to own shares in the company.

Q93 Andrea Leadsom: Mr Skeoch, would you saythat the row over Stephen Hester’s bonus hasworsened that? In a sense, has that arguably meantthat investor confidence in RBS has been damaged bythe fact that there has been a public row over StephenHester’s bonus that has resulted in him not being ableto take it?Keith Skeoch: By and large that is correct, and I thinkit has had knock-on effects about the extent of debateand, as I said earlier, on the tenor and tone forsentiment. If you are looking to generate an attractivereturn, one of the things investors are trying to do ina very difficult world is look for things that they canattach some degree of certainty to. Anything thatcreates a degree of uncertainty, whether it is theregulatory framework or indeed the stability of asenior management team, inevitably increasesuncertainty and depresses sentiment and, therefore,has a depressing impact on the share price.

Q94 Andrea Leadsom: That is a very interestingpoint. Mr Buxton, I was going to ask to what extentis it the fact that Stephen Hester did not get his bonusand therefore people might question his commitment,versus the fact that there is seen to be politicalinvolvement in the question over bonuses that leadspeople to think maybe there is political involvementin other issues to do with running the bank. Is it aboutthe incentivisation of the individual to perform or is itabout the political involvement that has a negativeimpact?Chair: I have to ask you for a brief reply.Richard Buxton: I think the two are completelyinterlinked, is a brief reply.

Q95 Andrea Leadsom: Mr Talbut, would you addto that?Robert Talbut: Yes, I would agree with that. The onlyaddition I would make is that I think the ability toretain a commercial management team, over themedium and longer term, is going to be significantlyinhibited if they do not believe that they can be paida commercial rate.Andrea Leadsom: One question about Lloyds then,if I may.Chair: If you can be very quick.




Q96 Andrea Leadsom: This is slightly off the saleof Lloyds. Do you think that it was right that Lloydswas allowed to choose which 600 branches it wasgoing to sell or should those have been chosen for it,as is the case in other countries? In other words, doyou think that the purchaser is going to find reasonsto buy those branches or will they have been cherry-picked to be the worst?Chair: If you want time to reflect on that question,take it and come back to us in writing, unless youhave an answer now.Keith Skeoch: I think it is appropriate because I thinkit is a decision for the board of Lloyds that we are allshareholders in. One of the things that connects it withthe previous question is the ability of management toexecute a board’s chosen strategy and, of course, theboard are our representatives.Chair: Anything anybody else wants quickly to add?No?

Q97 Mr Love: Mr Talbut, given all the challengesthat you have spoken about so far, and the regulatoryuncertainty, is there any realistic possibility that theGovernment will make a profit out of the sale ofthese shares?Robert Talbut: My personal view on that one is thatit is unlikely in the short to medium term. One of theabiding lessons that you are taught in investment,when you first enter the field, is that the price at whichyou sell a share should have no relation at all to theprice at which you originally bought it, that is, youshould not be hung up about the price that you boughtinto a particular investment. That you should alwaysevaluate what the prospects are for a share at the pointat which you decide either you are going to stick oryou are going to twist. That would be exactly the samewith Lloyds. For me, it is a case of not necessarilythinking about what the in price was, I am simplyinterested now in the prospect of appreciation of theshare price from where we are today. But the simpleanswer is it is unlikely that the Government will seea profit in the foreseeable future.

Q98 Mr Love: Let me press you on that, becausewhen the Government purchased these shares it wasconsidered a depressed market. The share price hadgone down considerably. There was almost anautomatic assumption that when the share marketconditions returned to something more approachingnormal that the share price would go up. That doesn’tappear now to be what you are suggesting. Are we totake it that the restructuring issues, the ownershipissue makes it not attractive to investors at the presenttime? What can we do, other than the issues that youhave touched upon so far, to make these banks moreattractive to the investor market?Robert Talbut: If we could all hope for a muchstronger fundamental economic background, I thinkthat would help all banks, RBS and Lloyds certainly.The prospects economically have turned out to bemuch more subdued than was envisaged was going tobe the case at the time at which the stakes werebought, so I think there was an expectation theeconomy would bounce back quite strongly, assetprices would bounce back quite strongly, and

therefore there was a prospect of some form of returnon the entry. I think economic prospects have been farworse. The uncertainties about the regulatory outlookare more significant, and therefore the prospects aremuch more diminished in terms of us being able toachieve a return.

