Interim Results 2014 Part 1

In Rates, volumes fell by 22 per cent with persistently low interest rates making clients less keen to hedge. Margins also fell, so income fell by 33 per cent, or $181 million. Most of this is cyclical, a result of the interest rate environment. However, longer-tenor, more complex derivatives face more of a structural challenge, given the impact of margining and capital requirements for non-centrally cleared derivatives. We are not immune to these changes, and areas such as hedging for project finance have been hit quite hard, but most of our business comprises relatively short-dated hedging for corporate clients off the back of trade or other commercial finance. According to Asia Risk Rankings, we are number one in corporate derivatives in Asia.

Our response to the challenges we face in Financial Markets reflect the mix of cyclical and structural factors, and the fact that even with this depressed performance, Financial Markets still produces a return on capital above the average for the Group as a whole. Financial Markets costs are down. Productivity is up.  We are shifting resources from the areas most affected by structural change towards the client-driven flow businesses that play to our strengths and that we are confident will bounce back.

Korea

Alongside Financial Markets, Korea was the other big challenge in the first half of 2014. Korea made a loss of $127 million, a $264 million decrease year-on-year. As we have said before, there is no 'silver bullet' in Korea. Turning this business around will take time and a lot of work on multiple fronts, not least because the industry as a whole faces huge challenges.

We are making progress. We have announced the sale of our consumer finance and savings bank businesses. This will have some negative impact on income, but the benefits in terms of costs, headcount, loan impairment and capital will more than offset this. We continue to take action on costs. Headcount is down around 9 per cent year-on-year. The branch network is down by 47 outlets, or 13 per cent year-on-year.

We continue to de-risk the balance sheet, tightening underwriting criteria for unsecured Retail lending and exiting third-party sales channels. As a result, our unsecured credit card and personal loan balances are down 10 per cent on a constant currency basis in the first half of 2014. While filings under Korea's Personal Debt Rehabilitation Scheme remain elevated, we have seen noticeably fewer filings from loans written in the last six months. 

Our actions to reshape the business have had a negative impact on this year's performance. De-risking and withdrawal from direct sales has hit income. Costs in the first half include $32 million of Special Retirement Plan expenses. Performance in the first half of this year has also been hit by lower principal finance gains and generally weak trading conditions, particularly in Financial Markets.

We continue to build business with Korean companies elsewhere in the network. This income, which is not included in our Korea numbers, amounted to about $100 million in the first half of 2014 and generates very attractive returns. With the recent announcement of renminbi (RMB) clearing and exchange in Seoul, we see a significant opportunity to leverage our distinctive capabilities in this arena. Just under 2 per cent of Korea's exports to China are currently settled in RMB and just under 1 per cent of imports. With China now settling more than 15 per cent of its global trade value in RMB, this is a considerable growth opportunity. 

There is no quick fix for Korea, but we are making progress, and we are determined to get this business into better shape: more focused, more efficient and delivering better returns.

Opportunities in our markets

Financial Markets and Korea accounted for much of the profit shortfall in the first half of 2014. However, we remain confident in the strong growth of the opportunities across our markets and in our ability to make the most of them.

Our markets across Asia, Africa and the Middle East are continuing to grow rapidly, and demand for financial services is growing faster than GDP. To make the most of this opportunity we have set out five aspirations, and to make us more effective in delivering against these aspirations, we have reorganised the Group around our key client segments - Corporate & Institutional, Commercial & Private Banking and Retail. Although the new organisation has only been in effect for four months, it is making a difference in how we look at our business and how we serve our clients.

Corporate & Institutional Clients

The Corporate & Institutional segment generates around 60 per cent of total income. This is the core of what used to be called Wholesale Banking. In the first half of 2014, profits were down 17 per cent year-on-year, largely due to lower Financial Markets income as well as an increase in impairment.

In this segment, we are focused on building ever deeper relationships with our clients, concentrating on our core commercial banking capabilities and putting even greater emphasis on our strengths as a network bank, providing seamless support to our clients as they trade and invest across borders. Network income comprises over half of total client income.