Q99 Mr Love: Mr Buxton, you wanted to respondbut I will add a question to your response. Do we needto wait for a return to a level of profitability that willmake an investor market more interested in payingwhat would be a profitable price for the shares?Richard Buxton: In the short term, you are not goingto make a profit, but I am a bit more optimistic thaton a five-year view you will be able to make a profit.As I say, on average over a series of tranches you canmake a profit because, accepting that the world haschanged, the regulatory background has very muchchanged from the entry price. Nevertheless, providedthese banks can get back to making a genuine returnon equity above their cost of capital and with a capitalbase that is more secure and with an ability to paydividends, you will be able to exit these banks I thinkat a profit, over time.The steps—in terms of getting back to profitability—I think they are making good progress on that. It isdifferent with Lloyds and Royal Bank. Royal Bankhas probably made more progress in terms of reducingthe size of its balance sheet and taking greater losses.It is less susceptible to a significant double dip thanLloyds. Lloyds are more susceptible to that, but theyhave made substantial progress on bad debt write-offs.In both cases, the formation of new non-performingloans has fallen away to very low levels, but there isstill a large outstanding stock of non-performingloans, so patience is a tremendous virtue here. Youonly have to look out to 2013, 2014, if the pace ofdeleveraging and taking losses continues at the currentrate then you could get back to something that ismaking an attractive return on equity and whereinvestors will be much more interested in investing.

Q100 Mr Love: Mr Skeoch, RBS have a five yearplan—I think it is—to divest some of the assets thatthey had taken on prior to the credit crunch. There isthe return to profitability that we have talked aboutthat may take some considerable time. Is there aconsensus among the three of you about how long theforeseeable future is, how long we have to be patientbefore we begin to realise the sorts of level of sharesale price that would return a profit?Keith Skeoch: There are two questions there. I thinkthe precise timing of when the prospect of a profitcomes into visibility is exceptionally difficult, becauseit will depend on market conditions at the time. I agreewith Mr Buxton that patience would be a great virtueand, if you can look out on a time horizon of fiveyears plus, there is every chance that there will notonly be a profit made but the prospect of a substantialand attractive return for the Exchequer and thetaxpayer, certainly one that is much more attractivethan today.

Q101 Mr Love: Are we talking about significantly inexcess of five years before we would be looking at




the foreseeable future, if the Government decided thatit had to realise at least not a loss on the sale ofthese shares?Richard Buxton: I think five years is appropriate.

Q102 Mr Love: Five years is appropriate, youwouldn’t disagree with that. Can I just ask finally—Chair: A brief reply, please.Mr Love: The share price is currently stuck around30p. There is a very small market in RBS sharesparticularly. Are they connected in any way, and is theshare price depressed for other reasons than the onesthat we have talked about this morning?Richard Buxton: No, I don’t think there is a fear of asmall share price in an absolute sense and there ishundreds of millions of Royal Bank turnover everyday, but it is all the issues that have been discussedalready. It is regulatory backdrop. It is ensuring thereis no major double dip and that, therefore, progress isbeing made on profitability. In Royal Bank’s case, itis the capital structure.Chair: Anything others want to add to that list thathas not already been added?Robert Talbut: No.

Q103 Mr McFadden: There has been a slightdifference in emphasis in your evidence comparedwith our first session this morning. I just want toexplore this issue of price and timing. The Abu Dhabisovereign wealth fund was recently reported as havingexpressed interest in taking out a sizeable stake in thebank. In answer to Mr Love, you were talking aboutfive years being a reasonable timescale. How thenwould you view an early sale of a significant stake inthe bank to a sovereign wealth fund like that? Wouldthat be important, in terms of establishing confidencethat big private sector investors were prepared to stepinto this field, or does that look like an unwise thingto do, because it would be sold significantly below theentry price that the taxpayer paid? I will start withyou, Mr Buxton.Richard Buxton: A sovereign wealth fund might havea role to play if there was the pursuit of—in particular,in Royal Bank’s case—this change in the capitalstructure, and perhaps they had an appetite for aninstrument like a convertible security that theconventional marketplace isn’t yet ready to take. Asale of straight equity to a sovereign wealth fund, Iwould personally be disappointed to see because Isuspect they would just be in it to make a lot of moneyfor themselves.

Q104 Mr McFadden: Isn’t that what any investoris doing?Richard Buxton: Absolutely. As I say, if you areprepared to be patient you don’t need to give theExchequer’s money to a sovereign wealth fund, youcan actually retain it over time and make that moneyback.