Our market position remains very strong. We are a top two global trade bank as measured by SWIFT messages, and our market share is stable. According to East & Partners latest survey, we are not just number one in transaction banking relationships in Asia, but strengthening our lead. This is despite the actions we have taken to cut back on low-yielding RWA. 

We have a very full agenda for this client segment, including deepening relationships, optimising return on capital and doing more with institutional investors. We are also working harder to leverage the relationships we have with these clients for the benefit of the Group as a whole: introducing owners and senior managers to our Private Banking offering and providing employee banking solutions through our Retail segment.

Commercial & Private Banking Clients

The Commercial and Private Banking Clients segment group has only existed since April 2014.

Commercial Clients combines the smallest, or middle-market, clients from our old Wholesale Banking business with the Medium Enterprise clients from our old SME business. There are about 50,000 clients in total with 90 per cent of the income from the top nine markets. This new segment has started life with a sharp drop in profit, down 61 per cent or $261 million. About 40 per cent of this is due to lower principal finance income. We had profitable realisations in the first half of 2013, valuation losses in the first half of 2014. Another 20 per cent is due to lower Financial Markets income, and higher loan impairment, mainly in Hong Kong and Korea, accounted for around another 20 per cent.

Despite this somewhat difficult start, we are enormously excited about the potential for the Commercial Client segment. Mid-sized companies play a huge role in the economies in which we operate, and represent a significant portion of the total banking wallet. However, we have never given this segment the focus it deserves. Our immediate priority is to bring together the teams, rationalising and standardising processes, such as credit and client due diligence. We are refining the product offering and delivery model and working together with the Corporate & Institutional segment to develop supply chain solutions that turn us from being a provider of finance to being a business partner that enhances supply chains, efficiency and resilience. 

Our commercial clients are largely family-owned businesses, and the families are a perfect fit for Private Banking. However, many, perhaps most, are not aware that it exists. So we are making introductions, doing joint meetings, showing clients how we can support them. To put this in context, we believe the private banking wallet of our existing Commercial Client base is about four times the size of our current Private Banking business. While relatively small in the scheme of the Group as a whole, Private Banking will become an increasingly important source of growth. With assets under management up 13 per cent year-on-year, net new money up 15 per cent, and income up 4 per cent, despite exiting subscale presences in Miami, Geneva, and Korea, Private Banking has good momentum.

Retail Clients

On a global basis, income from Retail is down 2 per cent and profits down 9 per cent. Excluding Korea, income is up 1 per cent and profits are up 12 per cent. In a number of key markets, Retail is doing well. For example, in Hong Kong income is up 10 per cent and profits up 16 per cent, in Singapore, income is up 3 per cent and profits up 57 per cent, and in Africa income is up 14 per cent and profits up 42 per cent.

We are assertively re-shaping this business:

·     Tackling Korea

·     Redeploying resources towards the high-value segments

·     Accelerating the shift from product sales to relationship management.

·     Disposing of subscale and non-strategic  franchises

·     Refocusing the product offering

·     Standardising platforms and processes

·     Reshaping the branch network as we increasingly engage with our clients via digital channels

We are transforming Retail to be more relationship-driven, more selective, more efficient and more digital. This is a big, multi-year project, and in the near term, some of things we are doing - de-risking, disposals, exiting direct sales - will impact income momentum, but we know where we want to get to and we are making real progress.

Building relationships with our clients

Our client segment strategies are the primary drivers of our overall strategy. We are focused on who our clients are, what they need, and how we can be distinctive in meeting those needs.

Underpinning this is a huge amount of work on products and infrastructure. There is a lot going on in Transaction Banking, particularly around the internationalisation of the RMB, in Wealth Management, particularly in Bancassurance, in Corporate Finance where we are seeing a good pipeline of deals, and in Retail Products, where digitisation is the overriding theme.

We are also revamping our infrastructure, rolling out standardised platforms and processes, automating manual procedures, reinforcing controls, deploying tools to enable us to extract more value from the vast amounts of information we generate and capture every day. Through technology-driven innovation, we can empower our clients, achieve significant improvements in efficiency and run our business with greater insight, flexibility and control.

All this comes together in an overarching roadmap, essentially the execution plan to deliver the strategy. Three themes from this roadmap are worth highlighting.