Q105 Mr McFadden: Can you just explain to theCommittee—forgive my ignorance—this issue aboutconvertible security, exactly what that is and why thatcomes into play more than a sovereign wealth fundin—

Richard Buxton: Yes. CoCo is convertible securitiescontingent capital. It is something for which as yetthere is not really a fully developed market amonginstitutional investors, let alone retail investors.However, some sovereign wealth funds are preparedto commit to that type of capital, which could form apart of the restructuring of the A and B shares, thedividend access scheme and so on. They may have aunique role to play in taking a part of a capitalstructure that the conventional bond or equity marketsare not keen to pursue as yet because it is a fairlynew market.

Q106 Mr McFadden: Mr Talbut, what do you thinkof this idea of a sovereign wealth fund?Robert Talbut: I would probably take a slightlynuanced different view from Richard. We would beunhappy if a single investor were to be invested in atpreferential terms to other shareholders. If that wereto be part of a sale that was wider than a singleinvestor, that might be seen as interesting, in terms ofattracting in another private sector organisation. Butin terms of some form of sweetheart deal, we wouldfind that very unattractive and we wouldn’t see that asbeing in the best interests of investors generally, orthe company.Keith Skeoch: I take a slightly different approach,given the strained circumstances they find themselvesin. Providing, first, the sale was of Government Bshares rather than the issue of new stock; and,secondly, that it was associated in some way with theremoval of the dividend scheme, or removal from theAPS, it could be seen as helpful. Most importantly,however, is that there was a commitment that thestrategic investor was going to be a long- term holder;strategic and long-term as opposed to a large holder,and I think the two are very, very different indeed. Ifit is perceived to be a long-term value play, it couldbe helpful in setting the ball rolling.

Q107 Mr McFadden: I want to clarify the view onthis, which Mr Mudie referred to earlier. TheGovernment bought these shares, on behalf of ourconstituents, at an average price of about 50p. It hasnever approached that price since and they are tradingsignificantly below that. As a current investor andpotentially a bigger investor, is it your view that wewould be better to sit tight and wait for RBS tocontinue with the path of change that it is taking toget back to that price, so that our constituents get theirmoney back or, because of the capital structure, whichwe have heard about today, these shares, the dividendaccess shares and so on, the deal with a sovereignwealth fund to get rid of these obstacles might actuallybe worth doing now?Keith Skeoch: It depends on the initial price. I mustsay, as a long term investor, my natural dispositionis—as Richard Buxton said—to be patient and makesure that full value accrues for the scale of theinvestment that was put in place. Given the strainedcircumstances, providing it was seen as kick-start, andalso it was an investor that would support acommercial board and a commercial executive, itmight be a good way of getting things moving. Itwould depend on the circumstances.




Q108 Mr McFadden: Finally, Mr Talbut and MrBuxton, I am taking your initial answers as saying youare in a bit of a different position on that, and that youare more in the hope that the taxpayer should sit it outand wait for Stephen Hester and his team to get thebank back into shape?Richard Buxton: I think that would be preferable.There is an element in which, perhaps specifically inRoyal Bank’s case, through an instrument that couldform part of the capital restructuring, a sovereignwealth fund might be appropriate. I completelyendorse Keith’s point: it has to be long term andstrategic. One is mindful of the fact that the sovereignwealth fund that supported Barclays capital-raisingclaimed it was going to be long term and supportive,and sold it very swiftly at a profit. Your constituentswould learn about that: I as a taxpayer don’t want toread a headline saying, “Sovereign wealth bought abig stake at 25p and sold it five years later at 50p”,when if we had sat there and been patient we couldhave sold it at 50p.Robert Talbut: Very briefly, my view is that I believe,yes, very firmly in the idea of patience. I believe weare looking at something like five years in terms ofrehabilitation, but I don’t necessarily think that itmeans five years before any stock could be sold intothe marketplace, into the private market.

Q109 Mr Ruffley: Just one question for each of youto answer; the same question. In the highways andbyways of Westminster, there is speculation that RBSmight be broken up prior to any sale, and the reasonthat might be a good idea is to engender greatercompetition. These are very ill-formed speculations.Could I just ask each of you, as market players,whether you have heard of anything that sounds viablein terms of breaking up RBS prior to a share sale?Richard Buxton: It has already been broken up by theEU, in terms of forced disposals of—Mr Ruffley: No. Over and beyond what we alreadyknow.Richard Buxton: I think we need to wait and see theconclusion of the Verde Lloyds disposal first, becausethat genuinely tests the appetite for the creation ofseparate or bigger banking entities and greatercompetition. I am not hearing rumours or discussionsof any magnitude about this, but I think it would bedetrimental to the taxpayer to enforce any break up.As the investment banker said—about the only thingI agreed with him on—demergers are verycomplicated and they do not always add value. Youare replicating head offices and HR functions and soon, which is why banks tend to consolidate and merge.I think the best value for the taxpayer will be allowingHester and the team to manage the existing business.Of course, in the fullness of time, it is highly likelythey will sell their US business but the longer weleave it the better price we will get, et cetera.Robert Talbut: I have a lot of sympathy with thatview, but I think continuing speculation about furtherbreak-up of the company is unhelpful in terms of theshare price, and is unhelpful in terms of themanagement’s ability to be able to commercially runthe organisation.