Investing for growth

The first theme is investment. We recognise that to create the capacity to invest for growth, we have to be relentless in driving cost productivity and capital productivity.

On the cost front the challenge is clear. People account for almost 70 per cent of our costs, and wage inflation is running at 4 to 5 per cent across our markets, so that alone drives at least a 3 per cent increase in total costs. Regulatory-related costs continue to increase at pace and we think it is safe to assume that regulation will add 1 to 2 per cent to total costs every year. Add in some non-wage inflation - particularly true of premises costs given real estate price trends in our markets - and there is an underlying cost dynamic of at least 5 per cent per year, before taking account of current year business growth, let alone investment for future growth.

We must therefore achieve a continuous stream of sustainable productivity improvements to offset these cost headwinds. This is not about short-term squeezes, cutting back marketing, or freezing hiring, since this kind of cost reduction cannot be sustained. This is about disposing or shrinking underperforming businesses, cutting out complexity and duplication, automating everything we can automate and rolling out scalable platforms and processes. It is what we have been doing - costs only increased by 1 per cent last year, and only increased by 1 per cent  in the first half of 2014 versus the same period of 2013, but given the pressures we are facing, we are redoubling our focus on costs and productivity.

We are not abandoning growth. Delivering sustainable and profitable growth is how we will drive shareholder value, but to deliver that growth requires investment and creating capacity for that investment requires a relentless focus on productivity improvement. 

The logic is absolutely the same on capital. By managing the underlying business to be capital accretive we create the capacity to absorb regulatory add-ons and fund growth. Excluding two one-off regulatory adjustments to our Basel III Common Equity Tier 1 calculations, the Group was capital accretive in the first half of 2014, adding some 20 basis points in the period.

Conduct

We are committing very significant resources to raising the bar on conduct - new people and capabilities, new systems and extensive training. We see this as an integral part of our strategy, a key component of what it means to be Here for good.

We recognise that this is no easy task. There are multiple dimensions to conduct - from protecting clients' data to maintaining market integrity and preventing financial crime. All are important, but they are very different. Some are about making sure we do the right thing for our clients, and some about playing our role in protecting the integrity of the financial system by ensuring our clients do the right thing. And raising the bar on conduct only works if it is embraced by everyone in the Group. One person who doesn't act responsibly can undo the work of thousands who do.

Consistent and effective execution is vital, and we acknowledge that sometimes we have failed to meet our own and others' expectations. Getting to where we want to be is a multi-year project requiring sustained investment and focus. That is why we are implementing a comprehensive programme of change. Specifically, in financial crime compliance we have added senior expertise and doubled overall headcount. We have established a Board-level Financial Crime Risk Oversight Committee, and are executing a far-reaching Financial Crime Risk Mitigation Programme. We have embedded consideration of financial crime risks into our strategic decision-making and, as a result, are undertaking extensive de-risking actions across the business.

Internationalisation of the renminbi

Finally, the third theme is the internationalisation of the RMB, one of the biggest changes taking place in the way the global financial system works. This is the mechanism by which China, which will become the world's largest economy, will ultimately link its financial system to global markets. It is happening at an extraordinary pace and Standard Chartered is superbly placed to facilitate and benefit from this process, so across all our segments and product groups we are taking advantage of this massive shift in the way money flows around the world.

Outlook

2014 will be challenging. We are taking action on multiple fronts, both in response to near-term pressures and to execute the refreshed strategy we have set out. In the first half, for example, we have completely reorganised the Group, made a number of disposals, re-worked our segment strategies, and redirected capital and investment spend. Some of the things we have done have exacerbated the immediate performance challenge, but they are the right thing to do in reshaping the business for sustainable growth.

Our objective is getting back to a trajectory of sustainable, profitable growth, delivering returns above the cost of capital and turning the opportunities in our markets, the strength of our balance sheet, and the depth and quality of our client franchise into sustained shareholder value creation.

We know it won't be smooth or easy. Disciplined, focused execution will be critical, and in that context I would like to take this opportunity to thank the people of Standard Chartered for their professionalism, commitment and teamwork. And to thank our shareholders for their support.

Peter Sands

Group Chief Executive

6 August 2014