Q110 Mr Ruffley: I understand that. It is clear whatthe detriment might be from the taxpayer’s point ofview, but in terms of challenger banks, morecompetition, driving down prices for the consumer, interms of the propositions you have heard of furtherbreak-up, is it just mere speculation or do you actuallyhave in your mind, or have you been told, what afurther break-up of RBS might entail?Richard Buxton: Northern Rock was a challengerbank, HBOS was a challenger bank. There is noevidence that challenger banks end up being bettermanaged and being good for the consumer. Theyhelped get us into this mess.Robert Talbut: The only other point I would make issimply that I am unconvinced that there is a plethoraof other organisations out there desperate to get intothe UK retail market.Keith Skeoch: I am not aware of anything, and Icertainly haven’t come across anything that I wouldbelieve was in any way credible.

Q111 Mark Garnier: Getting back to the PortmanCapital suggestion of essentially distributing shareswith a face price, which I am sure you are familiarwith. Robert Peston has said that his guess is that theCity establishment will view the Portman Capitalproposal to distribute shares in RBS and Lloyds to thetaxpayer as “naive and impractical”. Do any of youagree with that? Free money for the taxpayer, what doyou think? Do they not understand it?Richard Buxton: I don’t know about naive. Whetherit is impractical or incredibly complicated and quiteexpensive, I think it is certainly those.Chair: It is quite bad.

Q112 Mark Garnier: On the subject of fees, I don’tknow if you were at the evidence session a bit earlier,but it was obviously the sell side of the marketplace,they were saying the fees would be 50 basis pointsacross the piece for any sort of distribution ortransaction. In your experience on the buying sidewhat do you usually expect to be paid forunderwriting of an issue?Richard Buxton: We are very happy to takesignificantly lower underwriting fees than very oftenthe investment banks claim that we—

Q113 Mark Garnier: They are taking their slice,aren’t they? You are not getting the whole of it, youare just sub-underwriting them, but you are taking allthe risk and they are sucking out some of that fee,aren’t they?Richard Buxton: Yes. But, as I say, the aggregate fee,the bit that they sub to us, is higher than it need bebecause we would take less, particularly for anexisting shareholding organisation.

Q114 Mark Garnier: What would you do, though—privatisation—what would you expect to be paid forunderwriting, as a sub-underwriter?Richard Buxton: I am not going to give a figure, butI am going to say—Mark Garnier: Go on, be a devil.




Richard Buxton: No, I am not. But I am going to saythat there have been two reports, both the Vickersreport and the report into underwriting practices,which have concluded that this is not a competitivemarket.Mark Garnier: Yes, that is right.Richard Buxton: But we are not going to do anythingabout it—

Q115 Chair: Maybe it is time we took a look at thesewholesale markets, don’t you think?Richard Buxton: Yes, because it is up to us, asinstitutional shareholders, to force companies to biddown the price. We spend our time constantly tryingto get companies to bid down the price of theinvestment banking underwriting fees, et al, and theysay, “Well, actually, we only ever do one capitalraising as a chief executive or finance director, and sofrankly it is not our money. It is the shareholders’money. We want the deal to go ahead”. We bang ourheads against a brick wall trying to get investmentbanking fees and underwriting fees down. However,there have been transactions in the last three years,where the institutional investors have played a moreactive role earlier in the process and been quiteprepared to take a much lower level of underwritingfee and, funnily enough, the investment banks aren’twild about it.

Q116 Mark Garnier: Do you think if this transactionwere to go ahead in one form or another, it would beone where the investment community would be quite

strong and unified in terms of driving down thoseunderwriting fees?Richard Buxton: If all the stars have aligned in theway that we have talked for the past two hours, thenyes.

Q117 Mark Garnier: Do you all agree with that?Keith Skeoch: Yes.Robert Talbut: Yes. I would agree with that, certainly.There would be plenty of opportunity for a lot ofcommunication between the company and prospectiveshareholders, and I am sure we could reach a veryamicable arrangement.

Q118 Mark Garnier: Cut out the middle man sothey would not get a lead underwriting fee?Richard Buxton: Cut the middle man amounts downto as thin an amount as possible.Robert Talbut: Which is commensurate with the taskthey actually do.Keith Skeoch: Yes, so maximum transparency andclarity.Mark Garnier: So one basis point maximum, maybe.Message received and understood.Chair: We will come back to you for some moreadvice on how to get these markets more competitive,yes, and we would want the advice to be free, asMichael has pointed out. Thank you very much forcoming to give evidence today. It has been extremelyhelpful to us and we really appreciate it, as we did thefirst panel.

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Written evidence

Written evidence submitted by Autonomous

The Treatment of RBS and Lloyds in the National Accounts

Under Eurostat guidance, the initial recapitalisations were treated as financial transactions considered to takeplace at the market price. Any excess payment above the market price at the time of purchase was recorded asa capital transfer. In effect, the government recognised a day one loss reflecting an unrequited payment to theprivate sector each time shares were purchased at above the market price. This excess was recognised as apermanent impact on the national accounts and so has already been reflected in the government’s preferrednational debt measures (which exclude the non-permanent impact of transactions related to the financial crisis).

The effect of this treatment is that the stakes are carried at the weighted average of the market prices fromthe days on which the shares were purchased, rather than at the actual prices paid. This carrying amount doesnot now vary with the market price and it is not written down regardless of any objective signs of impairment.

Taking RBS as an example (Table 1), this means that the shares are carried in the national accounts at aprice of 41p. For Lloyds (Table 2), the shares are booked in the national accounts at 61p (versus the 74paverage in price).

Table

UK GOVERNMENT INVESTMENT IN RBS

Market price on day of Paid price (“in-£ purchase price”)

Initial recapitalisation Dec 2008 55p 66pPref. share conversion Apr 2009 30p 32pAPS B shares Dec 2009 38p 50pWeighted average 41p 50p

Source: Bloomberg, Autonomous

Table

UK GOVERNMENT INVESTMENT IN LLOYDS

Market price on day of£ purchase Paid price (“in- price”)

Initial recapitalisation Jan 2009 132p 183pPref share conversion Jun 2009 66p 38pRights issue Dec 2009 59p 37pWeighted average 61p 74p

Source: Bloomberg, Autonomous

Upon sale, the impact of the transactions becomes permanent and so the difference between the sale priceand the carrying amount (not the in-price) would immediately impact the stock of national debt. For example,if RBS were sold for 35p, the incremental impact on the national debt would be based on a 6p loss (thedifference between the 41p carrying value and the 35p sale price).

However this difference would only be recognised for the amount sold; a tranched sale program would notlead to the residual stake being revalued.

It should also be noted that there is an ongoing cost associated with carrying the stakes in terms of the giltinterest paid to finance the holdings. To the extent that any sale generated cash to reduce the stock of debt, thiswould generate ongoing savings.

The detailed impacts on each of the national debt measures are summarised in Table 3.

Table

SUMMARY OF ACCOUNTING TREATMENT

PSNB1 PSNB ex2 PSND3 PSND ex4 Carrying value

Initial treatment Excess payment above MV Full cost Excess cost MV on date ofincluded in the relevant quarter included above MV purchase(capital transfer) included

Subsequent No change; the holding is not remarked or impaired MV from date oftreatment purchase

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PSNB1 PSNB ex2 PSND3 PSND ex4 Carrying value

Sale treatment No direct impact unless sold The full difference between For any residualbelow MV; indirect benefit initial transaction and sale holding, BV remainspost-sale in the form of prices is included (permanent the MV from date ofreduced borrowing effect), offset by cumulative purchaserequirements savings from reduced

borrowing

Source: ONS, Autonomous(1) net borrowing, reflecting the difference between income and expense in a period;(2) net borrowing ex. non-permanent impacts;(3) net debt, reflecting the stock of debt at a point in time; and(4) net debt ex. non-permanent impacts.

May 2012

Written evidence submitted by Standard Life

The European Commission state aid paper (http://ec.europa.eu/eu law/state aids/comp-2009/n428–09.pdf) setout the divestment commitments of Lloyds Banking Group relating to the state aid. These were subsequentlysupported by the ICB report in September 2011.

It was appropriate for Lloyds’ management (as our representatives) to draft a detailed proposal on whichassets it should divest within the stipulations given by the European Commission. This proposal would havebeen thoroughly scrutinised by the UK authorities and European Commission before being agreed.

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